In commercial leases spanning multiple years or containing renewal terms, the amount of base rent or additional rent due may be adjusted in response to increases in the Consumer Price Index, or “CPI”. What does this kind of provision mean for rents and sums due under a commercial lease that you are currently negotiating, or if you have a commercial lease with that type of provision already?
What is the Consumer Price Index
The United States Bureau of Labor Statistics (“BLS”) measures inflation by comparing monthly changes in consumer prices via the Consumer Price Index. The CPI measures the average change in prices paid by urban consumers for consumer goods and services, which can be grouped into eight broad categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other general goods and services. Each month, the BLS releases national (or U.S. city) data on consumer spending and if a commercial lease contains a CPI escalation provision it may be based on the US City Average or the closest U.S. city’s CPI.
What does a CPI provision look like?
A typical CPI rent increase provision in commercial leases might look like this:
It is agreed that rent will increase at the rate that has been determined by the Consumer Price Index for the previous twelve (12) months. Consumer Price Index as used in this Lease is referred to as ‘Consumer Price Index for All Urban Consumers (CPI-U), US City Average, All Items, 1982-84=100, not seasonally adjusted’ published by the Bureau of Labor Statistics. Department of Labor.”
What does a CPI provision mean?
Rent increases under a lease provision similar to the provision above will be determined by the consumer price index for the last reported 12-month period.
In the above case, the specific consumer price index is for all urban consumers, which represents 94% of the total U.S. population. “U.S. City Average” refers to an average based on localized data collected across multiple urban areas in the United States. The phrase “all items” refers to the idea that this provision applies to all types of goods and services. CPI is based on 1982-84=100, which was chosen as the reference base in 1988. As a final adjustment, seasonally adjusted CPIs may be used to adjust for changes in housing prices due to seasonal effects, such as reductions during colder months.
Consumer price indexes are also created for different populations, geographical areas and types of goods and services. These different indexes may be included iif the lease involves a specific type of industry or area. However, the more specific a CPI gets, the more volatile it can be as well.
What Do CPI Provisions Mean for Landlords & Tenants?
Over the past few years, most commercial leases included fixed rate base rent increases during the term of the lease. In the past year, we have seen more landlords include provisions requiring that base rent increases by a measure of CPI to keep pace with inflation. This enables the Landlords to not only increase their base rent to keep up with the market, but also to ensure that increases in operating expenses keep up as well. Additionally, higher rents mean higher property valuations for landlords, so it is important for a landlord considering an upcoming property sale. One major objection posed by Tenants, however, is that there can be a disconnect between property values and the basket of goods and services CPI tracks.
For example, a tenant with a yearly base rent increase based on CPI might find themselves paying 7% – 8% higher rent next year, which can squeeze profit margins and budgets. If certain measures are not in place or taken, this can severely impact practice valuations and an owner’s ability to sell their practice at the conclusion of his or her career.
As another example, a tenant with a CPI provision over the last decade might have benefitted from smaller increases in the base rent due to the relatively low inflationary environment that preceded 2022. Generally, tenants prefer predetermined, or at least capped, rent increases so expectations are set and inflation does not seriously impact business operations during high inflationary periods. Tenants may also be able to lower their rent in a market experiencing a decline in CPI.CPI provisions can be effectively used to benefit both parties. It can mitigate inflationary impacts for landlords on rents and property values; it can also result in slower than average base rent increases in low-inflationary times. It is critical to understand how this provision works in order to ensure that you are prepared when negotiating a commercial lease. If you have questions about the CPI provision in your lease or any other aspect of your commercial lease, consult an experienced attorney who can advise you of your rights and obligations.