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Watch Out for Freehold Estate Rentcharges or Service Charges!

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The payment of a service charge to cover the cost of maintaining communal facilities is well established for leasehold properties, such as apartments. What is not so well known however is that freehold houses can also be subject to a service charge, or an estate rent charge, and this can come as something as a shock to a buyer. Furthermore, unlike leasehold property owners, who enjoy some statutory protection, freeholders have very limited options when it comes to querying or objecting to demands for service charges. For example, they do not have the right to challenge the reasonableness of service charges, or the standard of the services provided, through the First-tier Tribunal (Property Chamber) as certain leaseholders can do. 

The concept of a service charge for freehold properties is not new and in fact has been around for many years. However, they are becoming increasingly common on new estates and are usually created to cover the cost of maintaining communal areas such as landscaping, play areas, street lighting and private (IE unadopted) roads. In years gone by these areas would have been taken over and maintained by the local authority, but because of the restrictions placed on local authority spending in recent years many councils are now unable to cover the cost and so no longer accept the responsibility. Accordingly, the costs are in practice being passed on to the owners of the properties on the estate.

How are service charges and estate rent charges set up?

A freehold service charge is normally created at the time when the property is first sold by the developer, and the provisions which detail the charge will be contained in the Transfer Deed which is signed by the developer and the buyer upon completion of the sale. The Deed should specify exactly what the service charge is intended to cover, how the charge is calculated and the dates when it is payable.

A management company will be appointed by the developer to undertake the works to the communal areas and to collect the service charges from the houseowners on the estate. This will either be an independent company in which the houseowners will have no share, or a company in which the houseowners will become the shareholders. Where the houseowners are the shareholders in the company it is open to them to engage a managing agent to undertake the day to day management functions on their behalf.

Ownership of the communal areas will, when all the properties on the estate have been sold, be transferred to the management company (where the company is one in which the property owners are the shareholders), so the houseowners will have an indirect interest in them.

In some developments the service charge is payable by way of a legal mechanism known as an “estate rentcharge”. The way this works is that the rentcharge creates a charge on the property which can then be enforced by the rentcharge owner in the event of any default with payment. The implications of this are therefore more severe and some mortgage lenders have concerns about lending against the security of a freehold property that is subject to an estate rent charge. This is because any default with payment can potentially give the rent charge owner the right to create a lease of the property to recover the arrears, which would put the lender’s security at risk.

Selling your property

Where a freehold property is subject to the payment of a service charge additional procedures (which usually come with more cost) must be followed whenever the property changes hands, which can be a cause of irritation to both seller and buyer. Initially the seller will have to obtain a management pack from the management company. This pack will then be passed on the buyer and will contain all the information that a buyer (or their solicitors) might reasonably expect to want to know about the service charge. The buyer may then be required to sign a deed of covenant which is in effect a contract by which they promise to pay the service charge in the future. If the management company is owned by the freeholders, then the buyer will also be required to make an application for membership. All of this can cause some delay with the sale and more expense, as the management company will charge fees for the supply of the management pack and for their input with the procedures with which the buyer must comply.

What can you do?

I have often been asked by clients, particularly in cases where they feel that their property does not take any direct benefit from the communal areas, whether they can buy out the service charge so that it no longer must be paid. In very exceptional circumstances there may be a slim possibility of this but in the vast majority of cases there will be no chance of doing so.

Some good news is that the Government intends to introduce legislation to provide more protection for freehold estate rent charge payers. The proposals include rights which would be equivalent of those of leaseholders to challenge the reasonableness of estate rent charges, and limits on the enforcement action that can be taken by the rent charge owner. 

One thing which is certain is that freehold service charges are here to stay!

For advice about freehold service charges or residential property, please contact me by email here or on 02476 999399.

Author: Harvey Gibbs

05 February 2021