Rumours of the Retail Price Index’s (“RPI”) death have been vastly exaggerated in the past. We were told back in 2013 that the Office for National Statistics was going to stop formally recognising the index as a national statistic, but it took a while for the industry to take note. We have all carried on using it in our indexed linked rent reviews since then.
Now it looks as though the final nail in the coffin will be 2030.
The government therefore recently called for a review and consultation on the adoption of an alternative methodology to align it more closely with CPIH (Consumer Price Index including owner occupier housing costs).
RPI is calculated and published by the Office for National Statistics and used to calculate the cost of living and wage increases, as well as government gilts and securities. Were a change to CPIH to be implemented, it could have an adverse impact on those gilts and securities in particular, which is something the Chancellor felt unable to sanction until the relevant index-linked gilts have matured in 2030. Accordingly, any change to RPI is likely to be postponed until February 2030 at the earliest.
What does all of this mean for the living sector? RPI is a common measure for increases in lease payments, such as rent and service charge, and so any shift to the use of CPIH is likely to mean that increases in such payments will be lower. CPI measures the average change in a “shopping basket” of goods and services over a period of time in a typical household. Consumer behaviour has obviously been affected by the lockdowns arising out of the pandemic as people have been unable to spend as much of their earnings on eating out or going on holidays, and so query what impact this will have on CPI in the coming months.
CPI generally results in a lower measure of inflation than RPI, at around 0.75%-1% less annually since 2011, and so this will mean that lease payments linked to the new measure will result in lower increases than has traditionally been the case. This is something that landlords in particular will be considering in any lease renewals and new leases going forward. We are certainly making sure in our deals, to the extent it was not the case already, that lease clauses are flexible enough to deal with a change in the way RPI is measured. Some clients are also considering building in a “top up” to CPIH rates to address any reduction that is anticipated, for example making the rate CPIH plus 1% to address the traditional discount to RPI.
Another unexpected consequence of any change in the measure of increase, by say a switch to CPIH, would be the way it is treated for SDLT purposes. Any uplift linked to RPI during the first five years of a lease is generally ignored, but this would not be the case for an increase linked to CPIH or for any adjusted measure such as CPIH plus 1%. It is hoped this will be addressed by the government to update the SDLT rules to ensure a consistent approach, but it is something for tenants be aware of when entering into such leases in the future.
Another potential impact is the way service charge costs are assessed. As CPIH is likely to result in a lower increase than has traditionally been the case, are there services which should be excluded from any cap in order to protect a landlord against a shortfall? For example, insurance or utility costs, where those costs increase at a rate higher than inflation. Again, this is something to be discussed and agreed at the outset of a transaction in order to mitigate any potential shortfall costs, which are always an issue for investors and lenders.
Other things for property owners to consider as a result of any convergence of RPI and CPIH would be the impact on any existing hedging and funding arrangements caused by a portfolio of assets which have CPI-linked long-term income.
One to watch, although a report in February 2021 by Aviva Investors pointed to the fact that there had been no noticeable change in the valuation of RPI-linked assets as a result of the government’s reform proposals, although it was also acknowledged that there had been limited transactional activity at that time.
This article appears in our Investing in Living report. To access the full report, please click on the link to the right of this page.