RPI is changing…

By Amy Cornelius – Commercial Property

RPI IS CHANGING: LANDLORDS AND TENANTS WILL NEED TO BE AWARE OF IMPLICATIONS FOR COMMERCIAL LEASES

In light of the situation with COVID-19, the consultation period for assessing the reform of the Retail Prices Index (RPI) has been extended until 31 August 2020, which gives businesses more time to respond on this important issue.

It has been acknowledged that RPI will go, or be brought in line with CPIH (Consumer Prices Index including owner occupiers’ housing costs) from 2030 but the Chancellor has given a clear indication that he is thinking about bringing that date forward, possibly to 2025 but no earlier.  This could therefore affect new leases currently being negotiated or those already in place.

RENT REVIEW

Although open market rent remains the principal basis for reviews, it is not unusual for commercial leases to have a rent review linked to increases in RPI.  RPI remained popular with property investors (and the Government) because RPI increases have tended to be higher than CPIH by around 1%, even after CPIH became the benchmark for inflation.  When RPI is brought in line with CPIH, rent increases and, in turn, investment value will drop.  This will already be having an impact on leases with RPI rent reviews due after 2030.

RPI-linked review provisions generally allow for the substitution of an alternative index if RPI ceases to exist or the basis of its calculation is materially changed.  However, there is no obvious replacement index apart from CPI (Consumer Prices Index) or CPIH so this gives little relief to Landlords.

The drafting of the rent review provisions in a lease will be important and Landlords and Tenants should audit all their current leases which contain RPI linked reviews to assess the potential implications.  The proposed adjustment is relevant for new leases and renewals where the review is due to take place on or after 2025.

A Landlord may look to pre-empt the change in RPI by seeking to agree new leases and renewals by reference to CPIH plus 1% or impose a higher minimum floor on the increase but even if this is commercially acceptable to the Tenant, they will need to be mindful of any Stamp Duty Land Tax implications.

SERVICE CHARGE

Where a lease contains a capped service charge, it is usual for the cap to increase in line with RPI to reflect the increase in the cost to the Landlord of providing services throughout the term.  If a change in RPI to CPIH results in lower increases than originally anticipated, Landlords will need to consider whether any items of expenditure should be excluded from the cap to ensure that the cap does not result in a shortfall.  One apparent example is utility costs, which can fluctuate considerably.

STAMP DUTY LAND TAX (SDLT)

Many rent reviews take place after the fifth year of the term of a lease and are not taken into account in the SDLT calculation. Where leases contain a rent review linked to RPI during the first five years, any uplift will still be ignored for SDLT purposes because it is classed as an ‘excluded adjustment’, even if there is a minimum increase.

However, where the review is linked to another index or where the review contains its own artificial adjustment, this will not be an ‘excluded adjustment’.  As a result, if there are any such reviews in the first five years of the term, its effect on the rent will need to be taken into account for SDLT purposes.

It is hoped that the Government will update the regulations to exclude CPIH increases but Tenants should not take this as given.

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