Background

The Retail Prices Index (RPI) is a measure of inflation and is widely used in real estate documents, particularly for index-linked rent reviews and service charge caps.

One reason for its popularity over other measures of inflation, such as the Consumer Prices Index (CPI), is that historically the RPI's methodology has often produced greater increases. The Office of Budget Responsibility website explains that: "RPI differs from CPI due to the way in which the indices are constructed, the goods and services included in the indices, and the representative population they cover. This creates a 'wedge' between RPI and CPI inflation, which we have previously estimated to be around 0.9 percentage points in the long run".

However, the shortcomings in the methodology behind the RPI led to it losing its status as a national statistic in 2013 with CPI subsequently becoming the UK's primary measure of inflation. It also led to a joint consultation in 2020 by HM Treasury and the UK Statistics Authority about reform to the RPI methodology. The consultation concluded that:

• RPI should continue in existence and continue to be published;
• the method and data sources of CPIH (being CPI including owner occupiers' housing costs and council tax) should be brought into the calculation of RPI from February 2030. In practice, this will mean that monthly growth rates of CPIH will be applied to the RPI from 2030 and, in turn, the annual growth rates of the two indices aligning from February 2031. This change is likely to result in lower RPI increases as CPIH has historically been lower than RPI (and, in turn, the "wedge" between RPI and CPI is likely to narrow);
• RPI and CPIH should continue to be calculated and published as separate indices; and
• the supplementary and lower-level indices of the RPI (such as RPIX) should be discontinued as and when changes are made to the RPI methodology.

Publications on the Office for Budget Responsibility's website (see, for example, The long-run difference between RPI and CPI inflation) maintain the ongoing intention to implement these changes in 2030.

Why this matters now

While the proposed changes will not take effect for several years, they are of relevance now to any real estate document that has been negotiated, or is being negotiated, with RPI-linked provisions and a lifespan extending into 2030 or beyond (including where there is a statutory right to renew).

The key implication is that the changes in RPI methodology in 2030 is likely (based on past performance) to result in lower/slower increases in RPI for the reasons set out above. For new documents, this may be enough to discourage the use of RPI. For existing documentation, in the absence of any appropriate substitution provisions, this may prompt landlords to request re-gears. In both cases, if an alternative index is to be used, it is worth noting that only straight-line RPI rent increases in the first five years of a lease term are treated as excluded adjustments and disregarded for SDLT purposes – reviews based on RPI +/- percentage points or based on another index such as CPI are not currently treated as excluded adjustments.

Where an agreement with RPI provisions extends into 2030 or beyond, consideration should also be given to what, if any, provisions for substitution of another index or mechanism are in place or should be put in place. This includes assessing:

• the trigger for the substitution provisions. For example, if the trigger is non-publication of the RPI or rebasing of the RPI, the substitution provisions are unlikely to be triggered by a change in methodology, which is what is currently being proposed for 2030;
• what the substitution should be. While some clients are now opting for CPI + 1%, there is no guarantee that this formula (or any other) would deliver results equivalent to RPI if it continued with its current methodology. There is also a balance between prescribing the alternative mechanism now and retaining flexibility to choose an alternative mechanism at the relevant time; and
• if the alternative mechanism is to be determined, the process for determining that mechanism. Often this will be by agreement between the parties and in the absence of agreement by third-party determination. Thought should be given to whether this is appropriate and, if it is, what type of third-party determination would be most suitable.

Another issue on the horizon is the treatment of leases with RPI provisions on any statutory renewal pursuant to the Landlord and Tenant Act 1954. Here, it is worth remembering that the starting position for the terms of the renewal lease is the terms of the existing lease and that any party wishing to deviate, for example, to introduce an alternative mechanism or substitution provisions will need to justify its position.

Conclusion

While RPI methodology changes will not take effect until 2030, now is the time to review affected agreements and consider appropriate index substitution provisions. This is particularly important for large portfolios, where even small changes to an index could have significant portfolio-wide financial consequences that would need to be factored into business plans going forward. Early assessment of existing portfolios and thorough acquisition due diligence will help you avoid financial surprises later. Please contact our team for help with any legal review of documentation.

This article includes contributions from Sophie Marks, Real Estate Paralegal.