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Inflation and rent adjustment: the new battlefield for landlords and tenants
In recent months inflation, a phenomenon that had not been at the centre of discussion for years, has become a hot topic also in the retail real estate market.
When it comes to leases, inflation impacts on the yearly adjustment of rents, which in Italy is made on the basis of the changes in the purchasing power of currency, as ascertained by the Italian National Institute of Statistics (“ISTAT”).
The gradual exit from the pandemic, with the stable reopening of businesses and the easing of restrictions on freedom of movement, led to a considerable and rapid increase in demand of goods at the macroeconomic level. Besides, the highly expansive monetary and fiscal policies that were put in place – in Italy and Europe in general – at the height of and following the pandemic further increased the demand for goods: in short, after a period of sharp – imposed – contraction in consumption, people went back to buying goods, all at once, overloading the system and setting the demand at a level that could not be immediately covered by the supply.
This sudden increase in the demand for goods led to an equally rapid increase in their cost, which was further aggravated by the difficulties encountered in the procurement of raw materials and in the supply chain in general, as well as by the extremely high cost of energy.
The surge in inflation has had (and most probably will keep having for more time) a strong impact on the retail real estate market, specifically with reference to the automatic adjustment of rents.
Italian law provides that the parties may agree in leases on the annual updating of the rent, on the basis of any changes in the purchasing power of the currency: in practice, this is a clause always present in leases, and that has its own more than legitimate raison d’être, as it allows the owner to keep the rent adjusted through the years on the basis of changes in purchasing power.
Italian law sets forth that the so-called ISTAT adjustment cannot be higher than 75% of the yearly variation, ascertained by ISTAT, of the consumer price index for blue and white collar households. Therefore, as it can easily be imagined, inflation is mirrored in the variation of the ISTAT index, which – per relationem – leads to an increase in rents.
Those that clearly suffer most from this circumstance are the retailers, who – after the drastic drop in sales due to the mandatory closures during the pandemic in 2020 and 2021 – find themselves with a further increase in their costs, in this case the rent, which comes on top of the increase in product production costs, logistics costs and energy costs.
According to the data made available in July 2022, rents for commercial properties increased – compared to July 2021 – by 5.85% (i.e. 75% of the increase in the consumer price index, which was 7.8%), weighing on average about 23% of a store’s budget (compared to just under 18% pre-pandemic).
Contrary to other European countries, Italian government has not, yet, adopted any measures to mitigate this effect, despite the earnest and urgent appeals of those directly affected.
At the very beginning of this month, Confimprese (the main association of retailers) officially asked the government for a moratorium on the increase in lease rents, hoping for a reaction similar to the one made in 2012, when the government ordered a freeze on the ISTAT adjustment for 10 years of the rents of properties leased to the public administration. Federazione Moda Italia (one of the main associations in the fashion and luxury sector) appeal is also in the same vein, according to which – in the absence of government intervention – at least 10% of the commercial activities in the world of fashion in Italy risk closure, for an equivalent of just under 300,000 employees.
For the time being, there have simply been discussions within the institutions on the possible adoption of corrective and limiting measures, but certainly the government crisis and the upcoming elections have slowed down the process.
In the meantime, while waiting for a legislative intervention, the parties can only rely on their negotiating autonomy to try to outline correctives, or at least limitations, to an uncontrolled increase in rents.
From this point of view, the main critical point is the agreement between the parties on the point: therefore, such corrective measures are very likely to be included in leases that are being negotiated at this time, rather than those that are already in force.
Somewhat like what happened with force majeure clauses – which were certainly not central to the pre-pandemic negotiations and have since taken on a decisive role – now the provisions relating to ISTAT indexation – no doubt marginal before the present period – are the subject of fierce negotiation between the parties.
There are therefore tenants that try to protect themselves by reducing the percentage of application of the adjustment. As mentioned above, the law stipulates that this adjustment may not exceed 75% of the increase in the consumer price index, but it certainly admits the possibility of the parties agreeing on a lower percentage: it is therefore not uncommon to find tenants who insist on reducing this percentage to 50%.
It must be said that the solution certainly does not solve the problem for tenants: certainly, the risk of having an unsustainable increase is reduced quantitatively, but if, however, the inflationary phenomenon was to continue and increase further, there would be no guarantee as to the sustainability of the contractual structure.
A more protective remedy and one that makes it possible to better predict the course of the rent adjustment is to provide a cap on the increase, so that at least the worst-case scenario is predicted for each year. This solution can be modulated in different ways according to preference, but the one most frequently used consists of tying the maximum extent of the increase in percentage with respect to the previous year’s rent.
To conclude, in the event of failure to reach an agreement between the parties, tenants of existing leases will have no other option but to resort to the classic remedies of the Italian Civil Code, which are not, however, a quick solution in order to restore the contractual balance between the parties.
Article from – TRENDS Real Estate No 9
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