South: Are local authorities taking a risk with property investments?

Outside of the real-estate arena, it might surprise many, particularly in times of reported austerity, that local authorities have consistently spent, year-on-year, over £1.6 billion on commercial real estate investments since 2016.

This equates to almost £5b over three years and is a significant increase from the £1.2b spent between 2008 and 2015. But local authorities could be taking a significant risk in investing in commercial real estate, according to Duff & Phelps, the global adviser that protects, restores and maximises value for clients.

James Liddiment, managing director in Duff & Phelps’ Real Estate Advisory Group stated: “The reason for the increase in activity from local authorities is simple. A relaxation in the Public Works Loan Board's (PWLB) rules in April 2016 made it easier for local authorities to borrow from the Treasury at low rates to buy income-producing assets. The spread between the loan rate and return rate on the rental income governs the profit made by the local authority to then spend on local services.”

Liddiment added: “However, we have seen this strategy used before and it did not work out too well. Local authorities notoriously used a not too dissimilar strategy when they placed substantial sums on deposit with Icelandic Banks, with the deposits yielding attractive interest rates creating a spread between the interest income and interest on borrowing commitments. After Iceland’s banking sector collapse, it took several years for these deposits to be recouped. This seems to be forgotten and now local authorities are driven by the desire to acquire income producing real estate.”

Many local authorities have purchased assets outside of their administrative boundary. For example, Broxbourne Council (Hertfordshire) spent £17.2 million on a Tesco investment in Grimsby and Bracknell Council (Berkshire) bought a £12.2m retail park in Lincolnshire. Spelthorne Council have been extremely active, they are responsible for £1b in loans from the Treasury having also made the well-publicised purchase of BP’s office complex in Surrey for £358.5m two years ago.

Liddiment added: “While the investments may seem promising at this point in time – particularly for fully-let, new buildings – they could be a resource drain in the future. There are very serious questions around how local authorities assemble a diverse and diluted portfolio, which spreads risk and income. Inevitably, there will be some failed investments, raising questions of the investment decisions made during this cycle, and how this then impacts PWLB borrowing, plus how local authorities will repay these interest-only loans without a need for a sale of the property assets at a future point in time.

“Furthermore, there is also the question of pricing and whether local authorities are paying market value to secure these assets. While other investors may only be able to seek a portion of debt on market-facing terms, local authorities are arguably in an advantageous position relative to the general market due to the attractive pricing and structure of the PWLB terms. This means they can potentially pay more and may compete against each other when acquiring assets 'off patch', driving the price higher. With this in mind, it should also be considered whether these values can be achieved again should these assets need to be liquidated due to a change in strategy or wider pressures. Only time will tell.”