The Critical Item In Your Lease Is Not The Rate But The CPI

By Robert Hand
July 12, 2023

Your lease always has language that describes how the rent you pay can be adjusted using the Consumer Price Index, meaning your rent payments increase at the end of each year because the rent rate you paid last year is multiplied by the index to determine the rent you pay in the next year.

The problem is that there is more than one Consumer Price Index and there are different ways to calculate each, so make sure your lease agreement contains language that is very specific. Most leases refer to the All Urban Consumers Price Index, but here are all four CPI databases:

The idea got its start in the 1970's when inflation was 20 percent and is meant to benefit only the landlord because it means the rental income to the landlord retains its purchasing power. One example of lease language referencing the CPI is:

How The CPI Is Calculated

So what is the Consumer Price Index and how is it calculated? The Bureau of Labor Statistics, under the Department of Labor, calculates the latest Consumer Price Index numbers. The CPIs are based on prices of food, clothing, shelter, fuels, transportation, doctors' and dentists' services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 housing units and approximately 22,000 retail establishments (department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments).

The All Urban Consumers Price Index consists of all urban households in Metropolitan Statistical Areas (MSAs) and in urban places of 2,500 inhabitants or more. It represents about 93 percent of the total U.S. population. Nonfarm consumers living in rural areas within MSAs are included, but the index excludes rural nonmetropolitan consumers and the military and institutional population.

In calculating the CPI, the urban portion of the United States is divided into 38 geographic areas called index areas, and the set of all goods and services purchased by consumers is divided into 211 categories called item strata. This results in 8,018 (38 × 211) combinations.

What Is Included In The CPI ?

The CPI represents all goods and services purchased for consumption by the reference population with all expenditure items divided into 211 categories, arranged into eight major groups:

  1. MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services).
  2. FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks).
  3. HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture).
  4. APPAREL (men’s shirts and sweaters, women’s dresses, jewelry).
  5. TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance).
  6. RECREATION (televisions, toys, pets and pet products, sports equipment, admissions).
  7. EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories).
  8. OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

Latest CPI Numbers Show a Trend Change

For the month of June 2023, the All Urban CPI rose 2/10ths of one percent and over the last 12 months increased 3.0 percent before any seasonal adjustments. This was the smallest 12-month increase since the period ending March 2021 and while some categories increased in price, others dramatically decreased. For example, the cost of shelter accounted for 70 percent of this increase because prices were 7.8 percent higher, but there was a major decline in the energy index which plummeted 16.7 percent.

CPI Data Just For The Southeast

The CPI is calculated for the U.S. as a whole but additional data is calculated for each state and also for each of the 7 regions. Louisiana specific data falls into the Southwest Region and Mississippi specific data falls into the Southeast Region. Above is the chart of CPI for the South Region which is comprised of Alabama, Arkansas, Delaware, District of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee, Texas, Virginia, and West Virginia. If you wanted your lease to more accurately reflect the CPI in your region, you would substitute these region numbers for the U.S. CPI numbers. For example, the 12 month South CPI rose 3.3 percent for the 12 months ending June 2023 compared to the U.S. number of 3 percent.

Summary: The 5 Things You Need Clear In Your Lease

  1. It Is Clear Where The CPI Is Published-If rent is tied to an index, what index is used and where can you find it? For example, the lease language can spell out that the rent is adjusted by the All Urban Consumer Price Index, and points out that the data is published by the Bureau of Labor Statistics, which is found easily online.
  2. It Is Clear What Type of Consumer Price Index Is Used-There are 4 methods used to calculate the Consumer Price Index, and if the parties both agree, they can select any method that works best.
  3. It Is Clear Whether The CPI Is Adjusted For Seasonal Changes-The CPI can be adjusted for changing climatic conditions, production cycles, model changeovers, holidays, and holiday sales which can cause variation in prices. For example, oranges can be purchased year-round, but prices are significantly higher in the summer months when the major sources of supply are between harvests.
  4. It Is Clear Whether The CPI Is National or Local-The CPI publishes unadjusted price indexes at the national, metropolitan area, and regional levels. So you could drill down and calculate your CPI based on your city’s MSA. This would be more meaningful if your economy is an outlier, such as Houston, Detroit, or New Orleans.
  5. It Is Clear How The Adjustment Is Applied-The CPI adjustment can applied to a lease payment monthly, quarterly, or annually, but be clear about what period of CPI is used. It is best that landlord and tenant agree the CPI is calculated based on the previous 12 months and applied to the last rent payment.

For more information on leases, read our blog "3 Common Mistakes In Every Lease".

Louisiana Commercial Realty

Commercial Real Estate Experts
Robert Hand, MBA, CCIM, SIOR
Licensed in Louisiana & Mississippi
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