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The growing trend for councils to invest in bricks and mortar in order to generate an income is ruffling feathers in the commercial property market while the sums involved in some transactions are reported to be raising eyebrows – and in some cases ringing alarm bells – in central government.
Leaving aside the self-interest of some of those who have been voicing concerns, it is easy to understand why those outside the sector, and indeed the general public, may feel some disquiet at the level of investments councils are making.
LGC’s research found 35% of the 265 councils that responded to a freedom of information request on this issue had invested in property in a bid to generate income since 2010, spending £2.4bn between them. Much of this will be financed through borrowing from the Public Works Loan Board, which lends at below-market interest rates and over long periods.
There are rumours the chancellor may be about to act to restrict borrowing for such investments in his forthcoming Budget. Depending on who you talk to, this is either in response to fears councils could be exposing themselves to too much risk or pressure from investors who feel councils’ access to cheap borrowing leaves them at a disadvantage.
Duncan Whitfield, president of the Association of Local Authority Treasurers told LGC it was hard to be critical when “councils are being invited to be ‘more commercial’” by the government.
In this context, and against a backdrop of rapidly diminishing central government funding, investment in an asset which offers the highest returns on the market makes logical sense. This is especially true when interest rates are low and councils have access to some of the cheapest and most reliable borrowing available.
Mr Whitfield says: “It’s very easy for those outside of the system to throw stones but I think that this can be a bit unfair. I am not aware of any council that has not followed rigorous approval processes in taking decisions to make acquisitions of this type and I am confident that all will have taken appropriate professional advice.”
Mr Whitfield is strategic director for finance and corporate services at Southwark LBC, which has invested more than £45m in income generating property since 2010. He also points out that as well as generating financial returns, many councils have also made use of the properties as part of development and regeneration projects, bringing wider benefits for their local populations.
Of the councils LGC spoke to for this piece, while some were very much driven by the desire to generate a new revenue stream, such as Surrey CC, Runnymede and Mansfield DCs, for others, particularly those in urban areas such as Leeds and Plymouth city councils, the strategic impact of an investment on plans for their place was equally important.
It is not always clear exactly where that line falls. For example, Manchester City Council is one of the country’s biggest council commercial landlords with an investment property portfolio worth more than £400m. However, despite having purchased property that provides an income since 2010, the council told LGC none of this was solely for revenue generating purposes but formed part of economic development plans.
In addition, while rental income can be game-changing for small districts with net revenue expenditure of just over £11m on average, it is less so for upper-tier councils whose budgets typically run into the hundreds of millions. This was reflected in LGC’s finding that the bulk of the £2.4bn has been spent by districts in the south-east.
In LGC’s investigation Surrey and Northumberland CCs were the only upper-tier councils found to have invested more than £100m since 2010. Northumberland’s approach was very much driven by local economic regeneration concerns as well as generating income, but as LGC reported last week it has yet to generate anticipated returns. Surrey has taken the opposite approach and invested almost entirely out of its area. With property prices in the county so high it is easy to imagine out-of-area investment may provide Surrey with better returns, as well as spreading risk.
For councils in some parts of the country, such as Mansfield, investing out-of-area is the only option if they are seeking levels of returns that can meaningfully support services.
Out-of-area investment has proved one of the most controversial aspects of councils’ increasing investment in property. As LGC’s analysis of this particular issue concluded yesterday, it gets to the heart of the question of whether there are limits to how commercially a council should behave.
So how risky are these investments? The Chartered Institute of Public Finance & Accountancy has just updated its prudential code to make governance requirements around investment activity more explicit, although councils LGC spoke to were confident they already complied with its requirements.
There is much muttering about one or two councils spoiling it for the rest, although those LGC spoke to as part of this investigation were reluctant to name names. Spelthorne’s purchase of an office complex for £358m has attracted particular controversy, not least as it accounts for the bulk of the council’s investment portfolio, leaving it heavily exposed. If the tenant, BP, were to fail, not only would the council face a loss of rental income but the associated loss of business rates would leave a huge hole in council finances. However, it seems unlikely BP would renege on its 20-year leaseback agreement and even if it did the council would be left with a prime bit of real estate on the banks of the River Thames, less than an hour from central London.
Ultimately, these investments must be judged on their individual merits. The chancellor should be wary of punishing the whole sector for the perceived imprudence of a minority, not least as doing so would likely only lead to further reductions in services.