Since 2010, up and down the country local authorities have felt the brunt of George Osborne’s austerity drive. Between 2010 and 2015 local authority budgets have been cut by £18bn in real terms with a further £9.5bn expected by 2020. In the face of such cuts, councils have seen their resources stretched by a combination of an aging and increasing population and the cost of assisting those hit by rising prices and falling incomes.
In response to this councils have been forced to find innovative new ways to plug the income shortfall, which has been well documented in recent press. Since 2015 councils have taken advantage of cheap borrower rates from The Public Works Loan Board (PWLB), a treasury agency, and have spent approximately£2.5bn on commercial property.
Councils are borrowing money at rates as low as 2.5% and are using these funds to invest in higher yielding property to plug the gap in their budget. On occasion, local authorities have been known to outbid hedge funds for such assets.
It’s not that unusual…
Across the globe commercial property investment by local authorities is not uncommon. Regional governments in Japan and China have been known to plug the gap between expenditure and central Government funding in a similar way. Investment in property by UK councils is also not new, local authority pension funds have invested in property for decades and post-World War II many councils invested heavily in property to regenerate local areas and subsequently retained an income producing element of the property.
The use of property investment to generate an income is a consequence of Government policy designed to make councils more financially self-reliant. As public bodies they have the opportunity to borrow at lower rates and generate an income that can be reinvested into the provision of public services.
The type of stock councils has typically invested in is varied, but popular assets include mixed-use developments and business and industrial parks, and they are as likely to invest in property outside of their borough, as within. To date, the largest property investment by a local authority has been an ‘in-borough purchase’ by Spelthorne Borough Council of BP’s business park in Sunbury-on-Thames for a reported £360m.
Criticism and calls for clampdown
However, there is mounting criticism over councils investing money from the public purse. Critics argue that this money should be spent on delivering the front-line services that many local areas have seen cut. Some also feel that councils are gambling in property markets and that their investment strategies are exposing themselves to unprecedented levels of financial risk, to the detriment of their residents. Some commentators have also stated that a number of councils have exposed themselves at such a level in property markets that they have become property investors with a side public service business.
Despite the criticism and rumours of a clampdown, the Chancellor did not restrict council spend on investment in the autumn Budget. As calls to clip the wings of local authorities grow, it is likely that their spend will continue to come under public scrutiny in the months ahead. The Government has already released proposals requiring more disclosure from local authorities on their commercial property investments and a threat to restricting spend outside of their own boroughs could yet be realised.
But is such a potential restriction fair and secondly are councils really over exposing themselves to risk in the property market?
Current property investment levels by councils is still considered relatively small compared to the volume and size of acquisitions by the private sector. In 2016 it is reported that councils invested £1.2bn in commercial property. In contrast, the renowned ‘Walkie Talkie Building’ sold for £1.3bn alone, to Hong Kong Giant Lee Kum Kee earlier this year.
The Localism Act 2011 gave councils the power to do anything that individuals generally do. Such a restriction would go against this Act and it would create unfairness between councils, harming those which are positioned in weaker economic locations which struggle to attract strong covenants on long lease terms.
Risk can be managed
With any investment comes an element of risk that must be carefully managed. Therefore local authorities must do their due diligence and weigh up the risk-to-yield ratio and determine what is fair to their residents and their stakeholders. As with the private sector, any property asset yielding an income must be part of a wider and solid investment strategy that fits with the business objectives of the local authority.
To manage risk, questions a local authority should ask before proceeding with a purchase should include; who are the tenants? How secure are they? And how long is their tenancy? There is great value attached to good tenants with long leases. Councils should also look at the local area – what are the long-term prospects, is regeneration likely? How strong is the local economy?
There is also the need for councils to balance the need for positive investment in their own boroughs, which should be applauded, to the need to invest in the best possible asset. To generate the highest but safest income possible and geographically spread the risk of their portfolio, it may be in the authority’s best interests to invest outside of its borough. Ultimately, securing a good yield enables councils to spend the income generated on the provision of services in their local area, bringing with it a wealth of benefits to residents.
Above all, a property investment must be proportionate with local authority spend and not expose councils to undue risk. But with a strong and transparent strategy and the right portfolio, such investment can have a positive impact on councils and their communities.