Leasehold Property - What is the Cost?

Financial costs and responsibilites associated with owning a residential leasehold property can be a difficult issue for those who newly own a property to get their heads around. We have covered this in our short eBook, 10 Things Everyone Should Know About Service Charges, but we're delighted to have Jo-Anne Haulkham, partner at accountant firm Kreston Reeves, as the guest author of a blog that delves deeper and aims to clear up more of that confusion.

Leasehold Property - What is the Cost?

Owning a residential leasehold property, most commonly a flat in a block, can often involve costs and responsibilities that new owners may not have anticipated. Here are some of the financial aspects that leasehold property owners should be aware of from the outset.

The lease

Leasehold properties will have a written agreement called a ‘lease’ that sets out the rights and responsibilities of each leaseholder. It is very important for a leaseholder to hold a copy of the lease and be aware of the terms within it. The lease will stipulate any expenses to be paid by the leaseholder.

Landlord company statutory accounts

The lease will set out the landlord, which is often a limited company. Under the Landlord and Tenant Act 1985, the landlord is defined as any person who has the right to enforce payment of service charges towards the property. Depending on the way the company has been set up, it may or may not have a legal interest in the property itself.

Often the company has been set up in the form of a Right to Manage (RTM) company which means that the leaseholders of the building have taken over the rights to manage the building in the future. This gives the leaseholders the key advantage that they can choose their own service providers, such as the managing agent and independent accountants. 

With this structure brings the requirement for a collection of the leaseholders to become directors of the limited company. These individuals should make themselves aware from the outset their duties and responsibilities under company law. Directors frequently comment that their role is to simply sign a set of accounts for the property/block each year.  However their responsibilities are far more wide-reaching than most realise, and so it is essential that they have good professional advisers on hand to guide them through their requirements.

From an accounting perspective the limited company will need to prepare accounts and submit them to Companies House each year. These are most commonly non-trading accounts, because the transactions that usually arise during a year relate to the collection of variable service charges under the terms of the lease which are trust monies. Trust monies do not belong to the company and under current best practice should not be recorded as an asset (and corresponding liability) in the company accounts. 

In addition, if the company owns the freehold interest in the property then it may receive ground rents or other forms of taxable income (for example, lease extension income), plus there will be related costs. A net surplus will often result in a corporation tax liability.

Directors often appoint an independent firm of accountants to help them to prepare the company accounts and calculate and advise on any associated tax liability.

Service Charge Accounting

A set of ‘service charge accounts’ are generally required for leasehold properties or blocks of flats where there are four or more dwellings paying a variable service charge.

A service charge is an amount which is payable by the leaseholder to the landlord to cover the costs of services, maintenance and repairs, insurance and management. Details of items covered by the service charge are determined by the lease for each dwelling. The lease will also state the percentage of service charge payable and the dates on which the amounts are due. Some leases, usually older ones, allow recovery in arrears such that the landlord has to incur the cost first.

There is no statutory requirement for the preparation and content of service charge accounts, but the accounts need to comply with the provisions of the lease in order to recover the service charge costs from the leaseholders. If the costs cannot be recovered from the leaseholders the freeholder may be held liable for these costs.

In 2011, specialist Technical Guidance (Tech 03/11 – Residential Service Charge Accounts) was prepared and issued by a joint working group with representatives from ACCA, ICAEW, ICAS, ARMA and RICS, to set out the best practice for accounting and reporting in relation to residential leasehold properties.

The key element from this guidance is that variable service charges paid by the leaseholders should be held on trust for the benefit of the leaseholders themselves for the purpose of paying for valid service charge expenditure. Given trust monies are not an asset of the landlord company, this therefore results in the need for a separate set of service charge accounts. Along with the requirement for separate accounts, the guidance emphasises money held in trust should therefore be held in designated trust bank accounts in accordance with the Landlord and Tenant Act 1987 (LTA 1987).

The accounts generally need to be issued to each leaseholder within six months of the accounting year end, although the lease should be consulted for specific timings. This ensures that the accounts are issued to the leaseholders regularly and that if the accounts show a deficit, then the additional costs can be demanded from the leaseholders.

In addition the lease may state that the service charge accounts be audited or certified by an independent accountant or other professional.

The lease may state that the landlord is required to estimate the amount to be spent over the next year. This is often prepared in the form of a formal budget by the managing agent. This budget then determines the amount of variable service charge to be demanded from each leaseholder in advance.  The managing agent keeps a record of the actual costs expended during the year and the resulting service charge accounts will set out if there is a surplus or shortfall of costs. 

If the year end accounts show that the landlord has spent more than was budgeted for, the lease will normally allow for collection of the shortfall from the leaseholder via a ‘balancing charge’. If less has been spent than was budgeted for, then the lease may state that a credit for overpayment can be carried forward as a credit against the next service charge demand for payment. Sometimes however, the lease may instead say the surplus should be refunded to the leaseholder, or be transferred to a ‘reserve fund’.

Details of any reserve fund requirement can be found in the lease. If the lease does not stipulate that a reserve fund is allowed or for monies to be collected for future maintenance, then reserve contributions should not normally be demanded from leaseholders. However, the managing agent of the property will be able to advise on the terms of the lease and how they interpret its application in practice. Ultimately, in the event of doubt, a specialist solicitor should be consulted for formal legal interpretation.

What is the golden rule?

From a financial perspective, there is a golden rule when considering the financial aspects of owning a leasehold property. This is to read the lease and ensure it is being followed in practice.

Directors can take comfort from appointing independent professional advisers to guide them through the legal landscape and to help them ensure they understand and are fulfilling their responsibilities.

About Kreston Reeves

Kreston Reeves LLP is a firm of independent accountants based in the South-East, London and Kent although we have clients across the UK and internationally. We recognise that the accounting requirements for leasehold entities is a specialist area, and we work closely within both managing agents, property managers and owners to help them meet their responsibilities.

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