Service Charge Seminar 2019 Over the last three years we have seen - - PowerPoint PPT Presentation

Service Charge Seminar 2019

“Over the last three years we have seen an increase in service charges of 20% and these continued increases are simply not acceptable, particularly in the absence of strenuous efforts by landlords to work collaboratively with us to reduce these costs”, John Lewis Statement as reported by the BBC

Talk to us about exercising control over your lease expenses……….

• Service Charges – Management for Occupiers
• Insurance – Check & Challenge
• Tenant Recovery & Service Charge Management
• Lease Expense Management
• Lease Expense Auditing
• Building Consultancy

Todays Contributions…

• Isabel Owen, Director of Assure - Our Data & Some Current Issues
• Lee Mason, Managing Director of Assure – Why did we commission this research?
• Professor Andrew Holt & David Barrass – The UK’s Top 60 - Research Findings
• Lee Mason, Managing Director of Assure – Challenges and What Next?
• Questions & Answers
• Drinks Reception

Our Data – Powered by Verivi

• Our in-house developed Database – software engineers constantly refining and

improving;

• Access to huge resource of information;
• Bespoke Reporting and Research;
• Assure Index

• A quarterly updated review of trends

in Service Charges budgets;

Budgets issued up to July 2020 compared to the last budget issued

• Measures changes across four main
• ccupier sectors over the last 12

month period

The Assure Index

The Assure Index

Our Data – Powered by Verivi

• Service Charge Caps can offer certainty….
• Index linked, RPI/CPI (collar/cap?), overall

total cap or £ per sqft;

• Review of clients lease terms found : -
• Overall Cap – 16%
• Marketing Cap – 11%
• Management Fees Cap – 40%
• Assure can advice on benchmark costs.

Our Data – Powered by Verivi

• RICS Code Mandatory Requirement –

‘any service charge that has been raised incorrectly should be adjusted to reflect the error without undue delay’.

• Track progress of dispute resolution;
• Easy to predict that the higher sums

take longer to resolve, BUT they aren’t always complicated issues;

• Even simple factual errors <£5,000

take on average over 4 months to correct.

Voids/Landlord Cap Shortfalls – a recent example

• When we first received this

Budget, we thought ‘what good news’! This Landlord must really be listening to their occupiers…

Voids/Landlord Cap Shortfalls – a recent example

• We even took to

social media to share the occasion!

• But there were doubters
• ut there….

• Four clients in this scheme = 13.5% of the occupiers;
• On closer inspection of our client lease terms : -
• 23% of the Scheme is vacant, so the Landlord is the biggest occupier by far (next biggest is 9.75%);

1 x closed and vacating 1 x short term licence 1 x capped at a low level 1 x all inclusive rent……

Voids/Landlord Cap Shortfalls – a recent example

• There was a real, active interest being shown in reducing costs;
• BUT what consideration was given to the occupiers open and trading and still requiring a

decent level of services??;

• Watch out for re-allocations and re-apportionments based on ‘use’ and a real cut back in

services, which may damage trade....

Voids/Landlord Cap Shortfalls – a recent example

Why did we Commission this Research?

Lee Mason, Managing Director Assure Consulting If you can’t measure, you can’t manage It’s Clear and Accurate ….and on time

What’s Happening to Service Costs?

• The Assure Index is showing that Service Charge

Growth is beginning to fall into line with Inflation (RPI is currently 2.6% and CPI is 1.7%) having sat above it for some time, especially in the larger schemes.

• Across the UK’s Top 60, increases have exceeded

inflation – why?

• Perhaps we can identify the main contributors.
• It’s not as simple as that…….

Your Major Work spend seems to be a series of round numbers adding up to £900,000, can we have some detail? We looked more closely and there were errors but the final number was correct and it was underspent - here’s some detail The breakdown includes Service Contract Overheads of £162,244 – please explain The ‘Overhead’ is apportioned throughout the Budget based on the % of the budget within the relevant cost centre So, what is the total ‘Overhead’ and what does it relate to? £453,230 and it covers Central Mgmt, Office Space, Shared Services AP, AR, Credit Control Should this form part of the Management Fee? The Management Fee is charged separately but I acknowledge your view

This is where it all goes wrong!

• Flawed Benchmarking
• Can’t measure, can’t manage
• Lack of Transparency
• Management Fee Caps Breached

We felt the need to take a closer look….

Retail Service Charges 2019 Research Initiative Project Report – Oct 2019

• Dr. Andrew Holt

Professor of Accounting aholt7@msudenver.edu 303 641 8308 David Barrass DMB Consultancy david.barrass@me.com

Assure 2019 Retail Service Charge Initiative

• Based on Industry Service Charge data – powered by Assure “Verivi”

Top 60 National Shopping Centers by cost – Certificates & Budgets

• Supplemented by sample lease data
• Conducted by Professor Andrew Holt, MSU Denver

& David Barrass BSc Hons, ACMI

• Timescale – Undertaken 2nd to 4thQ 2019
• Results 8th October 2019 – Assure Industry Seminar @ RICS
• Objective Outcomes:

Cost metrics – principle drivers, trends, areas for action Compliance status Examples of best practice – areas of excellence?? Benchmarking – costs & compliance, ongoing reporting Conclusions & Action Plan – Clients, Assure, Industry

Top 60 Centre Data Acquisition Metrics

Calendar Year to 31st December 2016 2017 2018 Actuals 60 56* 19 Budgets 60 60 60 Service Char arge Do Documents Received & Analysed St Status as as at t 30 30 April il 20 2019 19

* 58 as at 30th June 2019

Top 60 Centre Service Charge Data Metrics 2018 Budget

• Total annual budget cost - £426.5 million per annum
• Total retail area – 54.3 million SqFt
• National geographic spread
• Unit service charge costs - £7.85/SqFt Average
• Main 2018 cost lines:

Cleaning/Refuse £96.6m per annum Management & Site Resources £86.0m per annum M&E/Repairs £80.0m per annum Security £69.5m per annum Marketing £46.2m per annum Landlords Contribution (£20.7m) Major works £40.2m per annum Utilities £35.8m per annum Income and interest credited

(£10.6m) per annum

• Provision for auditing - £308.9k total - £5.1k per Centre!!

Variability in Overall Service Charge £/SqFt Costs Merits Further Understanding

2 4 6 8 10 12 14 16 1,000,000 2,000,000 3,000,000 Service Charge (£/SqFt) Centre Size SqFt Impact of Centre Size on Service Charge Costs £/SqFt

Underlyin ing Upward Pressure

• n
• n Unit

it Cos

• sts:

Repairs & Renewals – Extension of Centre Age Wages - Increases in UK Living Wage Financial Reporting – Extension of Accrual Accounting

6.00 6.50 7.00 7.50 8.00 8.50 9.00 2016 2017 2018

Average Service Charge (£/SqFt0

UK Top 60 Shopping Centres 3 Year Average Service Charge Cost Trends (£/SqFt

Budget Actual

* 2018 – 19 Actuals

• f 60 in Sample

Aging Stock

• f Major UK

Shopping Centres

10,000,000 20,000,000 30,000,000 40,000,000 50,000,000 60,000,000 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Cumulative Centre Area (SqFt) Year of Opening

Growth in UK Shopping Centres

Current Average Age = 29.4 Years

But No Clear Impact on Overall £/SqFt Costs?

0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 10 20 30 40 50 60 70

2018 Service CXharge {£/SqFt} Centre Age {Years}

Impact of Centre Age on Service Charge Costs £/SqFt

Evidence of Ongoing Expenditure on Major Works

500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 4,000,000 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000

Annual Centre Expenditure. (£) Annual Service Charge Budget {£}

Current Plans For Major Works Where Disclosed £43million Cumulative in 2019

Marketing is a Clear Strategic Priority …But Unexplained Variability in Spend??

Note: 49 Centres - Excludes Marketing Spend in Tenant Associations

1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 5 10 15 20 25 30 35

Annual Service Charge Budget (£M) Millions

Gross 2018 Marketing Spend (£) Versus Shopping Centre Annual Service Charge Budget (£M)

Findings So Far Costs, Benchmarks Beacons

• Further work needed on Cost Leader “Beacons” to

reach valid conclusions

• No clear relationship – Unit Costs with Size or Age
• Little evidence of cost innovation through time
• Variable Marketing spend & impact – extend scope

to include Tenants Association spend?

• Further cost research would be beneficial –

relationship with service delivery {major service lines}

• Objective - evidence based service charge cost

priorities

Top 60 Centre Transparency

• f Financial

Data

Number of RICS Code Compliant Documents 2016 2017 2018 Actuals 12 {20%} 8 {14.3%} 5 {26.3%} Budgets 7 {11.7%} 11 {18.3%} 13 {21.7%}

Tim imelin iness of

• f Key

y Fin Finan ancial l Do Documents: St Status As s At 30 30 April il 20 2019 19

Average Days to Start/End Period 2016 2017 2018 Actuals (Target<120) 220 189 178 Budgets (Target<-30) 37 11 (2)

Governance & Compliance

Date Development of Professional Guidance for Commercial Service Charges 2000

Guide to Good Practice Working Party – Service Charges in Commercial Properties – A Guide to Good Practice, 2nd ed.

2006

RICS - Service Charges in Commercial Property

2011

RICS, Service Charges in Commercial Property

2014

RICS, Service Charges in Commercial Property ICAEW, Accountants’ Reports on Commercial Service Charge Accounts: Technical Release: 11/13BL

2018

RICS, Service Charges in Commercial Property: Professional Statement – 1st Edition

Reg egulatory gui uidance in n pla place, but but adv advancement of

• f

be best pr practic ice sti till ll a a con

• ncern:

Potential conflict with the lease - to what extent have RICS requirements been incorporated within modern lease provisions?

Accruals

“Expenses incurred in a period for which no invoice has been received at the period end” “An estimate of a liability that is not supported by an invoice or a request for payment at the time the accounts for the period are prepared” When is an accrual, really an accrual? A health warning from the RICS (2018, p. 51):

“Large round sum provisions included to spread the cost of significant works over a period of time are not accruals as they as they do not represent a liability at the end of the period. Accordingly, they should not be included as accruals”.

• Detailed examination of 60 most recent (2017/18) certificates
• Accrual accounting used at 38 Centre accounts
• Impossible to determine accounting basis and/or extent of the

accrued amounts at 22 centres

• Accruals adjustments are material (5 - 30% of expenditure)
• Other findings:
• Opening and end-of-period balance sheets absent
• Disclosure notes vary in detail and clarity
• 2 qualified audit opinions given for inappropriate accrued amounts – no

restated certificates yet issued in either case

• Impact of Landlord forward funding
• Lease provisions/permissions??
• Many certificates still include unexplained ”provisions” and/or

fail to explain accrual adjustments made….

Evidence of Significant Use of Accruals

Note: Initial Assessment of 38 Centres

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00% 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000

% Total Certified Expenditure Annual Service Charge Budget {£}

Preliminary Result - {38 Centres} Percentage of Actual Annual Service Charge Which Is Accrued Expenditure

Findings, Accounting Issues

• Preparation of future service charge accounts –

cash or accruals??

• Explanation of budgetary principles – cash or accruals
• Funds, Accruals & Major Works - lease compliance

Balance Sheet = full control & transparency?

• Year to Date Performance? Rolling forecasts, rather than

periodic budgets?

• Purpose of Audit:-

Assurance?? Compliance with lease provisions? Compliance with service contracts? Compliance RICS Code/regulatory? Costs offer value for money?

• Lease “final & binding” provisions
• Sign-off process and certification statement varies – who

should sign? What do leases require?

• NB Current provision for auditing - £308.9k total - £5.1k

per Centre!!

Findings, Research

• Clear need for further applied research to identify

accounting practices and problem areas.

• Research is a USP – costs & service delivery
• Consider ongoing tailored research??
• Cost benchmarks
• Disclosure standards/accounting
• Renewals/major works
• Governance & Compliance
• Resourcing? budget? funding mechanism??

Leases, the Code, and incorporating best practice

• A prediction from the RICS (2006, p. i):

“The current trends…show that leases are now being granted for shorter

• terms. Consequently, the opportunities and challenges for all

[stakeholders], either when renewing existing or agreeing new leases, are to ensure that the agreed documents adhere to this Code and thus promulgate best practice. Given the prevalence of shorter lease terms the constraints on the delivery of this Code will quickly fall away”.

• Lack of adoption of the 2017 BPF’s MCL template
• Further research is needed in this area!
• Holt and Eccles (2019) “Leases as Inhibitors of Best Practice in Service Charge

Management”, Property Management, Vol. 37, No. 2.

• Findings from scrutiny of SC provisions within 60 leases
• Only 5 referred to a need to comply with the RICS Code
• Often deviate from RICS best practice recommendations
• Huge degree of variability in specificity, presentation, clarity, and

understandability

• Silent on many aspects of the accounting process
• No lease specified whether accounts must be prepared on a cash or accrual

basis

• 43/60 specifically allowed occupiers to inspect the vouchers and accounting
• records. What are the rights of occupiers at other centres?
• When compared to the SC accounting requirements, many

leases are much more prescriptive when outlining the accounting basis for calculating turnover rent!

Findings: Leases as barriers to best practice

• Legal language make most leases difficult to navigate and

interpret

• Creates uncertainty and limits understandability
• Provisions may be interpreted in different ways
• Significant differences in how legal and accounting professions

understand “expenditure incurred during the year”

• What are “reasonable and proper costs”?
• Many leases create an illusion of certainty, but are

undermined by a lack of specificity. For example:

• 48/60 included a provision that states that advance payments are set by an annual

forecast but only 27/48 specifically required the preparation of a written detailed service charge accounting budget that identify specific heads of expenditure

• 57/60 included a provision that defines a timescale within which an annual

certificate should be prepared But 30/57 left this period unspecified – “as soon as practicable” is the common wording

• For the benefit of all stakeholders, urgent need to improve

both the clarity and specificity of commercial lease terms for service charges.

• Need to develop leases that incorporate the best practice

accounting recommendations of the RICS Professional Statement

Potential Fixes??

Short Term

• Awareness & Training
• More Robust Enforcement
• Create Effective Audits – forensic assurance process?

Medium Term

• Extend Research, Create & Finance Sustainable

Program with Teeth

• Extend Financial Reporting Requirement, Balance

Sheets Long Term

• Forensic Legislation?
• All-inclusive Rents??

Findings, Opportunities

Priorities For Occupiers:

• Decide preferred accounting basis – cash or accruals??
• Rigorous investigation of most recent accrual-based

Certificates & Budgets

• Service charge expenditure priorities –

costs & service delivery

• At lease end - accruals balances?
• Lease commencement/renewals – require cash

accounting; balance sheet; examination of vouchers

• Accounting sign off – policies on your requirements
• Working together in Centres – further research;

marketing; accounting sign off; major works

• Constructive engagement with Landlords

Findings, Opportunities

Prio riorit ities for

• r La

Landlords: On Purchase

• Be aware of your obligations & liabilities
• Secure “proven” Service Charge balance sheet together with a

full listing of opening and closing accrued amounts

• Up to date Certificates & Budgets – Code Compliant
• Knowledge of Accrual (& Utility) balances
• Verify cash balances

On Sale

• All of the above

Ongoing

• Service charges on Risk Register
• Service charge strategy on Lease renewals
• Review auditing policies & instructions

Findings, Opportunities

Priorities for the Industry:

• Consistent, transparent financial sign off
• Better financial controls; rigorous Audit – Balance

sheets/Cash Accounting?

• Improve timeliness, depth & transparency of financial

accounts

• Further Research, measurement of service outcomes,

smarter working?

• Could more effective Marketing help??
• Training – Managing Agents
• The role of the RICS…& PMA, active engagement of all

key stakeholders

• Is the RICS working? Is it working well??

Research Next Steps & Timetable

• Update findings – Accruals, 2017/2018 Missing

Actuals & 2019 Budgets?

• Engage with Tenants {PMA?} & Landlords on Actions.

Agree communications plan.

• Stakeholder interviews – opinions – 4Q19
• Elicit views about the current regulatory environment,

accounting practices, other problem areas, and solutions for UK commercial service charges

• Are you willing to participate in these interviews?
• Opportunity to make your voice heard!
• Academic paper 1Q20. Publish updated results &

recommendations.

Conclusions from the Research

• During last decade, resources have been invested to

improve Service Charge transparency and governance.

• This research has identified evidence of deficiencies

in foundational guidance, governance, and best practice.

• Could these deficiencies potentially have an adverse

impact on investment values?

• Question(s) :–
• What are the implications for the commercial property

market?

• If needed - how can we best fix it??

We have covered Timeliness, Problems with Accounting, Examining VFM Then there’s Transparency………using the Professional Statement as a means to limit what’s provided What leading Managing Agents do & say:

We Have Some Challenges

We have been advised not to provide that information unless firms are Regulated by the RICS Please get that off your client or we will charge you for a further copy We are Governed by Society

• f Chartered Surveyors

Ireland (SCSI) – no ‘professional standard’ on service charges The Professional Statement: Managers are to provide a full apportionment matrix to all occupiers that clearly shows the basis and method of calculation, and the total apportionment per schedule for each unit within the property/complex Our Apportionment table complies with the requirements of the Professional Statement

Summing Up……..

Pre Contract – Don’t enter the unknown, take control Benchmarking – Massive Improvement under the ‘Code’ Measure & Manage – Comparative Data to Drive Down Costs Meaningful Consultation - John Lewis Statement: “absence of strenuous efforts by Landlords to work collaboratively with us to reduce these costs” Scrutiny of Service Charge Accounts – Eliminating Bad Practice Quality Data & Research - Key steps in the process

VERIVI

THE ASSURE INDEX Warning – Above Trend On Trend Cost Leader TRAFFIC LIGHTS – ‘ASSURE ALERT’ Service Costs across all Centres

Thanks for coming along Hope you enjoyed or …… at least found it informative! Feedback is important – what do you think? Any Questions?