Increase in the consumer price index of commercial leases
Commercial leases for office, retail and other commercial space typically contain two elements of rent: (i) a base rent calculated by multiplying the rental rate per square foot by the leasable square footage of the leased space, and (ii) a maintenance of common areas (CAM) calculated by multiplying the tenant’s proportionate share of the total leased space in the building by the amount of operating expenses, such as utilities, repairs, maintenance, taxes and insurance, incurred by the owner. Usually, the base rent increases each year according to an agreed “escalator”.
Consumer price index
For many years, the commonly used indexation for rent increases was the Consumer Price Index (CPI). The CPI, which officially originated in 1919, is a measure of the average change over time in the prices paid by urban consumers for a basket of consumer goods and services. Indexes are available for major consumer expenditure groups, such as energy and food and beverages, housing and medical care. Indices are available for the two population groups of census geographic areas: a CPI for all urban consumers (CPI-U), which covers about 93% of the total population, and a CPI for employees and salaried employees. offices (IPC-W), which covers 29% of the population.
The particular CPI that has been used for rent increases is CPI-U, All Urban Consumers, US City Average, 1982/84=100. In 1988, the CPI baseline was changed from 1967=100 to 1982-84=100 to coincide with updated expenditure information prepared for the Bureau of Labor Statistics for 1982, 1983, and 1984. The calculation of the annual indexing is simple. ; it is determined by subtracting the CPI of the immediately preceding rental year from the CPI of the current rental year and multiplying the result by 100.
Over the past 20 or so years, the use of the CPI has declined for two main reasons. First, calculating annual rent increases using the CPI can be administratively cumbersome for both landlords and tenants; second, and most importantly, the rate of inflation has been relatively low and stable. Underlying inflation has averaged 2.15% per year between 1995 and 2022. As a result, landlords and tenants have chosen to use a fixed percentage, say 2%, as the escalator.
But over the 12 months from January 2021 to January 2022, the CPI-U increased by 7.5%, not seasonally adjusted. This is the largest 12-month increase in 40 years. Food prices rose 7%, while energy prices rose 27%. This reflects an inflationary trend that began several months ago and which analysts predict will diminish in the latter part of 2022. The horrific invasion of Ukraine and the effects on energy prices, coupled with the problems supply chain issues, however, have made these projections more uncertain. . But the harsh reality is that the rate of inflation could continue to be well above the average annual rate of 2.15% since 1995.
Given these changes, landlords must now reconsider the escalation to be used for rent increases in new leases and lease renewals, including the possible reuse of the CPI, either alone or in conjunction with one or several other indexes. Additionally, landlords locked into long-term leases with a fixed percentage of rent escalation below the rate of inflation may face the challenge of seeking ways to renegotiate those leases within the parameters of contract law. Conversely, tenants considering entering into new commercial leases now face the challenges of negotiating rent indexation that does not burden the lease too financially and the prospect of landlords seeking to renegotiate rent indexations. rent.
©2022 Norris McLaughlin PA, All Rights ReservedNational Law Review, Volume XII, Number 61