The sale in February 2019 by Network Rail of a commercial property portfolio, comprising primarily of railway arches, raised £1.46 billion which was a fair price and more than expected. However, the long-term value for money of this transaction will depend how Network Rail manages its ongoing relationship with the leaseholder and the impact of the sale on tenants and local economies, according to the National Audit Office.
The sale means that Network Rail has balanced its funding position for the five-year investment period ending in March 2019. However, this also follows the cancellation of projects (such as electrification works), efficiency targets imposed in April 2017, and £1.8 billion of additional grant and loan funding from the Department for Transport. Following an earlier agreement with HM Treasury, the sale contributes around £500 million to Network Rail’s funding shortfall in its investment programme. The remaining proceeds were used to offset against expected borrowing from the Department.
Network Rail had a conservative valuation of £950 million for keeping the portfolio in public ownership; it assumed it would not be able to invest in improving the portfolio because of government borrowing restrictions. Reflecting its potential to buyers, Network Rail valued the portfolio prior to the sale at a price of £1.17 billion. Network Rail’s financial adviser separately valued the portfolio from the perspective of potential buyers using market assumptions and no investment restrictions at £1.4 billion, close to the final sale price.
The property was sold on a 150-year lease rather than a freehold sale thereby achieving Network Rail’s primary objective of not prejudicing the safe and sustainable management of the railway infrastructure. It identified that only a leasehold sale would allow access to the properties in the future, for example, for maintenance. However, this objective was at the expense of HM Treasury’s aim of deficit reduction.
The Department and Network Rail did not explicitly seek to deliver wider government policy objectives such as business support, tenant protection or community regeneration. However, Network Rail did consider government’s housing policy as a part of its wider disposal plan, and excluded land with known residential development potential from the sale so that this could be sold separately. The new owners set out initiatives to support tenants, but these intentions are not legally binding nor are investments contracted. Support to tenants was negotiated in the final stages of the sale process.
Network Rail expects the buyers to invest in the portfolio to increase revenue. Network Rail has forecast that the portfolio’s total rental income, which it will now forego, will increase from £83 million in 2017-18 to £160 million in 2027-28, mainly through a major investment programme and expected rent increases. There are also opportunities to commercialise approximately 760 unrented spaces (around 15% of the portfolio). Network Rail’s financial position did not allow it to exploit these opportunities before the sale.
The transaction was managed and executed professionally and generated a large amount of market interest. Network Rail undertook an extensive process to identify properties for sale. It excluded around 2,500 rental spaces because they were either required for the operation of the railway or marked for future development. The resulting portfolio was large for a single transaction, but indications of high investor demand supported the decision to pursue a single sale. A single transaction also increased the likelihood of Network Rail achieving its objective to complete a sale by March 2019. The sale generated substantial interest from investors and strong competitive tension between bidders with a shortlist of five for the final round of bidding.
The sale took two years longer than expected and transaction costs exceeded those estimated at the outset. Reasons for the delay included: the decision-making process between Network Rail, the Department and HM Treasury in relation to the sale structure and accounting treatment; and selection of the properties for sale. The costs of the sale were £35 million (2.4%) of the overall proceeds. At sale launch, Network Rail expected costs to be around £20 million. The costs were affected by the choice of the leasehold sale structure which added complexity, the inclusion of an additional round in the sale process in response to high bidder interest which increased the cost of legal advisers, and the cost of separating the property portfolio from Network Rail’s retained assets.
Network Rail highlighted to prospective buyers the upside potential of rents: it estimated a 54% rental increase for a sample of properties over the next three to four years owing to market conditions and irrespective of a sale. The impact of the sale depends on the buyers’ future activities. The new owners have taken over the existing contracts with tenants. They have committed to adopting a ‘Tenants’ Charter’ to guide their practices in relation to tenants and their leases.
Amongst its recommendations the NAO says HM Treasury and the selling department should consider the potential impact of the disposal on wider government policy delivery. Where the impact could be significant, the Department should engage with policy leads in other departments to consider broadening the sale’s objectives.
“Network Rail achieved value for money in terms of the price paid and the achievement of its main objective of obtaining access rights to ensure the continued operations and safety of the railway. However, it is concerning that tenants as stakeholders did not form part of the aims of the sale and that they were only fully considered late in the process.”
Amyas Morse, the head of the NAO