Building your first service charge budget: a director's walkthrough

Setting the annual service charge budget is one of the most consequential things a new director does. Get it right and the block runs smoothly: contractors get paid, reserves build steadily, and your neighbours feel fairly treated. Get it wrong and you can find yourself facing a shortfall, unhappy leaseholders challenging whether charges are reasonable, or — worst of all — bills that arrive too late to be legally recoverable.

The good news is that the process is logical and repeatable once you understand the structure. This walkthrough takes you through each step, from listing the cost lines to issuing your first demands.

A note before we start: service charge money belongs to the leaseholders, not to the management company. Under Section 42 of the Landlord and Tenant Act 1987, service charge contributions — including reserve fund contributions — must be held on a statutory trust in a designated account at a relevant financial institution, separate from any manager's own funds. Any interest earned belongs to the leaseholders too. That is the legal foundation everything else rests on.

Step 1: Understand what your leases say

Before you write a single number down, read the service charge provisions in the leases. The leases define:

• What costs can be recovered through the service charge (the scope of the landlord's or RTM company's obligations).
• How costs are apportioned between flats — this is often a fixed schedule or percentage, and it is frequently not equal. Some leases split by floor area; others use a fixed-fraction table; a few use equal shares. You cannot simply divide the total by the number of flats unless the lease says so.
• When demands must be issued and what they must contain.

If you have inherited incomplete records from a previous managing agent, your starting point is to locate the original leases or a lease summary prepared by a solicitor. Getting this right at the outset saves considerable difficulty later.

Step 2: List every cost line

A service charge budget for a typical residential block will include some or all of the following categories. Not every block needs every line — a single-storey building with no lift will not have lift maintenance costs — but work through the list and consciously decide whether each applies.

Recurring operational costs

• Building insurance (this is usually the largest single line for a small block; obtain a renewal quote early)
• Electricity for common parts (stairwell and car park lighting, communal boiler power if applicable)
• Water charges for communal areas
• Cleaning of common parts (entrance hall, stairwells, bin store)
• Gardening and grounds maintenance
• Window cleaning for common areas
• Waste and recycling collections where the block pays separately from the council

Maintenance and repairs (day-to-day)

• Reactive repairs to common parts
• Lift maintenance contract (if applicable; lifts also need a thorough examination under the Lifting Operations and Lifting Equipment Regulations — LOLER)
• Boiler and heating system servicing (for any communal plant)
• Fire alarm system service contract
• Intercom and door-entry system maintenance
• Lightning conductor testing (if applicable)
• General handyman provision

Management and administration

• Management fee or software costs (self-managed blocks using tools like Reeve OS, for example, replace a managing agent fee with a much lower software subscription — worth budgeting for)
• Accountancy (preparation of annual service charge accounts)
• Company secretarial / Companies House compliance
• Postage, printing, and sundries

Compliance

• Fire risk assessment (must be reviewed regularly; frequency depends on the risk level determined by the assessor)
• Asbestos management survey (if the building was constructed before 2000, an asbestos register is required)
• Electrical installation condition report (EICR) for communal areas (recommended every five years)
• Legionella risk assessment (if there are communal water systems at risk)
• Building Safety Act compliance (relevant for higher-risk buildings — those 18m or over, or seven or more storeys)

Reserve fund contribution (see Step 5)

Step 3: Estimate each line

For recurring items like insurance and maintenance contracts, get actual quotes. For insurance in particular, do not rely on the previous year's premium — the market moves.

For variable or one-off items, use your knowledge of the building. If the external redecoration is due in three years and the last time it cost (say) £30,000 for a building of your size, you need to be building towards that in your reserve. If you genuinely have no historical data, speak to a surveyor or managing agent who knows buildings like yours.

Keep a note of your source or reasoning for each line. This is helpful when communicating with leaseholders and essential if any charge is ever challenged as unreasonable.

Step 4: Check reasonableness

Under the Landlord and Tenant Act 1985, service charges must be reasonably incurred and the works or services must be of a reasonable standard. Leaseholders can challenge charges they believe are unreasonable at the First-tier Tribunal (Property Chamber).

In practice, "reasonable" means: obtaining competitive quotes where costs are significant, not paying over the odds for services, and being able to justify why you chose the contractor or approach you did. You do not need to take the cheapest option every time — quality and reliability matter — but you should be able to explain your decision.

Step 5: Build in a reserve contribution

A reserve fund (sometimes called a sinking fund, depending on what your lease calls it) is not a luxury. It is the mechanism that ensures large, infrequent costs — roof replacement, lift refurbishment, external redecorations — do not arrive as a sudden shock demand on leaseholders who may have no spare money.

Best practice is to have a reserve fund study (sometimes called a long-term maintenance plan or schedule of dilapidations) prepared by a surveyor, setting out the major works anticipated over the next ten or twenty years and their estimated cost. You then work backwards to determine the annual contribution needed.

If you do not yet have such a study, a reasonable starting point is to set a contribution that reflects the age and condition of the building and the scale of work you can foresee. Even a modest contribution each year — say, £500 per flat — can make a significant difference over time.

Remember: reserve fund contributions, like service charge contributions generally, sit in the block's designated trust account. They belong to the leaseholders, not to the director, not to any software provider.

Step 6: Build in a contingency

Add a contingency line — typically 5–10% of the operational budget — to cover unforeseeable reactive repairs. Boilers fail unexpectedly. Roofs leak. A modest contingency buffer means the block does not run into arrears mid-year while waiting for a special levy.

Step 7: Apportion to each flat

Once you have a total budget, apportion it according to the lease schedule. If your lease uses floor area, you will need the area of each flat. If it uses a fixed-fraction table, use those fractions exactly. Do not improvise apportionment without checking the lease, as demanding more than the lease permits is legally problematic.

For a worked illustration: say the total annual budget is £45,000 for a ten-flat block, and the lease apportions costs in equal tenths. Each flat's annual contribution would be £4,500, paid in whatever instalments the lease or your demand schedule provides.

Step 8: The Section 20B 18-month rule

This is the timing trap that catches new directors. Under Section 20B of the Landlord and Tenant Act 1985, a landlord (or RTM company) cannot recover service charge costs incurred more than 18 months before the demand is issued, unless the leaseholder was notified within that period that the costs had been incurred and would be demanded later.

In practice this means: do not let costs accumulate and then try to demand them in arrears a year and a half later. Issue demands on time — whether that is monthly, quarterly, or annually as your budget and lease provide. And if you have inherited old costs from a previous period, take advice promptly on whether and how they can be demanded.

Step 9: The Section 20 interplay for major works

If any item in your budget involves works that will cost any individual leaseholder more than £250, you must follow the Section 20 major works consultation process before entering the contract. This is a separate process from the budget itself — but it affects how and when you can include those costs in your demands.

Plan your larger works projects early enough to complete the consultation (which requires at least 30 days for observations at each stage) before you need to commit to a contractor.

Step 10: Communicate before you demand

Particularly as a new self-managing director, take the time to share a draft budget with residents before issuing formal demands. This is good practice for transparency and trust — and it often catches errors or omissions you had not spotted. It also helps leaseholders plan their finances.

Some directors hold a brief residents' meeting; others circulate a budget summary by email. Either works. What matters is that residents feel informed, not ambushed.

Step 11: Issue compliant demands

Service charge demands must be in writing and must be accompanied by a summary of leaseholders' rights and obligations (as required by the Landlord and Tenant Act 1985). If your demand does not include this summary, leaseholders are not obliged to pay until it is provided.

Get this right from the start. A correctly formatted, properly served demand is the foundation everything else rests on.

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Reeve OS drafts budgets and compliant demands for directors' review and approval, handles Direct Debit collection into the block's own trust account, and maintains the audit trail you need for reasonableness challenges and year-end accounts. Funds always sit in the block's account — Reeve never holds the money.

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Frequently asked questions

Can I just use last year's budget as a starting point? Yes, but review it properly rather than rolling it forward automatically. Insurance premiums change; contracts expire; compliance inspection cycles mean some costs fall in some years and not others. A budget that worked last year may be meaningfully wrong this year.

What if a leaseholder disputes a charge as unreasonable? The correct route for a leaseholder to challenge a service charge is the First-tier Tribunal (Property Chamber). As a director, the best protection is to be able to demonstrate that each charge was reasonably incurred — which means keeping records of quotes, decisions, and the reasoning behind them.

Does the reserve fund appear on the annual accounts? Yes. The reserve fund balance, and movements in and out of it, should be shown in the block's annual service charge accounts. This is one of the reasons good record-keeping matters: the accounts need to distinguish between the operational account and the reserve fund.

Who approves the budget? The board of directors sets the budget. While it is good practice to consult residents, you are not legally required to hold a vote of all leaseholders before setting the service charge (unless your lease says otherwise). That said, transparency builds trust and makes collection easier.

What happens if I underbudget and run out of money mid-year? You may need to issue a supplementary demand or a special levy. These are legally recoverable in the same way as regular demands, but they are disruptive and erode goodwill. A modest contingency reserve and an honest reserve fund contribution are the best protection.