There’s a new property player in town. It has access to cheap money and is not afraid to splash the cash. The name of this new investor: your local council.
According to provisional Savills figures shared exclusively with Property Week, last year local authorities invested £1.2bn in commercial real estate to account for 2.76% of the overall UK market, compared with just 0.03% in 2000. And Brexit concerns have done nothing to curb their enthusiasm - rather the reverse.
The Savills research reveals that in October 2015 councils accounted for 0.2% of the market, but that at that point in 2016 they accounted for 2%, a figure that has since leapt three quarters of a percentage point.
As William Hill, director of Mayfair Capital Investment Management, puts it in his comment piece this week: “Local authorities are behaving like hedge funds exploiting a financial arbitrage.”
So what sort of property are they eyeing up, why the sudden surge in interest and are they looking before they leap?
The trend of councils buying property is not particularly new. For many years, local authorities have invested in retail assets in particular, not least in a bid to regenerate their town and city centres. What is new is the rate at which they are buying and what they are buying, with most councils now looking beyond the old retail stomping ground to acquire a wider range of assets.
Perhaps most eye-catchingly, at the end of September, Property Week revealed that Spelthorne District Council in Surrey had splashed out £360m on oil and gas giant BP’s business and technology campus. The deal was the biggest-ever commercial investment made by a local authority in the UK.
While the deal stands out in terms of size and the fact that the purchaser was a relatively small district council, it is far from the only big-ticket purchase made by a council in recent months. In the summer, for instance, Leeds City Council announced it had bought 3 Sovereign Square - a brand-new 94,000 sq ft office building in the city centre - for just shy of £44m.
Chris Lewis, a partner in Cushman & Wakefield’s capital markets division who worked on the BP campus deal, says it should come as no surprise that local authorities are pushing to become larger commercial landlords. “BP has been in Spelthorne for more than 100 years,” he says. “It makes sense that they [the council] should be buying into the location.”
Some authorities have gone as far as to establish distinct management and investment vehicles to manage their property interests. In Warrington, for example, the council has set up Warrington & Co to manage all its property affairs. According to Warrington & Co’s managing director Steve Park, the body makes acquisitions in order to boost the regeneration of the town, but also as straight investments designed to produce new revenue streams.
Driving this push for revenue is a desire to plug the growing funding gap. “As central government funding reduces, local authorities have sought additional funding methods,” says Kevin Mofid, a director in the research team at Savills.
“Directly purchasing real estate, particularly local projects that can seek to create social and economic benefit for their residents or to kick-start regeneration, is therefore seen as an attractive option.”
The economics also make property investments attractive. Authorities can currently borrow up to 100% of the funds required to make an acquisition at interest rates approaching levels normally associated with government gilts.
So the financial argument stacks up, but that doesn’t mean making investments is necessarily straightforward. Making the case to politicians and the local electorate is vital, says Park. “The difficulty lies with politicians themselves first of all, and then the wider electorate, getting their heads around capital borrowing versus annual revenue funding,” he says.
The electorate, says Park, typically objects when it sees cuts to everything from bin collections to adult social care. Objections can translate into outright hostility if it fears its local authority is splashing out £5m on a building.
The solution, says Park, is to tell a compelling story. “It’s about saying that actually the acquisition of that building enables you to continue to deliver those other services,” he says. “It’s about saying that we are able to borrow cheaply and with low levels of risk to achieve an income surplus to deliver services that themselves aren’t revenue generating.”
The case is easier to make when councils are investing in their local areas, but not all councils are content to focus on their own markets: local authorities are increasingly comfortable with buying up assets located outside their boundaries, sometimes controversially.
In September, for instance, Surrey County Council was slammed by the Surrey Comet “for buying up land for £67m while ‘pleading poverty’”.
The council’s crime had been to buy up, through its investment company Halsey Garton Property, six properties located outside the county: four sheds in Wiltshire, Bristol, Nottinghamshire and Salford, and retail and office buildings in Worcestershire and Bristol.
Such purchases clearly have nothing to do with councils investing in their own physical realm. They are revenue-raising plays pure and simple.
That should not necessarily be a problem, says Centre for Cities analyst Edward Clarke, who has looked into the councils-as-property-players phenomenon, as long as it is clearly stated that the investments are being made to raise revenue and that this revenue will be pumped back into the local economy.
He cites the example of Mansfield, which took the unusual step of buying a Travelodge in Edinburgh, arguing that the property would provide better and lower-risk returns than investments within its own boundaries and that it needed the revenue to support its day-to-day spending on services.
“It can be difficult to sell politically, but it is important,” says Clarke. “If you’re looking to maximise revenue, then the primary concern shouldn’t be whether it’s within your authority or not. While in Surrey there might be a debate because there is a strong market, in other places that isn’t the case. I can’t see what the problem is if the priority is maximising revenue.”
It can be difficult to sell politically, but it is important - Edward Clarke, Centre for Cities
Others, however, aren’t convinced that councils making property investments - whether in their own areas or not - is a good idea.
The committee noted that councils investing in property was a growing trend, prompted by the need to find new revenue streams to replace ever-diminishing grants from central government. However, it also raised several concerns, chief among them the question of whether councils have the expertise to make sound investment decisions and to manage property effectively.
“We are concerned that some authorities might lack the necessary commercial skills and experience among both members and officers,” it said. “If commercial decisions go wrong, council tax payers will end up footing the bill and other services will be under threat.”
Clarke acknowledges the skills issue. “The level varies massively,” he says. “It is a concern for a lot of places. There are places that are doing it, so it isn’t impossible. It’s about what your priorities are and putting the right resources in place.”
The problem isn’t just that councils often lack commercial property expertise, but that local government pay grades are inferior to those found in most private sector property companies, so competing for talent is difficult.
In Warrington, Park thinks he’s found a solution, although it isn’t cheap.
All 12 of Warrington & Co’s staff are former private sector workers and Park has successfully made the case that the staffing bill for the organisation should reflect its purpose - to achieve a certain level of income for the council.
“The business case for delivering that income includes the staff who are responsible for delivering that income,” says Park. “So we go to our directors of HR and say that if we are going to secure the talent, they are going to have pay an uplift of, say, 50% on the current rate that you normally pay people at that grade. It’s authorised on a case-by-case basis and we’ve done that with three or four people already.”
According to Lewis, councils that are serious about their property investment strategies also recognise that they don’t have the skills in-house and therefore “take advice from the right people - they’re not doing this on the cheap”.
We make extensive use of agents - they do a lot of the legwork for us - Steve Park, Warrington & Co
Park agrees, adding that even with his dedicated team there is still a need to bring in outside help. “We do make some extensive use of agents who are out there - they do a lot of the legwork for us,” he says. “We’re an example of the intelligent client model.”
The concerns aren’t just about skills and the potential fallout if an investment goes bad. Another issue is whether councils are operating on a level playing field. Through the Public Works Loan Board (PWLB), councils have access to debt at interest rates rarely available to private investors. In Warrington, Park certainly makes use of the facility, but he also has another trick up his sleeve.
“We can establish a bond with the finance markets,” he says. “We say that we have a credit rating and we want to draw down a certain amount from the market in the knowledge that your investment is gilt-edged in terms of its security.
“That security means we can borrow even more cheaply than we can via the PWLB.”
As a result, Warrington & Co now has access to a £200m facility. “We got an A** credit rating from Moody’s, which put us ahead of China, any European bank and most European countries - certainly Spain, Italy and Greece,” says Park. “It doesn’t mean we will choose to draw down the £200m, but we have the option. Interest rates can be as low as 1.5% in some cases, and that’s fixed. It’s really quite attractive.”
Private investors would describe rates of 1.5% as attractive too, but given that they can rarely get access to such cheap debt, is it fair that they are increasingly being forced to compete with councils?
At Cushman & Wakefield, Lewis can’t see a problem. “I think every investor has their own criteria and way of borrowing or raising money,” he says. “It just depends on the market forces at the time. Some of the annuity funds are complaining because they’re missing out on opportunities because they’re being outpriced. But does that mean it’s wrong? It’s fair competition - somebody else just has a cheaper cost of capital.”
Fair or otherwise, what is certain is that councils aren’t about to retreat from the market. Local authority finances are tight and even with increasing fiscal devolution are likely to remain so. Private sector investors need to get used to the competition.
13 January 2017
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