A capped CPI review is a fixed uplift with an option sold to the tenant. Price it under a few inflation paths and the fixed equivalent is lower than it looks.
Compare the two by discounting the rent each produces under several inflation paths. On an illustrative 15-year warehouse lease at 750,000 a year with five-yearly reviews, a CPI review collared at 1 per cent and capped at 3 per cent is worth 7,714,655 across four equally weighted paths, the same as a fixed uplift of only 2.19 per cent a year. A fixed 2.5 per cent is worth 7,815,984, 101,328 more, and loses to capped CPI only if inflation runs above 2.5 per cent for years.
Worked in full in Logistics and Industrial Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A capped CPI review sounds like inflation protection with a bit trimmed off the top. It is more accurately a fixed uplift with an option sold to the tenant: the landlord keeps the downside of low inflation down to the collar and hands back everything above the cap. Whether that is a good trade depends on what the cap and collar are worth against the fixed alternative on the table, and that is arithmetic, not a view on inflation.
| Input | Value |
|---|---|
| Area, m² | 10,000 |
| Starting rent, 75 per m² | 750,000 |
| Term and reviews | 15 years, reviews in years 6 and 11 |
| Option 1: fixed uplift, compounded | 2.5% a year |
| Option 2: CPI, annualised, collar and cap | 1.0% to 3.0% |
| Discount rate | 6.5% |
Both options review every five years, compounding the annual rate over the period. The fixed option lifts the rent by 13.14 per cent at each review, to 848,556 in year 6 and 960,063 in year 11. The capped CPI option lifts it by between 5.10 per cent (the collar) and 15.93 per cent (the cap), depending on what CPI did over the previous five years.
Review factor, capped CPI = (1 + MIN(MAX(annualised CPI, collar), cap))5
Value = Σ rentt ÷ (1 + r)t, under each inflation path
In Excel, with the five-year CPI ratio in X: =(1+MIN(MAX(X^(1/5)-1,1%),3%))^5. Run the 15 annual rents for each path, discount them with =NPV(6.5%,B2:P2), and compare with the fixed schedule. Then solve with Goal Seek for the fixed uplift that gives the same value: that is what the capped review is really worth.
| Inflation path | Fixed 2.5% | CPI 1 to 3% | CPI uncapped | Capped minus fixed | Fixed equivalent of capped |
|---|---|---|---|---|---|
| Low, 1.0% a year | 7,815,984 | 7,341,755 | 7,341,755 | −474,229 | 1.00% |
| On target, 2.0% | 7,815,984 | 7,652,385 | 7,652,385 | −163,599 | 2.00% |
| Sticky, 3.5% | 7,815,984 | 7,985,360 | 8,160,712 | 169,376 | 3.00% |
| Spike: 8, 6, 4%, then 2.0% | 7,815,984 | 7,879,122 | 8,205,375 | 63,138 | 2.69% |
| Equally weighted | 7,815,984 | 7,714,655 | 7,840,057 | −101,328 | 2.19% |
The paths are illustrative, not a forecast, and equal weights are a starting point to argue with. The shape of the answer survives most reasonable weightings: the capped review wins only in the two paths where inflation runs above the fixed rate, and there it wins by less than it loses in the two where inflation runs below.
In the spike path, CPI annualises at 4.37 per cent over the first five years, but the cap holds the first review to 3.00 per cent. The cap costs the landlord 326,253 of present value in that path, against 175,352 in the sticky path, because the excess arrives early and is compounded into every later review. That is the scenario capped indexation is sold as protection against, and it is exactly where the protection runs out. By year 15 the rent buys 15.2 per cent less than it did at the start under the fixed option and the capped option alike.
| Fixed uplift | Present value | Versus capped CPI |
|---|---|---|
| 2.0% | 7,652,385 | −62,270 |
| 2.19% | 7,714,655 | 0 |
| 2.5% | 7,815,984 | 101,328 |
| 3.0% | 7,985,360 | 270,704 |
A tenant offering fixed 2.0 per cent instead of capped CPI is asking for 62,270 of value; one offering 2.5 per cent is giving away 101,328. Uncapped CPI, for comparison, is worth the same as a fixed 2.57 per cent on these paths: the 1 to 3 per cent band takes 38 basis points a year off it.
The common mistake is to compare a fixed uplift with the expected inflation rate and stop. If the market expects 2.5 per cent inflation, a fixed 2.5 per cent and CPI look identical. They are not, once a cap and collar are added: the band is not symmetric in value. In these paths the cap binds in two of the four and the collar never adds anything, because the paths chosen put more room above the cap than below the collar; if your own paths have a fatter upper tail, the cap costs more still. The second mistake is to treat the capped review as the inflation-protected option in an investment memo. Here it protects against inflation up to 3 per cent and not one basis point beyond.
Price the capped review as a fixed uplift equivalent under a few inflation paths. Here a 1 to 3 per cent collared CPI review is worth a fixed 2.19 per cent a year, so a fixed 2.5 per cent is worth 101,328 more to the landlord on a 750,000 rent. The companion workbook prices a fixed uplift against its own average and shows, year by year, what a cap on an indexed lease surrenders: it is in the free files for the book. For the same question on a data centre lease, see what starting rent matches a 3 per cent escalator, and for why lease structure moves yields, multi-let vs single-let industrial.
It depends on the fixed rate against the value of the collared review. Illustratively, on a 750,000 warehouse rent, CPI collared at 1 per cent and capped at 3 per cent is worth the same as a fixed 2.19 per cent a year, so a fixed 2.5 per cent is worth 101,328 more, while a fixed 2.0 per cent is worth 62,270 less.
Whatever inflation above the cap would have added, compounded through later reviews. In the illustration a 3 per cent cap costs 175,352 of present value if inflation runs at 3.5 per cent, and 326,253 if it spikes to 8, 6 and 4 per cent before settling at 2.0, because early excess feeds every later review.
Project the rent under several inflation paths, apply the collar and cap to the annualised CPI at each review, discount each path and average them, then solve for the fixed uplift with the same present value. In the example the result is 2.19 per cent, against 2.57 per cent for uncapped CPI.
This article is one calculation from Logistics and Industrial Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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