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BE SURE YOUR CPI-BASED LEASE AVOIDS COMMON MISTAKES

BE SURE YOUR CPI-BASED LEASE AVOIDS COMMON MISTAKES

CPI does not protect inflation loss. You should lease up. Many do, few choose to pass on the opportunity to achieve long term peace and harmony with residents. Assuming leasing is for you (as is the case for most all park owners), that effort entails attention to term, COLA, CAM, Cacho Pass-throughs, Cap X, VD adjustments, market, financing, and inflation. Your lease options (yes, leasing means more than one choice and product) with the homeowner probably have terms that are not good such as just 100% CPI adjustments (because that alone falls short of compensating for loss of purchasing power). But the industry as a whole mostly relents to the story (CPI) that the BLS tells us (which they have re-defined 30 times during the last 20 years).

Let's just make sure lease renewals do not contain the most common mistakes. Even small mistakes can be very costly unless the lease is clear on every detail. All ambiguities are construed against the drafter absent a course of invoicing to show mutual intent performed before the existence of complaints and disputes.

Make Your Lease Clear How What CPI Is Used To Adjust Rent

Here is an example of the lease language used by a large company in 3,000 different locations:

"If this agreement is for a term of more than 12 months, the Provider will increase the monthly office fee on each anniversary of the start date. This increase will be by the local Consumer Price Index or such other broadly equivalent index where a consumer price index is not available locally."

Some would say this lease language leaves a gaping hole of uncertainty, because the Consumer Price Index has several ways of being calculated. The four types of Consumer Price Indices are:

All Urban Consumers (Current)-Consists of all urban households in Metropolitan Statistical Areas (MSAs) and in urban places of 2,500 inhabitants or more. Nonfarm consumers living in rural areas within MSAs are included, but the index excludes rural nonmetropolitan consumers and the military and the institutional population.

Urban Wage Earners and Clerical Workers (Current)-Consists of clerical workers, sales workers, protective and other service workers, laborers, or construction workers. More than one-half of the consumer income has to be earned from these occupations, and at least one of the members must be employed for 37 weeks or more in an eligible occupation.

All Urban Consumers (Chained)-The urban consumer population is deemed by many as a better representative measure of the general public because 90% of the country's population lives in urban areas. Using chained CPI means the rate at which Social Security benefits tick up would be slower, because it reflects substitutions consumers would make in response to rising prices of certain items. It utilizes a basket of goods and services that are measured changes from month to month; much like a daisy chain. If the cost of a certain form of transportation goes up, people might switch to another kind and this kind of "substitution" is part of what is factored into chained CPI. So the real costs which may spike, are discarded and attenuated, resulting in lower CPI. So CPI is not inflation adjusting, it is a political view of wishful thinking about inflation-the rates the public will better tolerate without efforts to 'throw the bums out."

Average Price Data- Calculated for specific items such as, household fuel, motor fuel, and food items. Average prices are best used to measure the price level in a particular month, not to measure price change over time.

There are other indices available which more accurately reflect inflation as a prime result of Quantitative Easing. Some of these are under development for leasing now and we expect to have progressive alternative "safety nets" available by Summer 2018.

The most common CPI Index is the All Urban Consumers Index, but it has two methods used to calculate the numbers: one uses a base period 1982-1984 as 100, and the other method uses a base period of 1967 as 100. Many leases make the mistake of not being clear about which index is used. In addition, the data can be seasonally adjusted or not seasonally adjusted (which is released more quickly).

Clearly Articulate How The CPI Is Calculated

As an example not for use in a mobilehome park but simply to illustrate, here is lease language which some suggest for a property that makes the CPI data source very clear:

"Consumer Price Index: It is further understood and agreed by and between Lessor and Lessee that, commencing with the first day of the second year of lease, the monthly rental as set forth above will be adjusted upwards at the beginning of the second lease year, and every year thereafter until expiration or termination of the lease using the all urban consumers (CPI-U) United States City Average, All Items, (1967=100) published by the Bureau of Labor Statistics, United States Department of Labor (referred to as "Consumer Price Index")."

CPI Adjustments Affect Property Value

Our economy today is driven by a different wage/price spiral which causes low inflation. One way to address the market, and at least the loss of purchasing power not reflected by CPI is to build in a fixed rate adjustment in addition to a CPI adjustment. The current CPI doesn't keep up with operating costs for mobilehome parks.

One strategy is to include lease language stating the rent adjusts based on the CPI or a fixed rate, whichever is higher. The 30 year table below shows how, during an extended period of low inflation, this strategy can dramatically increase the market value. This lease would include language with adjustments based on the CPI, which we assume in this scenario will continue at an average 1.3% annual rate, compared to a fixed rate of 3%. The result, assuming current rent income of $100,000, would be to increase rent by $95,399 in year 30, which at an 8% cap rate adds $1,192,486 more market value to the property.

Summary

In conclusion, make sure your lease language details how your rent is adjusted.

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