The base rent of commercial properties often increases every year according to criteria stipulated in the contract, with the two most common methods being flat rate and CPI.
In this post, we talk about flat rate and CPI lease increases, and discuss the pros and cons of each alternative.
Commercial Lease Increases: What Is a Flat Rate?
As the name implies, a flat rate increase means that the base rent of a commercial property will increase at a steady, agreed-upon rate every year.
The most important advantage of flat rate increases is that they are straightforward, easy to understand, and easy to calculate. This simplifies processes and reduces the administrative burden associated with managing a lease.
However, flat rate increases may be a disadvantageous choice during periods of high inflation. This hasn’t been a concern during the last two decades. But with inflation hitting record highs recently, the choice is not so obvious anymore.
Commercial Lease Increases: What Is CPI?
The acronym “CPI” stands for Consumer Price Index. The CPI is calculated by the U.S. Bureau of Labor Statistics (BLS) to measure “the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
To put it simply, the CPI measures inflation.
The government uses the CPI to ensure that the benefits it pays to certain people are in tune with the actual cost of living. However, this index is also relevant to commercial real estate because it’s often used as the “escalator” or reference to calculate lease increases.
How to Calculate a Commercial Lease Increase Using CPI?
The BLS publishes many different indices, but the most widely used is the one known as “All Items Consumer Price Index for All Urban Consumers” or CPI-U. However, you should review your contract to verify which index is being used.
To calculate a commercial lease increase using the CPI, you subtract the CPI for the immediately prior lease year (or base index) from the current CPI. Then you divide the result by the base index and multiply it by 100.
- For example, if the current CPI is 216 and the base index is 196, you would first subtract 196 from 216, so 216 – 196 = 20.
- Now we take 20 and divide it by the base index: 20 / 196 = 0.10
- Now, to determine your lease increase, you multiply 0.10 by the initial base rent. So if the initial base rent was $25,000, we have: 25,000 x 0.10 = 2,500
- Your rent increase will be $2,500. This means that instead of paying $25,000, your new rent will be $27,500
Flat Rate or CPI?
As you can see, the choice between flat rate or CPI is not an easy one.
There are many factors to consider, including expected inflation rates, the general economic outlook, and the state of your local commercial real estate market.
This post has provided you with the basic information you need to start the decision-making process. If you need a professional opinion, feel free to contact Chantel Aguilar. With extensive expertise and in-depth knowledge of the Southern California market, she is uniquely positioned to offer expert advice.
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