What is CPI in Commercial Property?
The consumer price index, or CPI for short, is a combined measure of price changes to a “basket” of goods and services that the typical consumer buys. It’s useful not only in determining the cost of living, but also to determine residential and commercial real estate rent adjustments. So, what is CPI in commercial property? Read on to learn more about CPI and why it matters.
How the CPI Works
The consumer price index is a measurement that is calculated by the Australian Bureau of Statistics (ABS) to keep track of household inflation. Inflation is defined as the change in the cost of the typical goods and services that households purchase. How the CPI works is that the ABS calculates the CPI each quarter based on the rate of change in the prices of a basket of goods and services. The basket includes housing, food and beverages, recreation, transport, health, alcohol, furnishings, insurance, education, clothing and communication.
The ABS releases its main inflation data each quarter, including information about which goods and services were responsible for any material changes in the inflation rate. To find out what is the current CPI in Australia, see the ABS website.
The quarterly CPI figure is used to index, or change, some government and private payments and costs so their value remains aligned with the inflation rate. The CPI is also the main indicator of the inflation rate, which is used to guide government and fiscal policies in Australia.
The CPI works to impact benefits or fees is that the indexation change over a period of time is applied to items like welfare payments provided by governments, government excise duties on products like beer and petrol and in business contracts like rental agreements. This is why CPI can impact commercial and residential rent prices.
CPI in Commercial Real Estate
When it comes to the CPI in commercial real estate, the index can be directly tied to rental agreements. Over a rental agreement period, the CPI index can be used as the basis for property owners to make fair rental adjustments based on the change in the CPI rate. This means that instead of a flat rate of increase over a given period, rental increases are linked with the rate of CPI change and calculated and adjusted at set times over the contract life.
With the consumer price index intended to reflect cost of living increases, CPI adjustments in commercial real estate agreements can be used to compensate for the likely change in the cost of services like maintenance and utilities. So, the CPI is used as a metric for adjusting the dollar values in commercial real estate rental agreements.
The CPI is not only produced as a national, headline figure, it is also calculated for each state. This means that the CPI indexation for commercial or residential real estate contracts may relate to the relative capital city inflation rate rather than the national figure.
An Example of Using the CPI to Adjust Rent Prices
When it comes to commercial real estate rent increases there can be a variety of different arrangements. Some contracts have fixed increases at timed intervals, other contracts use the rate of CPI to adjust rent prices at a point in time. This may be accompanied by a portion of a fixed rate of increase as well. It is important to understand which CPI rate will be applied to a rental agreement, such as the national weighted average of the eight capital cities or the individual capital city rate.
To understand how to work out a CPI increase on rent in Australia, you need to first understand your base index rate and the current CPI rate. Your base index rate is usually the rate of CPI at the time the lease was signed. The current CPI rate is the most recent index rate published by the Australian Bureau of Statistics. Once you have these two figures, a simple formula will help you work out the rent increase.
For example, if a rental agreement was signed in January 2021, the applicable base CPI index was 119.7. If the rent is due for review in January 2022, the applicable new CPI index was 128.4. To calculate the rate rise, subtract the base index figure (119.7) from the current index figure (128.4) and divide by the base index (119.7). That equates to an index increase of 7.26 per cent. Therefore, if your base rent is $100,000 , your rental increase will be $7,260.
Rental and housing costs are part of the basket of goods assessed when the CPI is calculated and any increases or decreases impact the resulting inflation rate. However, only the purchase of new dwellings is taken into account, while purchases of established dwelling are considered existing assets. The Reserve Bank of Australia says price inflation in rents and new dwellings is influenced by conditions in local housing and construction markets. This includes the cost of common materials used in construction such as timber, brick steel and concrete. The ABS surveys home builders to obtain the latest information about house prices. For rental prices, it tracks the rents paid on a sample of rental dwellings in capital cities and also tracks advertised rents.
When it comes to commercial leases and rental agreements, flat rate and CPI increases each have their advantages and disadvantages. Flat rates mean the lessee is clear about how much the rent will rise while CPI increases are less certain. If inflation is running low, this can be to a tenant’s advantage, however, if it’s running high, it can mean the rent increase will be higher than usual.
