Last month, the Office for National Statistics published a consultation on options for amending the way that the Retail Prices Index is calculated.
The consultation closes on 30 November 2012 and any changes would be introduced in March 2013.
The consultation is about the so called "formula effect" which gives rise to differences between the RPI and the Consumer Prices Index (CPI) estimates of inflation. The formula effect results in the RPI increasing between 0.5% and 1% per year more than the CPI. Although the consultation is primarily about statistical methodology, any change is likely to result in increases in the RPI being closer to increases in the CPI. This change could impact on a number of real estate transactions.
Despite the many uses of the RPI in real estate, the real estate sector is not mentioned in the consultation, which focuses on government bonds, regulated charges such as rail fares, taxation rates and private sector pension funds.
Many leases provide for increases in rent and other sums to be linked to increases in the RPI. This is particularly the case for sales and leasebacks where occupiers require cost predictability. It also gives investors predictable rental growth, which may need to match the growth in their liabilities, particularly if they are pension funds. The RPI is used to calculate increases in the uniform business rate, in service charge caps, and in swap rates in financing transactions.
Some leases deal with what happens if the RPI ceases to be published, is rebased, or the method used to compile the RPI is changed. Such clauses may provide that the parties will agree a suitable replacement index, or continue as if the method had not changed.
Changes in the method could therefore result in uncertainty in the index to be used, or a lack of transparency when trying to operate rent review provisions. If the investor and the occupier have made assumptions on the increases in the RPI, the result may be a change to the commercial deal, and there could be a negative effect on valuations.
If you have any views on the changes to the RPI we would be interested in hearing from you.