CPI stands for Consumer Price Index. PPI stands for Producer Price Index. CPI and PPI are two inflationary measures used to calculate the change in prices of a set of services and goods. However, the two price indexes have fundamental differences and intend to demonstrate different aspects of economic activity. CPI and PPI target different types of goods and services.
CPI refers to goods and services bought for consumption by US residents, which can include imports. CPI is primarily used to adjust income and expenditure streams for variations in the cost of living. PPI is a broad index that focuses on the whole output of producers in the US, including goods and services purchased by consumers directly from producers and retailers. PPI is primarily used to deflate revenue streams to measure real growth by adjusting inflated revenue sources. Unlike CPI, PPI does not include imported goods.
When it comes to commercial real estate, CPI is the metric that property owners use as an economic indicator and to gain insight into tax structure changes. More importantly, CPI and the current inflation rate give a property owner insight into how to increase or decrease rent fairly.
The impact inflation has on commercial real estate The CPI was at 8.5% in March 2022, the highest in 41 years. Data shows that the CPI slowed to 8.3% in April. And PPI has increased by 11.2% over the past 12 months. But how does rising inflation impact the commercial real estate market?
Inflation affects supply and demand and the general cost of purchasing and production. Inflation also impacts operational costs. So, when maintenance expenses, utilities, and insurance prices go up, expect a decline in overall cash flow. When the CPI fluctuates, commercial real estate leases can be determined by tying base or additional rent to the national or regional CPI, which is common in government leases.
Commercial real estate investors can react to the impacts of rising inflation depending on the type of asset. For example, the property owner of a fully-leased asset on a long-term lease would be locked in a longer rent schedule and cannot change contract terms or rent quickly to keep up with rising inflation. On the other hand, an owner of a property on a shorter-term lease would be able to adjust the rent to keep pace.
Because of the fluctuations in inflation, many landlords use a CPI index clause in their leases, which adjusts rent to correspond with changes to inflation rather than a fixed percentage increase. A common CPI clause would include:
* The selection of a base month.
* Selection of a specific index.
* Timing of adjustment.
* Minimum or maximum caps.
Do you need advice on how to include a CPI clause in your lease? To understand how CPI impacts your commercial real estate investment, contact us at email@example.com