By Ben Darlow, legal director and commercial development specialist, and Simran Kang, trainee solicitor at law firm, Shakespeare Martineau
The Retail Price Index (RPI) has long been the default reference for inflation, despite having many shortcomings. Now, moves are being made by the Government to phase its use out by 2030 in favour of new, more ‘reliable’ metrics, the Consumer Price Index (CPI) and Consumer Price Index with Housing costs (CPIH). This will shake up property prices, and if not taken into consideration could potentially jeopardise a landowner’s future earnings. It’s crucial that an informed decision about which inflation metric to use is made well before 2030, to give landowners enough time to adjust and monitor the potential impact it may have on any agreements they have in place or are currently negotiating.
RPI, CPI and CPIH are indicators that track inflation by measuring the cost of selected goods annually. Because the metrics do not use the same items to calculate the final figure – RPI tracks 730 items, CPI tracks 650 items and CPIH tracks those same items but also factors in council tax and housing costs – they can end up with wildly different inflation percentages.
In almost all property agreements where indexation is a factor, RPI is often blindly accepted as the benchmark for inflation, without being interrogated. Allowing for adjustments to values in property agreements according to, for example, CPIH instead can have massive implications on the amount of those values, potentially producing much lower or much higher receipts for landowners depending on what measure of inflation is adopted.
It is imperative that this issue is considered in property deal negotiations taking place now, as many agreements (such as those relating to the promotion and development of land) can last over 20 years, spanning several periods of financial turbulence. It is important to ensure that landowners are being properly compensated in property negotiations, especially at a time when the property market is particularly volatile.
Landowners can take two immediate actions to mitigate the impact:
Firstly, for agreements that have been entered into recently, but end after 2030, it is important to read over the property agreement carefully as most do not state which other measure will be used in its place. Instead, they can state that if RPI at some point no longer exists, both parties will reasonably try to agree an alternative. However, this can lead to a stalemate with both parties wanting to pick a metric that suits their own needs.
As it currently stands, both parties have time to measure the data over a period of years, therefore ensuring the most appropriate inflationary measure is picked. Taking these precautions now will allow both parties time to make an informed decision and permit plenty of time for negotiations and potential variations of current agreements.
Secondly, for agreements that have not yet been made, deciding which measure is used should also be added as a point of discussion during negotiations. It is important for land agents to be as informed as possible and not simply go for the generally accepted RPI, as this may be detrimental to their clients’ interests. In addition to this, agreeing a suitable metric beforehand makes for a smoother process later down the line. However, if RPI is beneficial at the current point of negotiation, using it may be logical, as long as discussions are had around which metric will be used in 2030 when RPI is phased out.
Before concluding any negotiations, it is important to consult professionals who will be able to give specific advice on the pros and cons of using different inflation benchmarks. This includes legal advisors, as well as accountants, financial advisors and land agents, who can all contribute to this discussion and show how different metrics will affect different parts of the landowner’s business and the transaction.
RPI being phased out by 2030 is a nuanced and important change that anyone involved in property or land development should be aware of now. Being prepared and lining up a new inflation metric in property agreements will make for a smoother and fairer process on all sides. Although it is not necessary to know all of the answers about inflation metrics, it is incredibly important to ask the right questions to the right people and aim to be as informed as possible.