commercial real estate · Malls · Office Properties · Retail leases · Shopping Center

Lesser of 3% or CPI – Caps in a world of high inflation

The January 2022 CPI just came out. 7.5% year over year. The highest in 39 years. Bob in my office joked about the happy dances some landlords might be doing because of CPI increases in their leases. Many leases still do have CPI adjustments – some on minimum/base rents, but more often than not, related to caps on Common Area Maintenance (CAM)/Operating Expense increases.

Tenant’s share of CAM charges shall not increase by more than the increase in the Consumer Price Index. In no event shall the increase by greater than 3% per year.

Tenant’s share of CAM charges shall not increase by more than the increase in the Consumer Price Index. In no event shall the increase by greater than 3% per year. The index can be defined many ways – for All Urban Consumers (CPI-U); for Urban Wage Earners and Clerical Workers (CPI-W); each of those with the possibility of being the US City Average, or for a specific City or Region; and with the possibility of using different base periods (1967=100; 1982-84=100). With the way the Bureau of Labor Statistics collects the data (pulling out specific or multiple items), there are thousands – probably tens of thousands – of ways the index might be defined.

You may look at the method in the quote above and think that you will just be getting a 3% increase this year, but there really is much more to consider.

If you saw this language, the first thing you should be thinking is whether the cap is cumulative or non-cumulative. Non-cumulative is easiest to understand. What was last year’s charge? If it is truly non-cumulative, the charge really can’t be increased by more than 3%. However, if it is cumulative, you would have to consider prior year charges.

There are many other variables I am glossing over in this following example including the actual CAM rate per square foot (which could make this much more extreme if actual was less than the cap in any year), but this will give you an idea of how this might affect a CPI calculation for the current year.

In the calculation above, you can see the January 2022 index is 281.148 and the January 2021 index was 261.582. Then you divide the 281.148 by the 261.582, you get 1.0748. That 7.48% – that’s the year over year increase in inflation that the media quotes.

That 7.48% – that’s the year over year increase in inflation that the media quotes.

But the difference between the non-cumulative (which applies the 3% increase to the prior year cap (or actual if less) and the cumulative (which applies the 3% every year to the original cap) in this case is over $.06/sf. If you have a 3,500 sf tenant, that is a $234.56 difference in the cap for the year.

Again, there are so many variables to be considered, each with the ability to make that difference much more extreme. And, there is even more to consider next year – specifically whether when calculating the CPI we are to calculate the year over year CPI (which we did above), or always go back to the base index. In the latter case, even without a cumulative cap, we might get the ability to pick up a bit of that 7.48% that we might not have been able to pick up this year.

Each case is a bit unique. If you have something a bit odd, reach out to me. I will be happy to walk you through it. But don’t just write it off. $.06/sf may not seem like much. $234.56 may not seem like much. Apply a cap rate (say 7.5%) to that $234.56 and you get $3,127.48 in value for the center. 20 tenants? That’s $62,550 in value for the property. Times the number of properties in your portfolio? Cumulative vs. non-cumulative in a period of high inflation can make a difference.

$.06/sf may not seem like much. $234.56 may not seem like much. Apply a cap rate (say 7.5%) to that $234.56 and you get $3,127.48 in value for the center. 20 tenants? That’s $62,550 in value for the property. Times the number of properties in your portfolio? Cumulative vs. non-cumulative in a period of high inflation can make a difference.

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