Author: James Norton
James Norton, Partner, Fladgate LLP (firstname.lastname@example.org)
Much has been written about local authorities investing in commercial real estate, particularly at a time when there is an increasing demand on community services and social care and the cutting of budgets that sustain them.
Commentators claim that local authority investment in 2018 was in the range of £1.5 – £2 billion, with investment over the past five years exceeding £4 billion. Figures quoted by Savills suggest that local authorities represent approximately 3.8% of all commercial property investment, an increase from 0.16% in 2014.
One might ask how cash strapped local authorities, the majority of whom regularly highlight their inability to properly fund local services, are able to invest such mammoth sums in real estate. The source of this funding is the Public Works Loan Board (“PWLB”), a statutory body operating within the United Kingdom Debt Management Office, an Executive Agency of HM Treasury. The primary function of PWLB is to lend money from the National Loans Fund to local authorities, and to collect the repayments.
The process of borrowing from PWLB is wildly dissimilar to that which a private entity would encounter when seeking secured lending from a traditional lender. PWLB are a “non-discretionary lender”, which in simple terms means that they are not required to ask what the money is being borrowed for nor do they carry out any meaningful assessment on the ability of the local authority to repay the loan. It is for the local authority to satisfy itself as to the soundness and affordability of the investment. In addition, the interest rates charged on PWLB loans are comparatively low and loans with maturity periods of up to 50 years are available.
Critics claim that the availability of this PWLB funding has led to local authorities over paying for assets, distorting the market and leaving local authorities exposed to the volatility and cyclical nature of real estate investment. Spelthorne borough council is often singled out for criticism, having amassed a debt of approximately £1 billion over a three year period on the acquisition of commercial property, most notably the BP’s International Centre for Business & Technology in Sunbury for a reported £360m (despite being one of the “smallest” councils in England).
The vast majority of the local authority investment has been the acquisition of property within their own boroughs but, in certain cases, they have broadened their exposure and have executed transactions on a pure investment basis. The Isle of Wight Council reportedly acquired an industrial estate in Salford Quays, Manchester for circa £11 million and investments outside of Surrey account for over 50% of Surrey Council’s property investments.
Whilst I have discussed the how, it is important to consider the why. The origins of this spike in property speculation are patently linked to the government’s announcement back in 2015 that local authorities must become self sufficient by 2020 and as such there is a clear and urgent need for incoming producing investments.
Should the Government and local residents be concerned? One could argue that, particularly in relation to investment within their boroughs, local authorities should be praised for taking the initiative to capitalise on the availability of cheap debt with the dual aim of funding public services and regenerating communities. Local authorities have a greater ability to pro-actively influence the outcome of their investments in local real estate, particularly the ability to shape the public realm more readily than independent investors. By contrast, it is believed that in excess of 100 UK local authorities had significant (circa £1 billion) investments in Icelandic Banks (over which they had no control) when that bubble burst and they were justifiably criticised for such speculative investment.
I watch with particular interest whether local authorities can make a success of their investment in commercial property. The majority of the investment is reported to have been in office (50%), retail (32%) and industrial (13%) (approximate figures) and in a world where occupiers within these sectors are demanding shorter lease terms and more flexibility, it remains to be seen whether local authorities will have the asset management flexibility and ability to approve and execute transactions quickly enough to compete.