RPI Cha-Cha-Changes

The Retail Prices Index (RPI) has long been used as a measure of consumer prices in the UK and, as a result, the RPI regularly features in contracts, including property contracts. However, the RPI has long been dogged by claims that it can often overestimate the rate of inflation. As such, changes as to how the RPI is calculated are being proposed.

How is the RPI used?

The RPI is used for a range of purposes, including the calculation of interest and redemption payments under index-linked government bonds. If it is reformulated then this could mean that investment firms who have invested in such bonds would stand to have lower returns on their investments.

How is the RPI to be changed?

The Chancellor, Rishi Sunak, has confirmed that the formula used for calculating the RPI will not be changed before the current proposed review date of February 2030. However, following this review, it is likely that the use of RPI will be discontinued and it will be aligned with the Consumer Prices Index (including owner occupiers’ housing costs) (CPIH).

The Impact on Property

In Property transactions, many rent review clauses in leases are index-linked by reference to the RPI. These include rent reviews that are calculated by reference to RPI increases, Stamp Duty Land Tax (SDLT) and Service Charges in leases.

Rent review clauses calculated by reference to RPI increases

When the formula used to calculate the RPI is revised to align it with the CPIH, the likely effect will be to reduce the increase in rent when compared to the rent increases when linked to the RPI. This change will be profoundly felt by those parties who have negotiated RPI linked rent review clauses and will mean that the value of the investment property will decrease.

As such, landlords might wish to alter their rent review clauses to contain provisions which allow for an alternative index to be substituted if there is a material change to the way that the RPI is calculated. They should also include provisions to allow for rent review clauses to be linked to the CPIH going forward or ensure that the rent review provision allows for the original method of computation after the RPI formula has been revised.

Stamp Duty Land Tax

Any change to the RPI will also impact on SDLT. This is because SDLT is calculated when the transaction takes place and will take into consideration any changes to the rent payable in the first 5 years of the lease.

In circumstances where the rent review provision is RPI linked, the SDLT does not take into account the increase in the amount since it is deemed to be an excluded adjustment. However, a CPIH linked rent review provision is not excluded and will normally mean that a higher rate of SDLT would be payable.

Service Charges

As with the rent review provisions discussed above, capped service charges are usually linked to the RPI to reflect the increase in costs incurred by landlords in charging such services. Should the service charge fall if the RPI is aligned with the CPIH then landlords could be in a position where they are left out of pocket for the expenses incurred in maintaining the common areas and as such may wish to exclude certain services from the service charge cap.

Should you wish to discuss the above, please do not hesitate to contact Joanne McIvor or any member of the Property team.

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