Fixed annual rental increases or CPI annual increases?

I am often asked by clients negotiating new leases whether it is better to go for fixed annual increases or CPI-linked increases.

Historically, fixed increases have been around 3–4% per year, while CPI increases have typically been set at CPI plus 1% per year.

Over the last 25 years, CPI has averaged approximately 2.5% per annum. While we saw a spike in the CPI in 2022 due to COVID-related spending, the Reserve Bank’s ongoing goal is to maintain inflation between 1% and 3%. Therefore, it would not be unreasonable to expect CPI to average around 2.5% over the next 10 years. Landlords securing a 4% fixed increase should therefore be better off than those who negotiate CPI plus 1%.

However, the leasing market heavily influences these negotiations. With vacancies rising over the past 12 months, the landlord’s position has softened, and a 4% fixed increase or CPI plus 1% may not always be achievable.

Personally, I prefer fixed annual increases. They provide both the landlord and the tenant with certainty around future rent levels, which is also valued by banks. Fixed increases are easier to manage, as there is no need to calculate CPI each year or notify the tenant of the adjusted rent. With fixed annual increases, the tenant knows what the rent will be in the years ahead.

While annual fixed or CPI increases are beneficial, research shows that market rents often surpass these rates of increase. Therefore, whether you choose fixed annual increases or CPI adjustments, it is essential to include market rent reviews at lease renewal dates or, for leases nine years and longer, at least every five to six years. I also suggest including a “ratchet clause” to ensure the rent never falls below the amount paid in the previous 12 months, in case a rent review coincides with a dip in the market.

I am aware of some leases that include annual increases, a market rent review every three years, and a ratchet clause. These leases heavily favour the landlord and, in my experience, are only achieved when the tenant is under pressure to secure the premises.

If you feel your current rental returns are not in line with market rates, and that you may be subsidising your tenant’s business rather than receiving a fair return, please feel free to reach out. I have helped many clients secure market-appropriate rentals without damaging their relationship with the tenant.

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