Is it RIP to RPI?

Future proofing your commercial lease for RPI reform

The UK Statistics Authority (the Authority) published its response to the consultation on the reform to the Retail Prices Index (RPI) methodology on 25 November 2020. The response confirmed that the Authority will be able to implement its proposal legally and practically in February 2030.

The intention of the Authority is to bring the RPI in line with the Consumer Prices Index (CPI) and the Consumer Price Index with Housing Costs (CPIH). The calculation of RPI will therefore change to use the same methods and data as CPIH. Whilst RPI will continue to be published, it is intended to abolish the supplementary and lower-level indices of RPI.

What should landlords and tenants think about now?

During the pandemic and with the reform date nearly a decade away, the proposal didn’t gain too much attention in commercial property news in November 2020. However, whilst February 2030 might seem like a long way away, landlords and tenants will be all too familiar with how quickly these dates come round (MEES being a prime example) and the importance of thinking ahead, especially when negotiating any new leases now that will span a term beyond February 2030 or which will have security of tenure under the 1954 Act and likely continue beyond 2030 on the same or similar terms.

Landlords and tenants should also review any existing leases within their portfolio that have a term beyond February 2030 and which contain index-linked rent reviews and/or service charge caps to check whether they use RPI and consider the practicalities of the reform on future rent and service charge contributions.

Indexed-linked lease provisions

The two main clauses in a commercial lease where RPI commonly features are the rent review and service charge clauses.

Index-linked rent review clauses are popular because the parties can assess the increase in annual rent easily and quickly without the ambiguity and cost of carrying out an open market rent review. It’s also common practice to see service charge provisions with an annual cap on a tenant’s service charge contribution that are linked to RPI, ensuring that a tenant’s service charge in any given year does not exceed the RPI-linked cap.

To date, RPI has been the landlord’s index of choice because it is usually higher than CPIH by around 1%, thus producing a greater rental figure on review and a higher index-linked service charge cap.

From 2030, the impact of the reforms means it is likely that rents and service charge caps linked to RPI will rise more modestly which will be a disadvantage for landlords but good news for tenants.

For new leases, landlords may therefore want to consider moving away from RPI and switching to CPI/CPIH or open market reviews or considering CPIH +1% reviews to counteract the impact of RPI reform in 2030. However, this may encounter resistance from tenants. Whilst CPI/CPIH currently tends to work in a tenant’s favour in producing a lower figure on an index-linked rent review or service charge, there is a disadvantage for a tenant when it comes to stamp duty land tax.

Stamp duty land tax (“SDLT”)

When it comes to calculating a tenant’s SDLT liability, any rent reviews during the first five years of the term of a lease may trigger a requirement to submit a further return to HMRC and to pay additional SDLT. Traditional RPI reviews are excluded from this requirement, but CPI/CPIH reviews are not. Therefore, a tenant taking a new lease which imposes index-linked rent reviews in the first five years needs to carefully consider whether an RPI or CPI/CPIH linked review is more advantageous when factoring in the potential SDLT liability.

Unfortunately, we don’t yet know whether the RPI reform in 2030 will include a similar RPI exclusion on SDLT assessment or whether tenants are potentially going to find themselves with an additional SDLT burden.

Will it be RIP to RPI?

It's unlikely to be RIP to RPI in commercial leases and, until the Authority implements its proposals in 2030, it’s a little too soon to tell. It will however be interesting to see how the market evolves and landlords and tenants would be prudent to prepare now so they can future proof for the changes.

For any further advice in connection with this topic or any other commercial property matter, please contact Clare Strachan on 01256854674 or [email protected]