For a tenant, the trouble with service charges is that they are variable in name, variable in nature and variable in the time they hit the tenant’s accounts.
It is getting worse. But for the property industry, they are big business. A recent study done by Loughborough University Business School estimated the service charge market to be £3.25bn in 2001. Later government data on the stock of commercial office space (ODPM, 2004) enables this estimate to be increased through £3.39bn in 2002, £3.54bn in 2003 to £3.59bn in 2004.
For several years, Jones Lang LaSalle’s Office OSCAR service charge study has provided an analysis of an alternative sample of buildings every year. This estimates average notional costs per sq ft grouped into a small number of broad cost groups. Until recently, this data has been all that is available.
The Loughborough study used a similar cluster sample but looked at the same buildings over several years and was based on real costs. These costs were then examined for patterns and used to measure performance. Tenants do not pay notional costs, so they need guidelines to check their actual costs.
Service charges vary with area
An analysis of the actual cost per sq ft has revealed that cost per sq ft is a meaningful ratio. In other words, the service charge costs seem to vary linearly with the area of a building. This means that there are no economies of scale. If anything, the reverse is true. Less than 5% of the variability in costs per sq ft is explained by area.
Furthermore, the cost per sq ft is not symmetrical about its average, so the average cost per sq ft is not very representative and hence not very useful to real tenants who pay the actual costs. They do not pay average costs so they deserve better guidelines against which to check their service charges.
The Loughborough study suggests a meaningful classification of real costs along with warning and action limits for actual costs per sq ft that are robust over time, as well as warning and action limits for the more important cost groups.
However, the data is not easily available in the absence of a nationally agreed cost classification, a central database of real costs per sq ft and an enforceable code of practice, let alone legal requirements. Rents are tightly controlled but service charges are the added, and sometimes hidden, costs of being a tenant.
Services charges are:
●described by lawyers drawing up the lease;
● incurred by building managers;
● paid for by accountants; and
● allocated to tenants by managing agents.
The business term for this is “not joined up”.
The first piece of information a tenant hopes to receive is the budget statement, which sets out the expected service charges for the next period. This allows the tenant to plan his or her budgets for the next period.
However, the Loughborough study reveals that no budgets for the sample buildings arrived more than three months before the period in question started and at least 45% arrived after it had started, with at least 13% arriving more than one year late. How can a tenant plan its cash flow in the light of such haphazard data provision?
This suggests that the industry needs more regulation – or at least an implemented code of practice.
Once the period is over, the tenant expects to receive a cost certificate. This is a reconciliation of the costs incurred and payments on account and allows the tenants to match actual costs with actual activity.
But our study reveals that at least 25% of all the certificates examined for the sample buildings arrived more than a year after the period in question had ended and at least 10% arrived more than two years late. This suggests that tenants need more up-to-date information. The current code of practice is not compulsory and not implemented in any obvious way.
Incidentally, budgets are not only late – they are also unpredictable, in that some are overestimates of actual costs and some are underestimates. Tenants need more accurate information than this. When a tenant receives a budget statement or cost certificate, the description and breakdown of those costs should be useful and allow some comparisons to be made.
However, every managing agent has a different attitude towards clarity. Certificates and budgets use a vast array of cost descriptions and sometimes use them inconsistently.
Use terms in a consistent way
In the Loughborough studies, over 230 different cost descriptions (a sample of the most used description appears in the table opposite, along with the number of times respondents used the description) were used and even a term such as “management fees” appeared on only 90% of budget/certificate documents. Tenants should be able to compare their charges with those in other buildings. To do this, they need a cost classification to group similar costs and allow comparisons.
The study shows the 10 most popular cost groups (see table, right). The costs in these popular groups can be analysed for higher-than-expected values.
Certificates reveal actual costs and these can be used to derive costs per sq ft.
Our research reveals that these vary widely and that most of this variability is not explained by location, size of building, air-conditioning, VAT or, indeed, the passage of time over the five years of the main study or the seven years of the extended study. So, even if a tenant has some data on average costs, there is no guidance on how much higher than the average is acceptable.
Indeed, the averages are of limited use owing to the lack of symmetry of cost per sq ft over the sample and are affected badly by extreme values. Tenants need ways of looking at their actual costs per sq ft which help them to monitor expenditure. The Office Oscar analysis suggested that average service charges had not changed. This is probably true but the updated study reveals that the middle 50% is more widely spread, so the tenant still needs some action and warning limits.
The Loughborough study shows that the median as a measure of centrality is more robust over time and can provide tenants with meaningful warnings and quartiles, and therefore meaningful action limits if they wish to investigate their costs per sq ft.
The five-year study produced a monitoring limit of £4.70 per sq ft. A certificate above this should be monitored over time. It also produced an action limit of £7.10 per sq ft. A certificate above this level should be immediately investigated. The new data for the same buildings revealed a similar warning limit of £4.76 per sq ft but the upper limit was higher at £7.45 per sq ft. The lower quartile was lower.
This means that the middle 50% of certificates is more widely spread than before – in other words, the variability in cost per sq ft is getting worse, and that using the original action limits would now involve 30% rather than 25% of certificates. This suggests such action limits are even more urgently required.
Dr John R Calvert is resources and systems director at Loughborough University Business School
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How to make service charges more transparent |
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● There should be a national code of practice with a kitemark to ensure tenants can demand timely and reasonably accurate information on future costs and timely information on actual costs incurred. ● There should be a nationally agreed cost classification, based on the Occupiers Property Databank (see box below), which all managing agents use to clarify the costs described. ●The industry should set up a feasibility study into establishing a central database of service charge data that can be used to provide national guidelines for warning and action limits for actual service charges. |
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Source: Loughborough University |
