It was late January 2000, when Steve the property manager was looking over the leases for a downtown office building and calculating the annual Consumer Price Index (CPI) increases for the tenants in the building. This year the CPI had increased by 2.7% compared to last year's 1.6%. As he looked into the expenses for the year he felt that his clients were being shorted. He felt sure that expenses were greater than 2.7%. He started wondering if the annual CPI increase was really the best way to increase the rents. So he started doing some research. This is what he found:

As part of the lease negotiations landlords have several choices available to increase rents to keep up with the expenses. One option is for Tenants to pay a fixed amount that is pre-negotiated as a rent increase. Another option asks Tenants to pay the difference between the base year rents and yearly expense increases. Finally, landlords use the Consumer Price Index (CPI) as a way to adjust their tenants rent's annually.

For ease of calculation (and negotiation with a potential tenant) many leases have included an annual CPI adjustment, to keep up with expenses or interest rate increases. In the early 90's pressure was put on the Bureau of Labor Statistics to make a major (once in a decade) change in the calculations of the CPI.

There was a sense that the CPI reflected a high percentage of inflation, so the Bureau tweaked the CPI in 1995 and again in 1996 with changes to the CPI Sample rotations. In the last two years the CPI has been adjusted even more. In February 1998 a new geographic sample item structure was created by the Bureau of Labor Statistics. From June 1998 to February of 1999 a new housing sample was built into the CPI, and in October of 1999 the redesigned Consumer expenditure survey was introduced. These last two adjustments were meant to lower the indicator.

To the average landlord these changes may seem insignificant. But if you have followed the increases in CPI over the last 25 years you will notice a slowdown in the CPI increases. This slowdown has dropped the CPI increases lower than the actual cost increases experienced by landlords.

Look at the numbers above, and then consider the estimated cost increases for downtown office buildings from the Building Owners and Managers Association. For instance, BOMA reports that such costs rose 4 percent for operating and fixed expenses in 1997 and 3 percent in 1998. For 1999, expenses actually fell from $9.67 per square foot to $9.61. Overall, however, for the three-year period the CPI did not keep up with real-world costs, and for 1998 and 1997 the CPI was significantly lower than actual expense increases. (Figures for the year 2000 will not be available until this summer.)

Or, consider a state where taxes and labor costs are forcing up costs by 4 percent a year -- not an unusual or unreasonable increase. If a landlord has expenses rising at 4 percent a year and leases automatically rising according to the CPI, then the landlord is losing.

As Steve reviewed these numbers he thought of a couple of options he could recommend to his clients to make up for the shortfall in income.

Published: March 7, 2001

Use of this article without permission is a violation of federal copyright laws.

Clifford A. Hockley is the President of Bluestone & Hockley Real Estate Services, one of the larger brokerage and property management companies in Portland, Oregon. Mr. Hockley holds an MBA Willamette University and a B.S. in Political Science from Claremont McKenna College. He is a Certified Property Manager and Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM). Mr.Hockley serves as member at large on the Portland IREM board. He has twice been named Certified Property Manager of the Year (2001 and 2003) by the Institute of Real Estate Management and is a frequent contributor to industry newsletters.