Service Charges in Commercial Property Explained

Whether you’re a landlord or tenant, it’s important to understand what a service charge in commercial property is - and how it works.

What are service charges on commercial property?

Service charges are additional costs paid by the tenant on top of rent. These charges cover the landlord’s expenses for maintaining and managing shared areas and services within a property. 

Service charge requirements can vary significantly depending on the type and size of the property. Smaller units may have minimal or no service charges, while larger office blocks, retail centres, or mixed-use developments typically involve higher charges due to the increased upkeep of shared facilities.

What do service charges cover?

Service charges in commercial property leases are often negotiated to suit both tenant and landlord's needs. Service charges could cover:

• Cleaning and repair work of common areas.
• External maintenance (e.g. landscaping, paths and access roads).
• Repairs and maintenance of the building's structure.
• Heating, lighting and electricity for shared spaces.
• Lift maintenance and operation.
• Health and safety compliance (e.g. fire extinguisher checks).
• Security and risk assessments (e.g. fire safety inspections).
• Insurance for common parts.

On top of any specific services specified within the lease, a provision is usually included to allow the landlord to deliver any additional services they deem necessary. Tenants typically seek to limit this clause by requiring any additional services to be "reasonable," preventing landlords from undertaking extensive or unnecessary works without justification.

According to the RICS 2018 Professional Statement, so-called ‘catch-all’ clauses should not be used to offer protection for services omitted during drafting. Instead, landlords should ensure that the scope of services is clearly and comprehensively defined from the outset.

While tenant’s (especially in larger commercial developments) may have limited negotiating power, they will typically want landlords to be contractually obligated to undertake core services, such as building maintenance and the upkeep of shared utilities and systems.

Example costs that tenants may want to be excluded from service charges include:

• Lost income from unlet units.
• Costs related to the landlord’s investment interests (e.g. letting fees, rent collection).
• Costs resulting from structural defects.
• Landlord or managing agent negligence.
• Development costs that exceed standard maintenance or repair.
• Costs associated with improving energy efficiency.

How are commercial property service charges calculated?

The lease should clearly state how service charges in commercial property are calculated and allocated. Charges must be fair, transparent and proportionate - landlords must not profit from tenants’ contributions.

Service charges may be:

• Equally apportioned among all tenants; or
• Weighted according to usage - e.g. tenants on upper floors may contribute more towards lift maintenance. 

Common methods for apportioning service charges include:

• Fixed annual figure - Suitable for short-term leases with predictable service needs.
• Landlord’s discretion - Based on what the landlord considers “fair”, but this can lead to disputes due to subjectivity. 

Regardless of the method used, landlords should provide tenants with a full apportionment matrix, clearly detailing how charges are calculated.

How are commercial service charges paid?

Before each service year begins, the landlord should issue a service charge estimate, including an explanatory breakdown and the apportionment matrix. Tenants are typically required to pay this estimated amount in advance (either monthly or quarterly).

At the end of the service charge year:

• The landlord reconciles actual costs against the budgeted estimate.
• A service charge statement is provided to tenants - usually within four months.
• Underpayments must be paid by the tenant.
• Overpayments may be credited toward the following year’s service charges or refunded if the lease is ending.

Most tenants prefer for end-of-year service charge accounts to be certified or audited by an independent accountant to ensure accuracy and accountability.

FAQs

Can service charges be capped? 

Yes, service  charges can be capped. However, tenants should be aware that these caps often rise annually in line with the Retail Prices Index (RPI) or a similar inflation measure.

Is a service charge mandatory?

Service charges are mandatory when specified in a lease agreement. They are a standard part of most commercial property leases and are used to ensure shared facilities are property managed and maintained.