Since 2010, local authorities have felt the brunt of George Osborne’s austerity drive. Between 2010 and 2015 council 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 and councils have been forced to find innovative ways to plug the income shortfall.
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.
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 investment.
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.
Councils have typically invested in a variety of stock, 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.
Calls for a clampdown
However, there is mounting criticism over councils investing money from the public purse. Critics argue that this money should be spent on delivering front-line services instead. Others believe that councils are gambling in property markets, exposing themselves to unprecedented levels of financial risk at such a rate, they have become property investors with a side public service business.
In response the Government has issued a draft paper, ‘Guidance on Local Government Investment’, issued under section 15(1)(a) of the Local Government Act 2003 which sets various new requirements for local authorities from 1 April 2018. This document highlights that the core function of a local authority is to deliver statutory services to local residents and where a local authority chooses to invest in non-core activities and investments, it should disclose in its Capital Strategy the financial contribution that the activity or investment will make towards the delivery of core functions.
Is it proportionate?
Current property investment levels by councils are still considered small compared to the volume and size of acquisitions by the private sector. In 2016 it was reported that councils invested £1.2bn in commercial property. In contrast, the renowned ‘Walkie Talkie Building’ sold last year for £1.3bn alone.
Risk can be managed
With any investment comes an element of risk that must be carefully managed.
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 borough’, to support regeneration,
versus the need to seek the best investment opportunities which might fall ‘outside borough’. 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.