The Government’s Plans to Replace RPI for Commercial Landlords and Leaseholders

The Retail Prices Index (RPI) has, for many years, served as a cornerstone in commercial lease agreements across the United Kingdom, functioning as a benchmark for rent reviews and annual increases. The government’s recent decision to replace RPI with alternative inflationary measures has prompted considerable attention throughout the commercial property market. Both landlords and leaseholders are required to adapt to the consequences of this significant development, which promises to redefine rent adjustment mechanisms and the negotiation of lease terms. 

This article provides an in-depth examination of the proposed reforms, the rationale underpinning them, and their potential impact on stakeholders within the commercial property industry.

Understanding RPI and Its Role in Commercial Leases

RPI, or the Retail Prices Index, is a long-established measure of inflation within the United Kingdom, tracking changes in the cost of a fixed basket of goods and services over time. In contrast to the Consumer Prices Index (CPI), RPI includes the cost of housing, such as mortgage interest payments and council tax. Due to these features, RPI has been widely used in the property sector, particularly in rent review clauses that enable rents to rise in accordance with inflation. This practice provides landlords with protection against inflation while allowing tenants clarity and predictability regarding rent adjustments. RPI-linked clauses have thus become a standard feature in office, retail, and industrial leases.

Rationale for Replacing RPI

The government’s intention to replace RPI is informed by longstanding criticisms concerning its methodology. Both the UK Statistics Authority and the Office for National Statistics (ONS) have identified flaws in the formula used to compute average price changes, which often results in RPI overstating inflation compared to other indices, such as CPI or CPIH (Consumer Prices Index including owner occupiers’ housing costs).

Moreover, RPI is no longer designated as a “national statistic”, with the ONS actively discouraging its use for official purposes. Critics assert that the continued deployment of RPI in commercial leases leads to disproportionately high rent increases, placing undue pressure on commercial tenants, especially in adverse economic conditions.

In response to these concerns, the government announced, in 2020, its intention to align RPI with CPIH by no later than 2030, thereby retiring RPI as a standalone index. This reform holds considerable consequences for both existing and future commercial lease arrangements.

Details of the Transition Process

The government has established a phased timeline under which RPI will be rendered obsolete and replaced by CPIH by 2030. Many stakeholders have already begun to anticipate this transition, with new leases increasingly referencing CPI or CPIH as the basis for inflation-linked rent adjustments.

Find the key aspects of the transition below.

Existing Leases

Leases that expressly reference RPI will continue to do so for the duration of their term, unless amended by mutual consent. After 2030, however, RPI calculations will conform to CPIH, thereby producing effects similar to clauses referencing CPIH.

New Leases

It has become increasingly common for new commercial leases to reference CPI or CPIH for rent reviews. This approach is designed to prevent disputes or confusion as the transition is formalised.

Contract Negotiations

There is now frequent negotiation regarding the appropriate inflation measure, with parties considering the expected long-term shift and the relative stability of CPIH in comparison to the more volatile RPI.

Implications for Commercial Landlords

For commercial landlords, the predominant concern is the prospect of reduced rental growth. As RPI has historically exceeded CPI and CPIH, rents indexed to the new measures are anticipated to rise more moderately. This development may, over time, affect investment returns, property values, and the perceived attractiveness of commercial real estate as an asset class.

Landlords are encouraged to review their lease portfolios to assess exposure to RPI-linked clauses, particularly regarding agreements that may extend beyond 2030. Effective communication with tenants and a proactive approach to renegotiating lease terms may be necessary to safeguard compliance and minimise disputes under the evolving regulatory framework.

Some landlords may consider adopting alternative mechanisms for rent adjustment, such as fixed or stepped increases, although these methods may not offer the same degree of inflation protection as index-linked arrangements.

Implications for Commercial Leaseholders

For leaseholders, the transition is generally advantageous. CPI and CPIH generally yield lower annual rental uplifts, resulting in a more gradual increase in rental costs. This change is likely to provide greater financial certainty and alleviate pressure on businesses, particularly those continuing to recover from the economic effects of recent global events.

Nevertheless, not all tenants will benefit immediately. Those bound by existing RPI-linked leases will continue to experience higher increases until such agreements expire or are renegotiated. When entering new lease agreements, tenants are advised to ensure that any inflationary indexation is clearly articulated within the contract to preclude ambiguity or future disputes.

Legal and Practical Considerations

The transition presents several legal and practical challenges, including the need for careful navigation of changes to lease terms and potential disputes arising from differing interpretations. Landlords and tenants must fully understand the implications of shifting indexation methods to ensure fair and consistent lease agreements moving forward.

Variation of Existing Leases

Amending the index used in a current lease requires the consent of both parties. Without mutual agreement, RPI-linked clauses will remain operative until expiry, even after the methodology underlying RPI is redefined.

Risk of Disputes

Uncertainty or lack of clarity regarding the transition may give rise to disagreements, particularly concerning interpretation of the equivalence of “RPI = CPIH” post-2030.

Market Fragmentation

The simultaneous use of RPI, CPI, and CPIH across active leases may generate market inconsistencies, complicating benchmarking and comparative analysis.

Lease solicitors recommend that both landlords and leaseholders undertake a thorough review of all lease agreements, clarify indexation terms, and consider renegotiating provisions as appropriate to mitigate the risk of future disputes.

Market Response and Best Practices

The commercial property market has responded proactively to these impending changes. Notable trends include:

• Increasing adoption of CPIH in new lease agreements and renewals
• Enhanced clarity in drafting inflation-linked clauses, with clear stipulations regarding the handling of index changes
• Constructive engagement between landlords and tenants, sometimes resulting in hybrid indexation formulas or the inclusion of caps and floors to balance risks and rewards

Professional organisations, such as the Royal Institution of Chartered Surveyors (RICS) and the British Property Federation (BPF), are issuing updated guidance and model clauses to support stakeholders through the transition.

Recommendations for Stakeholders

As the 2030 deadline draws nearer, it is incumbent upon landlords and leaseholders alike to take proactive measures:

• Conduct a comprehensive review of lease portfolios to ascertain the extent of RPI exposure
• Consult commercial lease solicitors or a commercial property solicitor to interpret the implications of existing lease provisions and assess the necessity of renegotiation
• Ensure that all new lease agreements employ clearly defined and current inflation measures, with accompanying provisions regarding potential future changes
• Foster open and transparent communication with contractual counterparts to mitigate misunderstandings and promote collaborative solutions

Find Expert Property Advice From Paddle & Cocks LLP

The government’s initiative to replace RPI in commercial lease arrangements constitutes a significant turning point for the UK’s commercial property sector. While the transition is anticipated to benefit leaseholders through more moderate rent increases, it will necessitate diligent management by all stakeholders to minimise legal disputes and market disruption. By adhering to best practices and maintaining clear communication, landlords and tenants can successfully navigate this transition and establish robust, future-proof commercial relationships.

How We Can Help

Paddle & Cocks LLP, based in Cornwall, is uniquely positioned to offer expert advice on commercial lease agreements. Cornwall's rich history in property management and its thriving business community provide the perfect backdrop for our specialised services. Our deep understanding of local market dynamics, combined with our commitment to protecting the interests of both landlords and tenants, ensures that our clients receive the most comprehensive and reliable guidance. 

Trust Paddle & Cocks LLP to navigate the complexities of commercial leases and secure your investment with confidence. Contact us directly to speak to our team today.