Service charges in the retirement sector explained
Integrated Retirement Community (IRC) operators like others in the retirement sector, offer a range of different approaches to service and service charges. Here we look at some of those approaches.
The traditional residential leasehold (for sale) sector approach to a landlord recovering the cost of services provided from its tenants is for the landlord to pass down the actual costs incurred, with the tenants each paying an appropriate share. These are known as variable service charges. This model is regulated by the Landlord and Tenant Act 1985 (the 1985 Act) which defines a service charge as:
… an amount payable by a tenant of a dwelling as part of or in addition to the rent—
- which is payable, directly or indirectly, for services, repairs, maintenance, improvements or insurance or the landlord's costs of management, and
- the whole or part of which varies or may vary according to the relevant costs.
If the 1985 Act applies, it imposes obligations on IRC and other retirement operators as landlords. For example, costs must be reasonably incurred, works or services must be to a reasonable standard, tenants must be consulted on certain kinds of contracts for services and prior to the carrying out of certain works, some operators must hold service charge monies on trust, and there are time limits and other statutory formalities for making demands for payment.
Ultimately, the requirements are completely manageable provided appropriate procedures are put in place (after all, the vast majority of leasehold property in England is operated in this way). However, the obligations are prescriptive and can trip over the unwary, with potentially significant limitations on the recovery of costs incurred. It's really important to know in advance if a structure is likely to fall into the regime or not, long before operations commence.
Offering a fixed service charge is increasingly common in IRC and some other retirement settings, where customers are often particularly sensitive to the price fluctuations which variable service charges can lead to.
Fixed can be a slightly misleading word as the charges don’t have to be fully fixed. Fixed is often equated to mean anything that is not a variable service charge as described above. This could mean fixed completely and for the full term of a lease or tenancy – but that's not a common model given the erosionary impact of inflation. More usually (with long leases anyway) is a fixed and indexed charge. There are many and varied approaches to indexation in the retirement sector. A couple of common ones are to index annually or to index on each resale so that each individual customer has their own completely fixed charge while they own the unit. Indices could be RPI, CPI, wage cost inflation or any other independently verifiable index, or a mixture of two or more of these.
Fixed service charges are not subject to the 1985 Act requirements. Even though they might vary (by way of indexation), it is not by reference to the landlord's actual costs of delivering the services. Having said that, there are risks, when balancing risk mitigations around cost divergence into an operating model, which could inadvertently bring the 1985 Act into play. There is also some slightly conflicting caselaw in this area, so it all requires careful thought and documentation.
Substance over form
It's worth noting that any charging structure which meets the variable service charge definition above will be a service charge regulated under the 1985 Act. Some operators prefer to give their periodic charges a different name e.g. a monthly management fee. The name won't change the outcome, what is actually happening will dictate whether the 1985 Act applies.
It's also worth noting that for rented accommodation the position is generally different – rents in a build to rent or private rented setting would generally be inclusive of service charges, so the tenant would generally just pay a single sum as rent and the landlord would meet the cost of providing any services from that sum. However, there are some rental models which more usually include a separate variable service charge, especially in the social housing sector, and there is no legal reason why a rental model cannot include a separate fixed or variable service charge.
Utilities and other occupier costs
Whether rented or long leasehold, in most cases the tenant would still pay their "direct" costs such as council tax and phone/internet charges to the relevant statutory authority or supplier (although again there is nothing stopping a landlord from charging tenancy rents inclusive of these). Utilities costs would be covered the same way traditionally, although the advent of communal heating systems has seen an increase in mixed structures where the landlord is in effect the utility supplier and so the utility costs can be metered (which is in effect a variable service charge) or fixed (or form part of an inclusive tenancy rent). Where the landlord intends to re-charge communal heating costs on the basis of actual consumption within the property, it is essential that this is properly documented.
Making room for flexibility
As well as the overall structuring of the service charge it's important to consider the need to adapt over time. Where the 1985 Act applies, the service charge is a pass-through cost to the tenants and so, if more or fewer services are provided, the service charge will go up or down. That arguably provides a degree of built-in protection for tenants, but they will still expect the promised range of services to be provided per the terms of their lease or tenancy and will have remedies if that doesn’t happen. For fixed service charges the service charge remains the same whatever services are provided but again they too will expect to receive all the promised services. In either structure it's highly important to strike the right balance between the extent of the promises made to occupiers and, the amount of flexibility the operator has to reduce or discontinue services that are not being used and to change what uses the communal spaces are put to. This will mean the operator can flex the service offer over time to be as attractive to existing and potential new customers as possible without breaching their obligations to occupiers. It is likely to be impossible to keep everyone happy when change happens, so it's important to have the right levers to make them even if a minority may not want it.
The remedies available to tenants if they wish to challenge services delivered under a fixed service charge are different to those available under the 1985 Act. With variable service charges, the tenant can apply to the First Tier Tribunal which is in principle a no cost forum – costs orders are only made against a "losing" party by the Tribunal on the basis of unreasonable conduct. The Tribunal does not have jurisdiction outside of variable service charge models but tenants would still have the usual rights to bring a Court claim for breach of the lease if the matter cannot be otherwise resolved. Tenants may also be able to complain to the Association of Residential Managing Agents (ARMA) or one of the formal redress schemes (the Housing Ombudsman, the Property Ombudsman, the incoming New Homes or the Property Redress Scheme) - if the operator is a member. ARCO members will be required to be members of one of these.
Although there is currently no regulation of service charges unless the 1985 Act applies, it could well be that fixed/indexed service charge structures will become subject to some form of regulation in the future. This seems potentially more likely than ever given the significant Government intervention into the wider leasehold sector, with ground rents banned and proposals that leasehold houses are too, and statutory rights to manage, extend leases and enfranchise all proposed to be made simpler in ways which favour end-users. While that may not be the same kind of regulation as applies under the 1985 Act, because the issues would be different where the leaseholder's charges are not directly linked to the cost of what is provided, operators would still need to consider and adapt to any new law.
How we can help
We are experts in structuring service charges in IRC and other retirement settings, whether variable or fixed and whether or not interfacing with an event fee model. We can guide you through the available options to fully appraise the possibilities.
We also have extensive experience of advising on service charge management issues and dispute resolution across the residential market and within the IRC and wider retirement sector and can help you effectively manage specific issues and make changes to your service models which are legally compliant.