Local authority investment in commercial property criticised – but is this the way forward?

The Public Accounts Committee (PAC) published a report on 14 July on “Local Authority investment in commercial property”, in which they accused the Ministry of Housing, Communities and Local Government (MHCLG) of being “complacent” and “blind” to the overexposure of local authority investment in commercial property.

Back in February, the National Audit Office (NAO) estimated that local authorities had spent £6.6bn on buying commercial property between 2016-2017 and 2018-2019. This represents an increase of more than 14 times the preceding three years. Local Authorities have invested an estimated £3.1bn in offices, £2.3bn in retail property, and £957m in industrial property, a large proportion of which has been financed by borrowing.

Against a background of austerity and having to provide more for less, local authorities have had to consider new ways to generate income and become self-financing. This approach was endorsed by Government, to not only plug funding shortfalls but also to help contribute to local economies. However, this model is not without its risks as Spelthorne Borough Council recently found out. The Council leader was recently deposed at a meeting of his fellow Conservative councillors amid increasing concerns about the Council’s unprecedented spending on office and retail space.

The leader of Spelthorne Borough Council lost power following a £1bn property spree. The council had invested heavily in commercial property borrowing the equivalent of nearly 50 times its spending power from the Public Works Loan Board (PWLB) in an attempt to become self-sufficient. This approach led to public criticism at a recent parliamentary committee hearing, particularly as the council had not put in place “proper arrangements to secure economy, efficiency and effectiveness in its use of resources”.  Put simply the council borrowed too much and its risk was too great, which is the very scenario that the PAC believe MHCLG should have been aware of.

Councils like any other commercial landlord will also not have escaped the impact of Covid-19. The risk is, however, greater for councils as a lack of rental income has a direct impact on the services that they are able to provide against growing debt levels. Spelthorne Council has reportedly agreed an 18-month rent deferral with one of its tenants ‘WeWork’, amounting to a £4.5m short-term loss for the council.  The situation will inevitably only get worse as councils face additional costs in service provision as a result of the pandemic, which will now include the cost of imposing restrictions on specific premises, planned events and open spaces to mitigate further Covid-19 outbreaks under the Health Protection (Coronavirus Restrictions) Regulations that came into force on 18 July.

But it is hard not to have sympathy for councils. Many have faced the unenviable task of considering whether to cut services as they face funding reductions or seeking alternative sources of funding to continue them – so it is no wonder that many have invested in commercial property which can offer significant investment returns.

Spending pressures on local authorities will only get worse, and there is no doubt that they will need to become more and more resourceful over the coming years in respect of the services they provide and how they generate the revenue to fund them. If managed and structured properly, the commercial sector could provide the opportunity to generate such income. However, if local authorities are to operate commercially, they will need to adopt a commercial approach at all times, and recognise the difference in providing statutory services and operating for profit.

Often the commercial activities of a local authority will be run by the local authority itself through a separate commercial vehicle known as a Local Authority Trading Company (LATC). LATC’s remain wholly owned and controlled by the parent council(s), but as a trading body LATCs are able to provide their services to a wider market than a council department, with key personnel effectively ‘swapping hats’ to represent both the commercial interests of the LATC and those of the local authority. However, with the same personnel involved in both LATC and Council projects, this can lead to clear conflicts of interests, and it is not hard to envisage that the one billion pound spending spree of Spelthorne could easily be repeated elsewhere.

In our experience the most successful LATC’s are those that are run as a separate and distinct company to the council. Employing their own staff who do not have a local authority ‘day job’ and who engage their own technical and professional advisers. In this way, the local authority can properly scrutinise commercial decisions made by the LATC and can call upon its own experts and advisers to do so.  This increased level of scrutiny will no doubt also provide the overview that MCHLG need as identified in the PAC report.

By investing in appropriate skills and expertise (required of any commercial business) there will be exciting opportunities for local authorities to contribute to the new post Covid-19 world and enable them to become more agile and responsive to changes in demand or funding. As the country emerges from lockdown, it makes sense that local authorities are central to the solution for their local communities. What better way to do this than for local authorities to invest and regenerate the communities they serve for the benefit of those communities. Local authorities are after all, best placed to understand what is required locally for their town centres, leisure facilities and housing.

Our Real Estate team have experience of working for and with local authorities so please get in contact if you require further assistance