Posted by John Pagliassotti on Friday, September 16, 2011
Lease-drafting Tip: anticipating delayed CPI reporting in Rent Adjustment Provisions
Rental adjustment provisions are a common component of commercial leases. These provisions are often linked to the rise and fall of the Consumer Price Index (CPI). Sometimes referred to as a Cost of Living Adjustment (COLA), these adjustments typically occur on the anniversary of the lease commencement date. Presuming the lease doesn’t contain a floor rent below which it cannot fall, if the CPI increases or decreases by 3% then the rent will increase or decrease 3% along with it.
An inherent problem with using the CPI as the index for adjusting rent is lag time in the government’s reporting the CPI. The CPI for January may not be published until March while the government gathers and analyzes data prior to releasing it to the public. Landlords must wait a few months before billing tenants for the newly adjusted rent, forcing them to bill tenants retroactively for the annual adjustment. This causes cash flow planning problems for landlords and can be downright irritating to tenants for whom retroactively invoicing causes budgeting problems and accounts payable hassles.
I have found one solution that mitigates the problem – setting the CPI index date as a date well in advance to the actual rental adjustment date. For example, if a lease commences in January and I want to bill and collect the adjusted rent annually in January rather than March, I set the CPI index date far enough in advance so that by January the percentage change has been reported and I am able to bill for the new rent in January. I have found that two months usually provides sufficient lead time without being so far in advance as to miss swings in macro-economic forces that would be meaningful to either party.
Conceptually, and in an abbreviated form, the lease language might read: "The monthly rent shall be adjusted annually in the month of January 2013. The adjustment will be based upon the difference in the CPI between the months of November 2011 and November 2012…"
Simple management tricks like this distinguish a good landlord from a great one.
One of the foremost experts regarding A.I.R. commercial real estate forms, Mr. Pagliossotti has 25 years of practical commercial real estate experience, including corporate real estate asset management, REIT oversight, commercial brokerage, and a significant private portfolio of domestic and international commercial real estate.