Speedread: Alongside Wednesday’s Spending Review, the government and the UK Statistics Authority (UKSA) have published their response to the recent consultation on reform to the RPI. The outcome to the consultation states that “it is UKSA policy to address the shortcomings of the RPI in full at the earliest practical time”. The earliest the proposed changes can legally and practically be made by UKSA will be February 2030.
The RPI is described as the oldest measure of consumer prices in the UK and is used widely across the economy and in financial contracts. However, for some time the government has perceived that the RPI has a number of shortcomings which, more often than not, overestimate the rate of inflation.
What is changing and when?
As an official measure of inflation, the RPI is used for a variety of purposes including the calculation of interest and redemption payments under index-linked government bonds. If the RPI is recalibrated then this could mean lower returns for funds which have invested heavily in those assets. In view of this the Chancellor has now confirmed that he will not consent to a change to the methodology of the RPI before the current proposed date of February 2030, which is when the last of the RPI-linked gilts mature.
The change, when it happens, will bring the methods and data sources of the Consumer Prices Index (including owner occupiers’ housing costs (CPIH)) into the RPI.
What is the practical impact for real estate?
In real estate transactions, many rent adjustment clauses (and service charge caps) are index-linked by reference to the RPI. This method of rent review is particularly popular in sale and leasebacks and other fixed income deals.
When the formulae used to calculate the RPI are altered to bring the index more in line with the CPI, the likely practical effect of such a change will be to reduce the increases in rent where they are linked to increases in the RPI. Parties who have negotiated clauses in the expectation that the RPI would give a greater return will not welcome this change, whilst others may well argue that index-linking is supposed to reflect inflation and the formulae used to calculate the RPI do not accurately do so.
Additionally, in some contracts, drafting will have been agreed which effectively seeks to preserve the original method of computation even after a material change in the RPI methodology, although how straightforward and/or contentious this might be to implement will remain to be seen.
In the meantime, for those contemplating entering into new index-linked deals, now is a time to give pause for thought about the choice of index if a contract’s duration will extend beyond February 2030, at which point it now seems certain the change will be made. Index-linking is unlikely to die out as an appropriate method of rental uplift, but the choice of index and, perhaps, the use of caps and collars will now come into sharper focus.