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Service Charge - The Hidden Rent

For many occupiers, 2010 - 2011 has been a time for consolidation and scrutiny of all costs, including accommodation and general running costs. The obvious outgoing to look at, after salaries, is occupational costs.

Pamela Gray, our Partner in charge of Commercial Asset Management, says that this has led to much soul searching with office tenants. Many of the larger corporate and professional operators expanded in the mid 2000s, acquiring spacious, open plan offices, in Grade A buildings, and happily paying headline rents which, in today's market, are excessive. Many of these companies have found that their businesses have retracted in the last five years and with a pro rata reduction in employees, the result is, in some cases, a massive fixed overhead, much of which is surplus to requirements. However, that is also only part of the story.

The service charge, being the additional cost paid by tenants in multi-let buildings for landlords to run the common services of the building, have in some cases virtually doubled over the five years since the initial lettings. In the boom times, tenants tended to be rather blas about this additional cost to the business, but in more straightened times, this charge, which in many instances has risen without check, has added an additional rent in some cases of up to 30% to the already exorbitant headline rents under the leases.

Pamela says that tenants are starting to sit up and notice particularly the larger occupiers where a service charge of say 6.50 psf applied to 50,000 sq ft adds a further 325,000 to the annual rent bill.

To take an example, this means that in Edinburgh City Centre, there are a significant number of tenants occupying space of say 50,000 sq ft, where the rent and service charge costs are well over 1.5 million per annum - BEFORE rates and other overheads are taken into account.

Tenants are now starting to fight back. Gone are the days when they would simply pay lip service to an audit of the landlords proposed budget for next year's expenditure and automatically accept the increased level proposed. Now tenants are, quite rightly, challenging every single item on the budget schedule to ensure they are obtaining:

  • Value for money at all times;
  • Evidence of appropriate planned maintenance by the landlords over the term of their lease;
  • An audit of expenditure and non acceptance where deemed inappropriate.

Some tenants are even undertaking their own separate audits to ensure that what they are being told is correct and fair.

Pamela acts for a number of large space occupiers in the Edinburgh city centre and in one case alone, the saving she has secured for a client from simply challenging these costs, is close to 100,000 per annum. After all, we are talking about the tenants' own money here and it is absurd to think that many occupiers don't realise that this can and should be interrogated regularly, to ensure that costs are being conserved / reduced wherever possible, but obviously never at the expense of the efficient running of the building.

It is important that tenants step up to the plate and ensure landlords are working to secure maximum efficiencies on their behalf. This not only conserves overall occupational costs, but if regarded in a positive way by landlords, this should be a good way to engender a good landlord tenant working relationship.

Also, no landlord worth their salt wants their building to get a name for being expensive to run, as this will ultimately affect the demand and hence the likely rent achievable on new lettings.

Service charge is as much an issue for landlords as it is for tenants because most landlords know how important it is to keep their tenants happy in a challenging market place.

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