Pointing the (index) finger at the use of RPI and CPI in commercial leases

Pointing the (index) finger at the use of RPI and CPI in commercial leases

Spring Budget 2020: what do employers need to know?

The use of the Retail Prices Index (RPI) and Consumer Prices Index (CPI) in leases is common in the market, but have landlords and tenants been using the wrong one and have predictions of the demise of the RPI been premature?

Index-linked investments have been the flavour of the month for some time now. Using indices such as RPI and CPI in rent review clauses in commercial leases has been increasing in recent years, and the current economic climate will no doubt see a further boom in index-linked rent reviews going forward. 

What are RPI and CPI?

The Office for National Statistics publishes these figures on a monthly basis as measures of inflation in the UK. They are used to track the average change from month to month in the prices of specified goods and services purchased by most households in the UK.

How are RPI and CPI used in real estate transactions?

RPI and CPI are often used in commercial leases in a rent review clause or to cater for an annual increase in a service charge cap. This is to ensure that rent levels and capped service charge figures keep pace with inflation.

One advantage of using an index-linked rent review is that the parties are able to determine the increase in rent levels quickly and transparently, without the uncertainty (or expense) of carrying out a full market rent review. 

Which index should be used?

The indices track the prices of different goods and services, and the formulae used to calculate the indices are different. This will generally result in a higher figure for RPI, leading to greater rental increases. 

Despite this, RPI has proved popular as it favours landlords but also protects tenants by avoiding the risk of a further Stamp Duty Land Tax (SDLT) charge on rent increases. This is not the case when using CPI (note the position is different in Wales, where the Land Transaction Tax ignores CPI-linked rent reviews when calculating the value of a lease). The use of CPI-linked rent reviews could therefore lead to an administrative burden for the tenant, or even a cash flow issue in the case of substantial rent levels if it is obliged to recalculate the SDLT due on the increased annual rent following a CPI-linked rent review. In many cases, this will outweigh the advantage of using the generally lower CPI figure. 

The future

RPI is often seen as the government’s index. Given RPI generally results in a higher figure for inflation and is used for a number of key public areas such as pensions, state benefits and tax allowances, there have been calls for a reform of its methodology. The UK Statistics Authority and HM Treasury launched a joint consultation earlier this year on proposed changes to the RPI methodology and when such changes should be brought in. The consultation ran until 21 August 2020 and the response from the government and the UK Statistics Authority is due in Autumn 2020.

While any such changes will not be brought in before 2025 at the earliest, they are likely to result in the difference between the RPI and CPI figures being reduced. However, this is unlikely to be the end of the RPI in commercial leases. The SDLT saving alone may mean that RPI continues to be the index of choice in commercial leases in England for many years to come.

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