Is it time for Local Authorities to sell their investment portfolios?
Barely a week passes by at the moment without hearing that another council is at risk of issuing a s114 notice as a consequence of exhausting all of their revenue reserves. No one council is the same, and neither, therefore, are the reasons for issuing as114 notice. However, it is clear that a consistent theme which is often cited, are high levels of debt, which has often been racked up following the development of large investment portfolios with Woking and Thurrock being the two with the highest profile.
Like any unhealthy relationship, issues do not typically start overnight, but may build up over time, shifting away from what started with promise, and what was (usually) entered in to with the best intentions by both parties. Such can also be the case of a council’s development of their investment portfolios.
The issues seen today with investment portfolios can be traced back to the start of austerity. From £46.5bn of grants being provided by central government to Local Authorities in 2009/10, this was cut by 31% (Local Government Institute, 2023) in real terms by 2021/22. Coupled with increases in demand and complexity, and large cost increases in both Childrens and Adults services this made setting a sustainable, balanced budget seem near impossible. Understandably, therefore, councils looked elsewhere as a means to raise revenue to pay for key frontline services, with many choosing to explore commercial opportunities.
Whilst you or me may turn to the dating market to find our partner, it was the property market which some councils turned to as a means to generate revenue income as a solution. The period post 2009 was marked by a period of historically low interest rates, with councils able to borrow short term from the Public Works Loan Board (PWLB) for less than 1% in the period May 2020 – January 2022 and borrow from other councils for less than 0.5%. These funds could then be used to purchase assets with returns of 5-10% typically targeted, which could be used to pay back the loans taken out, make an allowance for Minimum Revenue Provision (MRP or loan principal) in addition to funding of other services, and thus avoiding painful cuts.
Despite warnings of risk from CIPFA, some councils borrowed substantially for commercial assets. Like all commercial opportunities an element of risk is involved, otherwise no property company would have ever have gone bust. Undoubtedly, some commercial opportunities have worked; however others present a high risk or can now be costing councils money which they need to make sure they are aware of. Increases in interest rates putting further pressure on some councils with PWLB short-term borrowing costs increasing to over 6%. This has changed a return from the investment to a cost for those that didn’t lock in low rates (20-year PWLB rates were less than 2% for long periods prior in 2021).
Further compounding problems for some authorities’ are not adequately providing for MRP, long-term maintenance, void periods at the end of tenancies, reducing rents, bad debts or property reducing in value, particularly shopping centres.
Whilst minimal information exists around the actual scale of Local Authorities investment holdings, it was clear that this was a trend which took off, with one report highlighting how investment in acquisitions in land and buildings holding relatively steady at £800m to £1.1bn between 2012-16, before increasing to as high as £5.07bn in 2018/19. Generally, this trend was met with caution by the industry, with several caveats to an increasing portfolio highlighted – the need to perform consistent performance reviews to qualify its success and benefits realisation, to protect the value of the asset through ongoing maintenance, to ensure a balanced portfolio of different asset types (offices, shopping centres etc.) to minimise exposure to risk, and to ensure MRP was being made back against the original investment.
Whilst the above was undertaken to a reasonable level pre-2020, the impact of COVID has had an illuminating, and negative impact, exposing those councils who took more risky investments, and who may have progressed with an investment despite it only offering a lower return.
So, is it time for Local Authorities to end its relationship with their investment portfolios, or can they work through the problems?
Like we mentioned in the introduction, each council is different, and therefore, it should be appraised on a case-by-case basis. The first step for any authority, should be to baseline the current position; what is the value of the asset and what is the future expected return on that asset, what are the ongoing and future liabilities, MRP and maintenance and what is the overall debt position of the council. Once the as is situation is established, consideration should also be given to making any ongoing investments, what are these, and can any be scaled back? Following the above, the council could then consider the disposal of assets, commercial and otherwise. This, however, may involve writing off a significant amount of the initial investment, but could still represent a cost saving and reduce risk. Despite this, government figures highlight that the level of capital receipts has remained relatively static in recent years, from £4.5bn in 2018/19 to a provisional £3.4bn in 2022/23.
At Peopletoo, we can work with councils to support the appraisal of the commercial and asset investment portfolio, delivering the above tasks and establishing the ‘as is’ position in partnership with the council’s Property teams. Likewise, if undertaking an asset rationalisation project, it would be recommended to consider the ‘operational’ portfolio concurrently, including Libraries and Leisure Centres etc.
As well as being property experts, Peopletoo also provide wider services across the whole range of council operations, working with LAs to redesign frontline services such as Childrens and Adults, and implementing best practice, Target Operating Models, and revised service strategies. As such, Peopletoo are uniquely positioned to work with your Property team, in addition to understanding the needs of frontline services, confirming their future requirements for operational properties, to likewise identify these assets for disposal to generate additional capital receipts.
After the above, councils should then be in a position to determine whether to retain or sell; to break up their assets, commercial and otherwise.