Index Linked Rent Reviews: RPI -v- CPI | Property Law Update 001

Index-linked rent reviews have become increasingly popular in recent years. By linking rent to inflation rather than to market rents, the rent review is reduced to a simple mathematical formula: but is it really that simple?

Although much will depend on the particular terms of the deal such as the length of term and existence of break rights, coupled with the current trends in the market value of the Property, there are some key questions raised by such reviews; principally, to what index should the rent review be linked? Historically, the Retail Price Index has been the preferred option. However, this index is more recently proving controversial.  

In many cases the parties will agree an open market review, which is subject to numerous assumptions to determine the rent payable in that current market at the time of the rent review. The unfortunate side-effect of this is it can produce a varying degree of uncertainty for both landlords and tenants. As an alternative both parties, in an attempt to restore some certainty to such reviews (but notwithstanding their differing interests), may agree instead to link reviews to an index, as a fairer way to protect the interests of both parties at the same time. 

Retail Price Index (RPI) -v- Consumer Price Index (CPI)

Both RPI and CPI reflect the monthly change in the cost of a “basket” of goods and services but they differ as they track the costs of different items. The level at which the index runs is critically important (in the context of rent reviews) because the higher the inflation figure, the higher the increase, and RPI has generally always given a higher inflation figure than CPI (save for notable exceptions such as in 2008 to 2009, when RPI plummeted lower than CPI in response to the financial crash). CPI therefore has the benefit of being less volatile than RPI, providing greater certainty for the parties, but it perhaps does not give a landlord the level of increases it might be hoping for or expecting over the duration of a lease term.

RPI linked rent reviews have in many cases proved to be more appealing to landlords, as the rent increases with general inflation rather than the rental market (which may have been less buoyant); though, with this said, in a booming property market the open market rent is likely to outstrip general inflation. Similarly, an RPI linked increase is often disliked by tenants as a result of the lack of connection between the inflationary increase and the local property market - though the tenant may prefer the perceived greater certainty of inflationary increases rather than the vagaries of the property market. 

With all this said, it's not all bad news for tenants. RPI also offers a Stamp Duty Land Tax (SDLT) saving - as it is the only index that can be ignored when calculating the value of a lease for SDLT purposes. The common way to offset the higher rate of inflation generally produced by using RPI is to agree a cap and collar. As the name suggests, a cap is the maximum increase or an upper limit - so if the formula in the lease produces a rent above the cap, the revised rent will be limited to the level of the cap. A collar is simply a minimum increase - so if the formula produces a rent that is lower than the collar, the revised rent will be bumped up to the level of the collar.

However, your chosen method of rent review may prove academic if it is not drafted correctly.

Drafting the Formula

It it is vital that you check the formula for a number of the reviews (not just the first one) to ensure there are no unintended consequences. For an annual straight line increase in accordance with RPI, there are generally two ways of drafting the formula:

• a % change in the Index is applied to the initial rent – so each year the formula takes the initial rent and applies the % change in the Index since term commencement; or
• a % change in the Index is applied to the current rent – so each year the formula takes the current rent and applies the % change in the Index over the previous year.

The danger is to get these two muddled up, which produces a ratcheting effect with an inflated rent and a windfall for the landlord. Only last year, in the case of Trillium (Prime) Property GP Limited v Elmfield Road Limited [2018], the Court of Appeal heard that, as a consequence of the way that the RPI formula was expressed, the rent was over-inflated by over ￡300,000 a year.

Are There Any Alternatives?

CPIH is an alternative currently being considered by many. It is a new measure of the annual rate of UK consumer price inflation but within its calculation it also includes owner-occupiers’ housing costs, such as council tax and changes in average residential rents - it does not, however, include changes in house prices. CPIH has been recommended for use instead of CPI as it more accurately reflects the cost pressures facing UK households.

Alternatively, one might consider a rent review in accordance with RPIJ. This measure of inflation has been published by the Office of National Statistics since March 2013 and uses the same basket of goods as RPI, but instead uses a geometric method of calculation similar to that of CPI. As the geometric formulation is said to capture the real behaviour of consumers, this will usually result in a lower figure, however this index will record these changes against the existing RPI basket (which includes those relevant property related items). So although like CPI, this index would potentially have the effect of lower index rates, it would at least be recorded by reference to property related trends.

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The view expressed herewith is exclusively my own. The contents of this article is not legal advice and should not be relied upon as such. Please note no attorney-client relationship shall be formed should any adverse consequence arise from reliance upon the information provided within this article.