The service charge is recovered from tenants, which is exactly why it is paid for by the landlord: out of the rent the next tenant will offer.
Occupiers budget for rent and service charge together, so every euro of service charge above the market comes off the rent the next tenant will pay. On an illustrative 10,000 m² office with a charge of 95 per m² against a market 80, the achievable rent falls from 400 to 385: 150,000 a year of rent and 2,553,626 of value, 17.0 times the annual gap, although the landlord recovers every euro of the charge itself.
Worked in full in Office Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The service charge is usually filed under property management, as a pass-through that the landlord collects and spends. That is true for the sitting tenant and false at the next letting. A tenant choosing between two buildings compares what it will pay in total, and a building that costs more to run is a building that must let for less.
| Input | Market comparable | Subject building |
|---|---|---|
| Lettable area, m² | 10,000 | 10,000 |
| Service charge | 80 | 95 |
| Tenant's budget, rent plus service charge | 480 | 480 |
| Net initial yield | 5.5% | 5.5% |
| Purchaser's costs | 6.8% | 6.8% |
The subject building is older, with less efficient plant and a larger common area to clean, heat and secure. Everything else is equal: location, specification, lease terms. All figures are illustrative. Business rates are left out. Because they follow the rent, a lower rent also means lower rates, so in practice each euro of extra service charge takes slightly less than a euro off the rent; the figures here are a modest upper bound.
Step 1. The rent the tenant can pay. Rent = occupancy budget less service charge.
Comparable: 480 − 80 = 400 per m²
Subject: 480 − 95 = 385 per m²
Rent lost = 15 × 10,000 = 150,000 a year, 3.75 per cent of the rent roll
Step 2. Capitalise it. Value = rent / (yield × (1 + purchaser's costs)). The multiplier is 1 / (5.5% × 1.068) = 17.02.
Comparable: 4,000,000 × 17.02 = 68,096,697
Subject: 3,850,000 × 17.02 = 65,543,071
Value lost = 2,553,626, or 255 per m² of the building
Excel: =(SC_subject-SC_market)*Area/(NIY*(1+Costs))
Each euro per m² of service charge, on this building, is worth 170,242 of capital value. That is the number to hold up against any proposal to spend money on the building's running costs, and against any argument that the charge is the tenants' business.
The landlord pays the service charge on empty space. With 15 per cent of the building vacant, 1,500 m², the landlord pays 142,500 a year at 95 per m² where it would pay 120,000 at the market's 80: another 22,500. It falls due during the re-letting, exactly when the building is already losing rent, and it does not appear in a valuation that assumes the building is let.
| Gap per m² | Achievable rent | Rent lost a year | Value lost | Share of value |
|---|---|---|---|---|
| 5 | 395 | 50,000 | 851,209 | 1.25% |
| 10 | 390 | 100,000 | 1,702,417 | 2.50% |
| 15 | 385 | 150,000 | 2,553,626 | 3.75% |
| 20 | 380 | 200,000 | 3,404,835 | 5.00% |
| 25 | 375 | 250,000 | 4,256,044 | 6.25% |
The relationship is linear, and it scales with the rent multiplier: the lower the yield, the more a service charge costs. If occupiers pass only half of the gap through to the rent they offer, perhaps because the building has other merits, the value lost is still 1,276,813.
Suppose 1,500,000 of plant replacement and controls would cut the charge by 12 per m². The tenant saves 120,000 a year, and a tenant's saving looks like a 12.5-year payback that no landlord would fund. Priced through the rent, it is different: 120,000 a year at a multiplier of 17.02 adds 2,042,901 of value, 1.36 times the cost, a net gain of 542,901. The works break even at a cut of 8.81 per m². This is the same logic the book applies to energy upgrades, set out in does an energy upgrade pay for itself on an office.
Valuations and business plans usually model the service charge as fully recovered and then ignore it. On the sitting tenant's lease that is correct. At every lease event it is wrong, because the rent the market will pay is set net of the charge, and a valuer who takes a comparable rent from a building with a lower charge overstates the subject's rental value by the gap. Ask for the service charge per m² of each comparable alongside its rent, and compare total occupancy cost, not rent alone.
Caps and fixed service charges do not remove the effect; they move it. Where the charge is capped, the excess is irrecoverable and comes out of the landlord's net income directly, as in the shopping centre case.
The book carries the total occupancy cost into the re-letting cycle, and the free workbook for this case includes the cost of a service-charge gap on its building.
Yes, when occupiers compare buildings on total occupancy cost. A tenant willing to pay 480 per m² for rent and service charge together pays 400 of rent where the charge is 80 and only 385 where it is 95. On 10,000 m² that is 150,000 a year of rent the landlord never sees, although every euro of the charge is recovered.
The rent it frees, capitalised at the yield after purchaser's costs. At 5.5 per cent and 6.8 per cent costs the multiplier is 17.02, so each euro per m² of service charge on 10,000 m² is worth about 170,242. A 12 per m² cut bought with 1,500,000 of plant works adds 2,042,901, a net 542,901.
The landlord. With 15 per cent of a 10,000 m² building empty, the landlord pays the charge on 1,500 m²: 142,500 a year at 95 per m², 22,500 more than at the market's 80. That is a second, smaller cost of a high charge, and it peaks exactly when the building is hardest to let.
This article is one calculation from Office Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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