Will SDLI become a replacement for other inflation indices?
By Ben Darlow, Shakespeare Martineau
Rather than using the traditional government indices, developers are now turning to the Savills Development Land Index (SDLI) as an alternative. Introduced by property agent, Savills, many are choosing to opt for this new indexing system due to sustained high rates of inflation and market turbulence. However, despite limited information publicly out there about the SDLI, landowners, developers, and other property agents need to do their best to understand SDLI and the different indexation options available.
In the UK, various indices are used to measure inflation, among them the Consumer Price Index (CPI), the Retail Price Index (RPI), and a variation of the CPI called the CPIH, which includes housing costs for owner-occupiers. The CPI measures the price change over time of goods and services consumed by households and includes the cost of utility bills, minor repairs, and maintenance. The CPIH is generally considered a more comprehensive measure of inflation as it extends from the CPI to additionally include the costs associated with owning, maintaining, and living in your own home, along with council tax.
The RPI measures the average change from month to month in the prices of goods and services purchased by most households in the UK and is often used in private contracts for maintenance payments and housing rents. RPI has traditionally been the default inflation measure for property leases, however, with critics identifying that the figures within this index are not always accurate, the Government has announced that it will be phased out by 2030, with CPI and CPIH due to take its place.
In a number of property agreements, SDLI is being considered as another alternative to these indices, and it is used to track UK greenfield and urban development land value movements at a regional level. Developers are beginning to use this index in more agreements, and as the RPI is phased out, there will likely be a push for the SDLI to become more widely recognised.
There are many reasons why developers are opting to use this index. For example, the RPI monitors the monthly change in the price of goods and services used by most households, while SDLI purely measures land value, which is usually a much lower rate and means that more can be saved on costs and other payments developers may be required to make under various property agreements.
However, due to the limited public information about the SDLI, there is a potential disadvantage for landowners signing new property agreements. It is important to know that those who are thinking of using this index in their agreements may not be able to view trends and information regarding the SDLI as easily as they could with other indices. This is because the SDLI is published on a quarterly basis and is only available to external parties through a paid subscription. This subscription model means there are potential concerns that this index may create a barrier between landowners and developers, especially if landowners are not able to easily access the data and information without a subscription.
Some also argue that the SDLI is a poor measure of inflation as it is purely based on land value and does not include costs and expenses relating to the properties which will ultimately be built on the land. Opponents suggest that this makes SDLI a less relevant figure than CPI, for example, which tracks rising utility costs, materials costs, and the building itself.
It is clear that with a greater number of choices, there is a potential for more confusion for those involved in negotiating and entering into property agreements, and some landowners may find it difficult to determine which index will work best for them and which index is fair and reasonable in the circumstances. Understanding the benefits and drawbacks of the different indices is crucial in being able to negotiate more effectively for all parties involved in property agreements, and it is vital that everyone is armed with the correct knowledge from the beginning.
Equally, property agents must be aware of the SDLI and ensure that they have access to the details about this index, as they will be heavily involved in negotiating a deal and will have to advise their clients accordingly. Whilst it is difficult to go back once a decision on which index to use has been made, there are ways to negotiate the introduction of another index if concerns are raised in time, and parties should always seek expert advice.
The introduction and adoption of the SDLI demonstrates that there is no case of ‘one index fits all’, as different metrics will affect different parts of the developer or landowner’s interests and the transaction generally. However, with (a) the turbulence of the current economic situation and property market still affecting many and (b) developers and landowners looking to minimise costs and maximise receipts respectively, the range of different indices and arguments about which index to use are here to stay.