Asset Management Q&A
Q: We are buying a let property and I am concerned that the service charge regime has been poorly run by the current owners. To what extent can we deal with this in the purchase contract?
A: On the acquisition of a multi-let investment property, the contract will usually provide for a service charge reconciliation to take place, typically within two or three months of completion. The seller is obliged to provide finalised accounts and the service charge expenses and receipts are then balanced against each other. If there is a surplus, this is then paid over to the buyer. Where there is a shortfall, usually the buyer will seek to collect it from the tenants and pay it to the seller.
To the extent there are any voids or service charge caps applicable to the current service charge year, the buyer will want to ensure that the seller is obliged to top up the service charge account prior to completion. This will prevent the buyer from losing out come the reconciliation, where there would otherwise be a shortfall.
Where there are current arrears due from tenants, it is possible that the seller will top up the service charge account and be credited as and when arrears are recovered, but often it is just left as part of a shortfall.
The reconciliation will often not take place until several weeks after completion, so a buyer may wish to seek a float from the seller to tide it over, particularly where significant items of service charge expenditure are expected. The float can then be factored into and closed off as part of the reconciliation.
Arrears for past years
Where there are arrears still outstanding in respect of past service charge years, it is often agreed that the buyer will seek to recover the arrears from the relevant tenants after completion and account to the seller for any monies recovered. This means the risk of non-payment remains with the seller.
A less common option is for the buyer to purchase the arrears from the seller, so assuming the risk of non-recovery. This may occur where the seller wishes to wash its hands of the property following the sale, provided of course that the buyer is willing to accept this position. Where the arrears are the subject of a dispute (more likely where the service charge regime has been poorly run in the past), the buyer may agree to acquire the arrears for less than face value to allow room for it to agree a reduced figure with the relevant tenant. Exactly how much less will depend on the nature and merit of the dispute.
Alternatively, if there is little chance of recovery the seller may be willing to pass the benefit of the arrears to the buyer and essentially write off its claim to them.
Closing previous years
Where accounts for prior service charge years have not yet been finalised, it will not be clear whether the tenants owe a balancing payment or alternatively are due a refund (or credit) as a result of their on-account payments exceeding what has been spent.
Since the seller will have the information required to finalise the accounts, the buyer should look to require the seller to close past years as soon as possible and by a fixed date – ideally before completion. The buyer can then ensure that, to the extent the tenants are due a refund (or a credit), the seller pays this into the service charge account before completion. Once the property has been sold, it will be much harder to get the seller or its managing agents to close the accounts or provide the buyer with the missing information to enable it to do so.
Provision of information
Often, where the service charge has been badly managed, the information and records provided to the buyer will be poor or incomplete. Since the buyer will be responsible for finalising the accounts for the current service charge year, it will want to ensure that the missing information is identified and provided by the seller, ideally before completion. There will doubtless be an ongoing obligation for information to be provided.
Sanctions for non-compliance
To the extent that the seller is unwilling or unable to commit to resolving one of the above issues by completion, buyers should consider whether it is possible to include enforcement provisions in the contract, such as a price retention or liquidated damages, to focus the seller's attention on the issue.
— Forsters Real Estate (@ForstersCRE) March 20, 2017