Don’t let service charges make your buy-to-let mortgage unserviceable
In the first part of this series of articles discussing buy-to-let cash flow, I introduced you to the basic concept and maths behind the estimation and calculation of cash flow on an investment property. I also introduced you to Jane, who had calculated that a property investment opportunity would produce more than £100 of positive cash flow per month.
Unfortunately, when making her buy-to-let cash flow calculations, Jane had omitted some expense items. They came as a shock to her and proved to be an expensive lesson. Here I look at the first of these charges she overlooked: service charges.
What is a service charge?
Jane’s property investment wasn’t a freehold property, but a leasehold. A month or so after she had completed the purchase, she already had tenants who were paying her the asking rent of £900 per month. She couldn’t have been happier. A few more weeks passed, and Jane’s property investment was working well. Then she received a letter that shocked her. It was a demand for £800 for service charges.
Jane spoke to the property management company she had hired, and they explained that this was perfectly normal. The service charges cover the running costs of the building, including:
- Landscaping and gardening
- Cleaning of communal areas, paths and pavements, and windows (inside and out)
- Maintenance of essential equipment such as fire extinguishers
- Maintenance of and repairs to lifts
- General maintenance works
- Redecoration costs
- Insurances to cover building and owners liability (or property owners liability for freehold property investments)
- Engineering insurance
Who should pay the service charge?
Jane felt that it should be her tenant who paid this, and asked if she could simply pass the bill. The property management company explained that the tenancy agreement stated that service charges were included in the rent. They also warned her that the service charge would be made at the same time every year.
There was nothing that Jane could do. She hadn’t considered there might be service charges to pay and hadn’t checked through the property management company’s standard tenancy agreement. In hindsight, she remembered that they had advised her to do so, but she hadn’t had time.
Jane paid the service charge – a big chunk of change for her – and moved on. She had a good tenant on her property. Her positive cash flow had been decimated, but at least it remained positive. Perhaps next year she would be able to increase the rent to cover the unexpected bill. Her cash flow now looked like this:
|Expense/Income Item||Per Month (£)||Per Annum (£)|
Beware of the hidden ‘service’ charge
For the best part of nine months, right through to November, Jane’s buy-to-let cash flow worked exactly as her new calculations said it would. Then she received another demand from the administrators of the apartment block. The roof needed repairing, and the cost allotted was £6,000 per owner.
Again, she spoke to her property manager. They were powerless. There was nothing they or anyone could do. Jane had to pay into what is called a ‘reserve (or sinking) fund’ because the service charge doesn’t always cover substantial repair work.
Jane had emergency cash in an instant access account and used this to pay her contribution to the reserve fund. But it didn’t do much to take the sting out of the mistake she had made when considering the investment opportunity.
The first year of owning her buy-to-let property had cost her more than £5,000, instead of a projected profit of more than £1,000.
What can you do about service charges?
Unfortunately, service charges are part and parcel of investing in apartments. They will be charged, and as the owner, you are ultimately responsible for ensuring they’re paid. To make sure you don’t make the same mistake as Jane, always ask about service charges and reserve funds. The best property administrators will charge a reserve fund on a monthly basis, building it up over a period so that major repairs don’t come with a hefty bill.
If you know the service and reserve fund charges upfront, before you commit to purchase, you’ll be more accurate in your buy-to-let cash flow projections and set your tenant’s rent at the right level.
If your property isn’t producing the cash flow it should, you could be overpaying for property management. And if your property manager hasn’t asked you about contract clauses in the tenancy agreement, especially those that cover extra charges, then perhaps your property manager isn’t the right one. Contact me or one of the Ezytrac team today on +44 1522 503 717. We’ll be happy to work through your cash flow with you and make sure that your tenancy agreement works as it should.
Read the next article in this series. Just as Jane thought she was back on track with her buy-to-let cash flow, her tenant gave her notice to quit. That caused Jane more financial aggravation.
Yours in effortless property management,