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Inflation and The Consumer Price Index-Calculating Rent in Commercial Real Estate Leases
During the past couple of decades, landlords of commercial leases have routinely used a fixed percentage rate to calculate yearly increases in base rent (i.e., a two to three percent increase per lease year). However, the significant rise in inflation during the past year or so is causing landlords to rethink their method of calculating rental increases.
In 1919, the Bureau of Labor Statistics (BLS) began publishing the official Consumer Price Index (CPI) to measure price variations (inflation and deflation) affronting urban consumers. Currently, each month or two, several CPI indexes are published. The publications are based on location, type of consumer, goods purchased, and services rendered to American consumers as a part of their daily lives. The BLS collects data via what is called the Consumer Expenditure Survey. The data collected is used to make adjustments to dollar values. Examples of items that are commonly adjusted are Social Security benefits, governmental assistance, wages and tax rates.
During the last period of high inflation in the 1980s, the CPI was frequently used to determine yearly rental increases in commercial leases. Using the CPI enabled landlords to tie base rent to inflation rates, so when consumer costs rose, so did rent. However, once inflation rates steadied, using the CPI to calculate rent fizzled in popularity. Fast forward to today, with inflation numbers going through the roof, use of the CPI has made a comeback as landlords are fearful of being locked into rental rates that are below the annual rate of inflation.
Using the CPI to determine rent increases in a commercial lease means that rent will escalate at the same rate that the CPI increased for the immediately preceding twelve-month period last published. Because there is no guaranty that CPI rent increases will keep pace with the market, it is recommended that commercial landlords provide in their leases that increases in rent shall be: (a) the greater of a percentage (such as three percent) or (b) a year over year increase in the CPI. Because the calculation of the CPI may vary based upon numerous factors such as the base month used to calculate the yearly change in the CPI or which index is used, it is extremely important for landlords to negotiate the correct CPI clause into its leases.
On the opposite end of the bargaining table, tenants, for obvious reasons, tend to shy away from surprise modifications in rent. They prefer predetermined or at least capped rental increases. However, if the lease language modifies rent solely in accordance with the CPI and not by the greater of the CPI increase or a percentage, tenants may find their rent actually decreasing along with decreases in the CPI.
Feel free to contact our team with any questions as to what is in your best interest when determining fixed rent. The attorneys at Obermayer are available for all of your leasing needs to include negotiating the appropriate CPI clause into your lease.
The information contained in this publication should not be construed as legal advice, is not a substitute for legal counsel, and should not be relied on as such. For legal advice or answers to specific questions, please contact one of our attorneys.