Some local authorities in England have invested significant public money in buying commercial property over the past three years with the aim of generating a financial return. Debt has increased for many of these authorities as a result, with a small group seeing significant increases in the amount they owe and the cost of repayment, according to the National Audit Office (NAO).
The NAO estimates that authorities spent £6.6 billion on purchasing commercial property from 2016-17 to 2018-19 – 14.4 times more than in the preceding three years. Many authorities have borrowed to finance these purchases. The NAO estimates that between 38% and 91% of spending on these purchases across the sector was financed by borrowing in this period.
Between 2016-17 and 2018-19 local authorities spent an estimated £3.1 billion on acquiring offices; £2.3 billion on retail property, including £759 million on shopping centres or units within them and £957 million on industrial property.
Local authorities can purchase commercial property for a range of reasons, such as to support local regeneration or growth. However, a key motive of some authorities’ recent investments in commercial property has been generating rental income in order to offset reductions in their funding. Local authority spending power (a combination of government grants and council tax) has fallen by 28.7% in real terms since 2010-11. In a review of 45 authorities’ strategies for investment, the NAO found that all but three identified generating income as a significant objective.
38% of spending between 2016-17 and 2018-19 was on properties outside local authorities’ own geographical areas, with 21% of all acquisitions by value made outside the local authorities’ home regions. However, where authorities had bought shopping centre properties these were almost always within their areas (95% of spending on shopping centres). Authorities stressed to the NAO that these purchases of shopping centres were primarily to support local regeneration and growth objectives, rather than to secure income alone.
80% of the £6.6 billion spend on commercial property in the last three years was by only 49 local authorities (14%). However, 105 authorities spent at least £10 million buying commercial property in this period, compared to only 13 authorities spending at least this amount in the previous three-year period. Local authorities located in the south east of England are highly active, accounting for 53% of commercial property spending in the last three years. District councils are also disproportionately big spenders in this area, accounting for 51% of commercial property spending from 2016-17 to 2018-19, but only 6% of the sector’s spending power.
Local authorities face potential investment risks from buying commercial property, such as in the event of an economic recession or a downturn in a particular economic sector, particularly where authorities are dependent on their rental income to keep up with debt repayments or fund local services. The scale of spending and borrowing by some authorities in recent years leaves them potentially exposed to these risks. For instance, the NAO identified a group of district councils (8% of all districts) that have been highly active in acquiring commercial property relative to their spending power. The median increase in their external debt was £88.8 million between 2015-16 and 2018-19 and median gross external borrowing levels have grown from 3% to 756% of their spending power.
There is also evidence of authorities mitigating these risks, such as by recruiting specialist staff, undertaking due diligence on their purchases, drawing on external expertise and establishing contingency funds. Nonetheless, local external auditors indicated to the NAO that there was room for improvement in the governance and risk mitigation arrangements of some authorities.
The Ministry of Housing, Communities and Local Government (MHCLG) is responsible for the framework of statutory codes and guidance that set the parameters for local authority borrowing and capital spending. MHCLG has made changes to aspects of the framework in response to the recent increased investment in commercial property. However, it does not expect any immediate, significant changes to local authorities’ behaviour. Recent activity has raised questions about the extent to which MHCLG can rely on the framework in its present form to support local authorities to make decisions which provide the taxpayer with good value for money.
The NAO recommends that MHCLG improves the relevance and quality of data and analysis it has on authorities’ acquisition of commercial property to understand more fully any risks and to provide greater assurance that authorities are complying with the framework. Given the recent increase in local authorities’ commercial activity, it should review whether the current framework is still achieving its intended aims.
“Local authorities have responded innovatively to the challenge of funding constraints, with some investing in commercial property to secure additional income.
“However, the benefits from this investment must be considered against the potential risks to authorities, particularly given the concentration of this activity and associated borrowing within a relatively small group of authorities. MHCLG needs to look again at the framework which governs local authority borrowing and investment and consider whether it is still fit for purpose.”
Gareth Davies, the head of the NAO