It’s a RPI Off!

Background

Inflation in the United Kingdom is measured using various indices by reflecting the period-to-period proportional change in the prices of a fixed set of consumer goods and services of constant quantity and characteristics, acquired, used or paid for by the reference population in the UK. The indices are published by the Office for National Statistics (ONS).

RPI

One such index is the Retail Prices Index (RPI) which measures the average change, month to month, of the cost of specific retail goods and services in the UK, including mortgage interest payments. Although it is still published as it continues to be used, RPI is no longer the principal measure of inflation of the UK, and the Consumer Prices Index (CPI) is now used more widely. In 2013, the ONS, determining that the formula used to calculate RPI did not comply with international standards, withdrew its status as a national statistic.

Annual RPI increases have typically tracked at about 1% above CPI and it is likely that this is the reason why RPI is still widely used in property transactions. In commercial leases where landlords want to hedge their inflation risk, instead of an open market rent review, annual rent payable is sometimes linked to the greater of: the amount payable on commencement of the lease, and that figure as adjusted by the increase in RPI over a certain period of time. The same is often seen with service charge cap figures.

Developments relating to RPI

Back in March 2020, in a bid to make RPI more internationally acceptable, HM Treasury launched a joint consultation between the government and the ONS’s regulator, the UK Statistics Authority (UKSA), on potential changes to the RPI methodology and, in particular, the realignment of RPI with another index, namely CPIH, which is CPI plus housing costs[1]. 

The response to the consultation, confirming that UKSA would be allowed to make changes to RPI after February 2030, was published in November 2020 and, despite an application for judicial review (initiated by the trustees of the BT, Ford and Marks & Spencer (M&S) pension schemes), the High Court has ruled that the UKSA decision to align RPI to CPIH was lawful. Consequently, the proposed reform will go ahead.

As yet, it is unknown whether the ONS will cease to publish RPI or whether they will retain it but alter its method of calculation. There is also the possibility that the ONS may specify another index as RPI’s official replacement.

Potential effect on calculation of rent under commercial leases

Since CPIH generally results in a lower measure of inflation than RPI (at around 1% less annually since 2011), commercial lease rent payments linked to the new measure will likely result in lower increases than have traditionally been the case.

Consequences for commercial real estate players and practitioners

Real estate documents that have not been completed and that will remain in force during or after 2030 should either not employ RPI or should contemplate that, come 2030, there is likely to be the need to use another index, if and when necessary. The relevant document should include a clause prescribing an alternative index, such as CPI or CPIH, or even a combination of CPIH plus a specified percentage increase to bring it more into line with a traditional RPI increase (for example, the rent will be increased by CPIH + 1% or + 2%).

With regard to existing leases prescribing RPI, these should be reviewed to establish potential exposure to lower than anticipated rent reviews in the future. They should also be scrutinized to identify whether the existing drafting allows for the substitution of an alternative index in the event that RPI is no longer published, if there is any change to the methods used to compile RPI (including any change to the items from which RPI is compiled), or if the reference base used to compile the RPI changes, to better understand what options will be available in 2030 and beyond.

No doubt there will be a rise in disputes in this area where existing drafting neither expressly states that a different index can be used nor caters for a change in index. Parties should investigate whether their documents contain dispute resolution clauses capable of being used to resolve potential arguments surrounding the change in RPI.

Please contact us if you need any help in exploring your options in connection with the anticipated changes.

[1] In contrast to RPI, CPI takes no account of housing costs, hence the need for CPIH which has the same basis as CPI but includes “rental equivalence”, being how much rent a householder would pay for an equivalent property. This is to be differentiated from RPI where the housing element is mortgage payments.