Consumer Price Index (CPI) is a commonly used metric for measuring inflation. Simply put, the CPI measures the price of goods and how they are trending by measuring change in the prices paid by consumers for goods and services over time.
How Does the Consumer Price Index Affect Commercial Real Estate?
In commercial real estate, the Consumer Price Index (CPI) refers to the lease amount paid by urban consumers for housing services and how that pricing corresponds to regional or national inflation. CPI enables property owners to fairly increase or decrease initial base rent required to be paid by a tenant over a period of time, depending on the changes in the regional or national inflation (or deflation) rate.
How Is the CPI Used?
The Consumer Price Index is used for several purposes. Some of them include:
The CPI is a widely used measure of inflation, and it can be employed to assess the effectiveness of government economic policies. It serves as a basis for individuals, governments and corporate bodies for making sound economic decisions and how price change influences sensitive assets, bonds and commodities.
A Metric for Adjusting Dollar Values
The CPI allows appropriate changes and adjustments to be made for different types of payments. For instance, the CPI gives insights into changes in tax structure, government assistance programs and pensions. It also impacts wages and salaries and how they influence cost of living.
Deflator of Other Economic Series
The CPI is a metric that gives insight into how to make adjustments for other economic series such as hourly, and weekly earnings and retail sales.
Example of CPI in Real Estate
The CPI gives insight into how to fairly increase or decrease the amount of rent required to be paid by a tenant over a period of time, depending on the current inflation rate. For instance:
The formula for CPI = (Ct/CO) * 100.
Ct = cost of market basket in current period
CO= cost of market basket in base period
To be able to account for the adjustment, you have to determine the index adjustment multiplier, which is:
(Current index – Base index) / Base index
Hence, if the index value for a lease in 2020 was 215.00 and in 2019 was 196.67. Then the index adjustment multiplier would be:
(215 – 196.67)/ 196.67 = 0.09. In percentage, this equals 9%.
If the initial base rent in 2019 was $20,000, then the value becomes $20,000 * 0.09 = $1,800.
The $1,800 represents the increase caused by the change in CPI, so, effective from 2020, the annual base rent would be $21,800 and would be up for re-calculation in 2021..
Is CPI Important?
CPI is important for investors for many reasons. First, inflation rate can have an impact across the financial market in any given economy. It affects the stock market, value of bonds and commercial property values. For businesses operating in a rising inflation rate environment, cost of operations become more expensive, profits may decline and stock prices may even fall.
What Is the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a metric that measures the weighted average price of a basket of consumer goods and services. A market basket of consumer goods and services refers to sets of items that people buy on usual basis such as food and beverages, housing, medical care, transportation, recreation, clothing, education and communication services.