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Benefits of an inflation clause in a lease agreement
Although an inflation clause is not explicitly defined in law, this does not mean that it is illegal. The Civil Code generally allows for the possibility of negotiating annual rent increases. However, it does not mention a specific form.
So what does an inflation clause mean? It is a clause in the lease agreement that allows the rent to be increased in line with the rate of inflation. In practice, when the prices of goods and services increase by a certain percentage, the rent will (usually) automatically increase in the same way. This is a protection for landlords in particular, but in certain cases also for tenants. It does not only apply to the rental of flats, but also to non-residential premises, land or other long-term leased items. And it can also be used outside the scope of tenancy agreements.
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What should the inflation clause include and how should it read?
A valid inflation clause must contain at least three points:
- thedate of the increase – the rent is always increased on a certain date and no more than once a year. Increases cannot be made more frequently. How the parties set the date is entirely up to them; it can typically be the anniversary of the contract or, for example, 1 September or 1 January. However, it is good to know that in January you will not know the current inflation calculation by the Czech Statistical Office. The latter usually provides it during March.
- the increase process – it doesn’t have to be anything complicated. Very often the increase occurs automatically, simply by anchoring the inflation clause. However, it is possible to negotiate a process whereby, for example, the property owner must call for an increase in rent. But then it is advisable to regulate whether this is done in writing or in some other form and by what time the actual increase follows. The application of an inflation clause may also be conditional on a certain larger increase in inflation (for example, a half percentage point increase in inflation will not add anything, but a 2% increase will reflect inflation in the rent).
- aspecific inflation indicator – the inflation clause should not be vague but should refer to a very specific index, for example the consumer price index published by the Czech Statistical Office or Eurostat. The specific inflation rate can be determined in several ways and each party to the contract could choose a different methodology. Therefore, vagueness or imprecision of the clause will render it invalid.
For example, once the three requirements mentioned above have been met, it may take the following form:
The parties agree that the rent shall be increased automatically each year from 1 September by the rate of inflation, expressed as an increase in the average annual consumer price index published by the Czech Statistical Office.
The Affordable Advocate office was recently contacted by Mr Karel who wanted to sue for an increase in rent based on an agreed inflation clause. The clause read “The tenant and the leaseholder mutually agreed that the rent would be increased annually by the current rate of inflation.” According to Mr Karl, although his tenant negotiated and signed the clause in this wording, he subsequently refused to increase the rent to take account of inflation and continued to pay the same rent. While we understood Mr. Karl’s indignation, we advised him not to waste energy and money on a previously lost lawsuit. His proposed clause was invalid as it was too vague and it was obvious that his tenant was well aware of this fact. Rather, we advised him to have his lease reviewed by a professional and to use a new and good quality lease, including a bulletproof inflation clause, after a certain period.
tip: The rent should be precisely defined in the lease agreement. We recommend that you specify how the rent will be increased, for example, by linking it to the inflation rate. However, it is most advantageous for the landlord not to make rent increases complicated in the contract, but to negotiate a contract for relatively short periods of time for a fixed term. The issue is discussed in more detail in a separate article.
What is not allowed by law when increasing the rent?
Certain limits for rent increases are set by law. For example, the Civil Code sets a limit on rent increases of 20% over the last three years, but this applies primarily to forms of rent increase other than through an inflation clause. In fact, we do not believe that it is fair to require landlords to be constrained by this limit if inflation were to rise radically.
What does the inflation clause protect us from?
Clearly, it is intended to protect against inflation in the first place. For landlords, the inflation clause is particularly beneficial because it allows them to keep rents in line with inflation. It does not necessarily reflect the real increased costs of maintaining and operating the property, but it can still bring in more income.
Tenants may wonder what positive benefits the inflation clause brings to them if it primarily means an increase in rent. The bottom line here is that the inflation clause will allow them to predict rent expenditure to some extent. This is because the inflation clause lets the tenant know that if inflation increases, the rent will be increased by the same percentage.
Tip: Rent increases can also take the form of an amendment to the lease agreement. We will advise you on how to draw up a lease extension and what must be included in the so-called lease amendment. We will explain whether the amendment changes anything significant in the contract. In a separate article, we will also tell you what to do if you want to end a tenancy with a problem tenant.
What if I don’t want to use the inflation clause?
In economics, many things cannot be predicted (think of the recent covid epidemic or the current military invasion of Ukraine) and prices can change almost overnight. That’s why we recommend that our clients who rent out their property take advantage of the inflation clause. However, if they do not want to burden their tenants, unless absolutely necessary, the wording of the clause can be modified so that the increase may or may not occur. All may be subject to the landlord’s call.
The rent increase may also be based on a different principle than inflation tracking. For example, a fixed annual increase of a certain percentage. Another option is to enter into fixed-term leases. However, this is to be limited by law in the future.
Where else can the inflation clause be used?
In our text we have focused on the inflation clause in lease agreements. However, this is not the only place they occur. Increasingly, it is also encountered, for example, in the construction industry and in various contracts for services or works. The contract price may then be increased by the current rate of inflation.
Other possibilities of use are, for example, a works contract or a sales contract (for example, if it is a recurring performance).