After a sustained period of relatively low and benign Consumer Price Index (CPI) rises, the current inflationary environment and higher increases in the CPI has put CPI rent reviews in leases back in the spotlight. It is therefore timely to consider how they work and, given their potential impact, to consider them more closely when negotiating new leases.
On a CPI rent review the rent payable under the lease is adjusted by the change in the Consumer Price Index from the CPI quarter before the previous rent review and the CPI figure for the quarter before the current rent review date. By way of example, where the CPI has increased by 7% over the previous year this would result in an annual rental of $100,000 increasing to $107,000 annually. Generally, rent can’t fall below the rent payable immediately before a CPI review date, however this does depend on the terms of the particular lease.
CPI rent reviews have traditionally been viewed by Landlords and Tenants as a way of providing some certainty as to rent increases with annual CPI increases having often been around 1% - 2.5%. However, recent CPI increases of over 7% have led to higher than expected rent increases. Another benefit of a CPI review (as opposed to a market rent review) is that it avoids the parties having to obtain costly market valuations and the increase in the CPI can’t be disputed.
CPI reviews don’t account for any increase in the value of the specific property and therefore CPI adjusted rent may be less than true market value of property. However, leases that contain CPI reviews generally provide for market reviews to occur periodically or on renewal dates, which provides an opportunity to have the rent reviewed to market levels.
Landlords may wish to consider using the current inflationary environment as an opportunity to lock in fixed rent increases with tenants more willing to opt for fixed rent reviews rather than face the current uncertainty of CPI increases. They may also want to ensure that leases include both market and CPI rent reviews - this helps eliminate the risk in a ‘normal inflationary environment’ where CPI reviews don’t take into account the property's true market value.
On the other hand tenants may want to consider trying to cap CPI rent reviews in leases going forwards (e.g., CPI increases but capped at a maximum of 5%) or may wish to opt for fixed rent reviews rather than CPI reviews to give more certainty to rent increases over the term of the lease (e.g., fixed 5% rental annual increases). The current inflationary environment has certainly highlighted just how significant CPI reviews can be.
If you require any assistance with rent reviews or negotiating a new lease our commercial property team are experts and can assist with your enquiries.
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