Service charges rise on somebody else's decisions

Treat the sections below as a sequence. With service charges on a leasehold flat, getting the early decisions right makes the later ones much easier.

What the charge covers

Service charges typically fund building insurance, communal repairs, cleaning, grounds, lifts, management fees and contributions to a reserve fund. The amount is set by the freeholder, management company or owners' association, depending on the legal structure where you live.

Because it funds actual costs, it rises when those costs rise, which recent years have demonstrated in several markets. A buyer comparing a mortgage payment to a rent payment without adding this is comparing incomplete numbers.

Major works are the large risk

Roof replacement, structural repairs, lift renewal and facade work can generate demands far larger than the annual charge. Where the reserve fund is inadequate, the shortfall is billed to leaseholders or owners directly, sometimes at short notice.

On the balance sheet, several markets have seen very large demands relating to building safety remediation, with liability rules that have changed during the process. These demands are generally enforceable, and non-payment can put the property at risk.

Read the accounts, not the brochure

The last few years of service charge accounts show the trend, the level of the reserve fund and any disputes. Minutes of owners' meetings frequently reveal planned works long before they appear in a charge. A survey may identify building issues that will eventually become a communal cost.

This information is generally obtainable before purchase, and it is the difference between a known cost and a surprise.

Ground rent and the structure of ownership

Some systems separate ownership of the building from ownership of the flat, with a ground rent payable to the freeholder. Escalating ground rents have caused significant problems in some markets, including making properties difficult to sell or mortgage. Reforms have been introduced or proposed in several jurisdictions, and the position is genuinely in flux.

The lease or equivalent document sets out the terms, and a lawyer reading it is not an optional step.

Short leases are a valuation problem

Where ownership is a lease of finite length, the value falls as the remaining term shortens, and below certain thresholds mortgages become harder to obtain. Extending the lease is possible in many systems and can be expensive, with the cost rising as the term gets shorter.

Buying a short lease without pricing the extension is a common and costly error. The rules on entitlement to extend and how the premium is calculated are jurisdiction-specific.

Budget for it as a housing cost

The honest total housing cost is mortgage, service charge, ground rent, insurance, local taxes and a reserve for your own internal repairs. Treating the service charge as an afterthought produces a budget that fails at the first annual increase. Where charges have risen steeply in recent years, projecting forward at the historic rate is more realistic than assuming the current figure holds.

Structures, rights and reforms differ substantially by country, so local legal advice before purchase is the sensible course.

The takeaway

Read the accounts and the reserve fund before you read the brochure. The charge you are quoted is this year's.

Costs compound as reliably as returns do, and in the same direction.