The property problem

By Lucy Woods | 06 May 2020

The National Audit Office has commissioned a report on local authorities’ investments in commercial property, the outcome of which is that the Commons public accounts committee has launched an inquiry into the issues raised.

This inquiry will focus on certain questions:

  •  Is commercial property a safe investment?

  • Have local authorities fully considered the potential risks involved in such acquisitions?
  • Are local authorities receiving value for money? Are local authorities meeting their Best Value Duty?
  • Do local authorities have the commercial skills and abilities to properly manage these investments in a way that yields a decent return? Local authorities are increasingly appointing consultants and agents to manage their property portfolios.
  •  In the light of COVID-19, will local authorities be able to meet their borrowing obligations, or will the Government need to bail them out? In addition, will the pandemic impact on the markets they have invested in?
  • Local authorities have increasingly been investing in commercial property to fill gaps in income to cover cuts in Government funding. These investments were originally mainly made in area and therefore usually had an element of public benefit to them – such as high street regeneration, and keeping anchor tenants in place. More recently we have seen an increased appetite to invest out of area for purely commercial purposes.

With the main finance coming from the Public Works Loan Board, local authorities have invested an estimated £6.6bn over a three year period. This finance needs to be serviced, even with its relatively low rates.

As the COVID-19 pandemic takes hold, the effects on the economy bring into even more focus the potential pitfalls of local authority commercial property investment being investigated by the inquiry.

Such investments are not a new thing, indeed local authorities have long had the power to enter into commercial arrangements which includes the ability to borrow and invest in real estate. Despite this, local authorities cannot be compared to a private investor. Purchases are restricted by governance restrictions, prudential borrowing rules, state aid and Best Value duty. Often there is a development element to the investment in order for local authorities to maximise return which can raise procurement issues. In addition local authorities always have policy positions to work to alongside heavy public scrutiny in relation to the spending of taxpayers’ money.

Up until now, as these commercial property investments have successfully brought in much needed supplemental and sustainable income for local authorities, any such restrictions and scrutiny are easier to work through. It will be interesting to see how the economic downturn will affect this.

The squeeze will likely hit local authorities in two ways, the additional COVID-19 related responsibilities of local authorities on the ground and their associate costs are at risk of leaving a funding gap over and above that which local authorities are currently experiencing. That means even with the £1bn already committed by Government, local authorities may get to a position where they struggle to service their debts.

From the other side, the commercial property market is already badly hit by the effects of the lockdown and there is a moratorium on evicting tenants and serving statutory demands where rent is unpaid. Similarly, the market value of the commercial property investments will drop. These effects will impact some types of commercial property more than others and local authorities need to ensure they have expert advice on their investment portfolio, ensuring it is sufficiently balanced to weather the storm.

While we await with interest the outcome of the inquiry, we know that most local authorities now have commercial property investments ranging from one or two properties, to a full portfolio. Because of the scale of such investments across the sector, a pragmatic and sensible approach to managing the recommendations from the inquiry will need to be taken as part of the nationwide battle to keep public services running at the required level.

For now, however, there is no doubt that local authorities will be nervous of the impact of the inquiry, and this will have an immediate effect on the public sector commercial investment market over and above the COVID-19 effect.

Lucy Woods is a partner at Ashfords LLP

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