Not so local authorities – getting carried away?
Having had a severe cut in government funding, local authorities have taken to property investment on a grand scale over the last few years to the tune of some £2bn. Many of these investments are not that local – Portsmouth Council has a distribution warehouse near the M6 toll road and Bracknell Council aims to have assets across the country.
Some Councils are investing locally; the most eye-watering is the purchase of BP's office park at Sunbury-on-Thames where Spelthorne Borough Council paid a reported £360m, while taking on borrowings equal to ten times its net assets.
Various authorities are openly saying that they cannot borrow to pay for services but that by buying real estate they get the rental income they badly need.
Who is funding this spending (might one say, overspending) spree? The answer is the UK Debt Management Office through its offshoot, the Victorian-sounding Public Works Loan Board (PWLB). This is a statutory body that issues loans to Local Authorities from the National Loans Fund within a poling framework set by HM Treasury. This is to all intents and purposes government funding, so the rates are linked with UK gilts, and are therefore temptingly low, especially when 100% of the purchase price can be borrowed.
For now, buying a warehouse yielding 6%, having borrowed at around 2%, certainly looks to be a good deal. Some commentators however, fear the worst if the market turns, and have likened this tactic to the 'carry trade' in Japanese Yen. This is where an investor borrows money at a low interest rate in order to invest in asset which is likely to generate a higher return. There must be a question mark over whether the PWLB will continue to lend to local authorities, which are frequently alleged to outbid others, for properties located a considerable distance from their own area.
Other Councils are staying closer to home, investing locally with the thought that, as well as much needed rental income, the local economy might be stimulated.
Still others are acting in ways closer to the intent of the PWLB's original mission; they are building. Some are setting up subsidiaries to build homes on their land and then selling them. This gives the Council an income and relieves pressure on the housing market locally. It may also bring income and help balance supply and demand. The variant on this is to sell to investment vehicles established between the local authorities and other investors. This model gives the local authority both developer's profit and enables it to keep a partial rental stream going forward.
Finally, Councils are using alternative methods of financing to cushion themselves against the fluctuations in the rates offered by the PWLB in future, by effectively entering into bespoke leasing structures. The practice is growing in any event, but if the PWLB ever stops lending for certain categories of project which it decides are no longer within its remit e.g. investments outside of a council's catchment area, these structures will really come into their own. Especially when compared to standard bank lending, they essentially allow borrowing up to 100%, at very low rates.
As pressure increases on local authorities to pay their own way we are likely to see a parallel rise in innovative approaches to finance and investment.
For further information, please contact Richard Honey, Partner and Head of the Asset Management team.