Managing The Risks Of Commercial Property Investment

Local authorities borrowing to invest in commercial property has increased in recent years as another way to plug the funding gap. As concerns about the practice mount, we speak to two councils about managing the risks.

The practice of investing in property is not new. But as more funding from Central Government has fallen away, many councils are increasingly investing in commercial property and using their ability to borrow money cheaply to compete with the private sector. 

In many cases, loans are secured from the Treasury agency the Public Works Loan Board (PWLB), which lends at a much lower rate than private sector borrowers can secure. There have been some well-publicised cases of councils borrowing vast sums in relation to their income and the Chartered Institute of Public Finance and Accountancy (CIPFA) is currentlyworking on further guidance to support local authorities.

“Recently there has been a move towards investments in commercial properties, funded by borrowing, and in some cases the sole driver of this activity appears to be the generation of revenue," said Don Peebles, Head of CIPFA Policy & Technical at CIPFA. "A look at both the statutory investment guidance issued this year from the Ministry of Housing, Communities and Local Government (MHCLG), and CIPFA’s Prudential Code quickly casts doubt on whether authorities should undertake such practices.

"We understand the financial challenges faced by local government and it’s essential that in these difficult times that the commendable drive for commercial opportunities does not result in inadvertent contravention of the prudential code."

Councillor Peter Heydon, Executive Member for Transformation and Finance at Bracknell Forest Council, said he understands the concerns but believes the risk-management process at Bracknell Forest is robust and measured. 

Bracknell Forest started to look seriously at investment in commercial property four years ago in tandem with a transformation programme aimed at making a target saving of £20m over four years by the end of 2019/20. The authority had an initial budget of £50m, but increased this to £90m as property prices increased and yields fell. It hit its target without investing the full amount and it is no longer looking for opportunities. Its total asset value has increased by around 20 per cent in the last three years.

"As you would expect, we did a lot of due diligence, seeking specialist legal advice, and compared our approach with other authorities. We have looked very carefully at that and the way that it is accounted for," he added. 

As well as careful consideration of the rules, Heydon says the council applies rigorous criteria to any potential property through scoring aspects such as: location, tenants, length of lease and age and quality of the building. "We have a template whereby every property is assessed and we are absolutely ruled by it - if it doesn't score enough we will walk away," Heydon said. 

While some have criticised councils for playing dangerous game, Heydon points out that Bracknell Forest's Assistant Director of Property has a strong commercial property background and leads a very strong and experienced team. "We have also used professional advice quite extensively. When people are accusing us of taking unnecessary risks they quite forget that our senior officers are professionally qualified and we take advice from experts in the field."

However, he doesn't believe all local authorities so strongly policed. "I have a feeling someone is going to come a cropper," he warned. "The private commercial property sector are very unhappy with it all and there have been a few prominent figures bashing away at the government. There is a political move to look at it more closely and that is welcome but I am confident that our strategy and risk management is robust enough."

Rushcliffe Borough Council is another local authority which has turned to property investment. The council faced a funding gap of £1.4m over three years, with an increasingly uncertain financial outlook, and needed to look for ways to plug the deficit. Peter Linfield, Executive Manager for Finance and Corporate Services, says the authority has been investing in property for many years (both for economic development and commercial reasons) and follows the maxim: Be brave but not reckless. 

"In 2013 we invested an office block called The Point. It has been a big success for us and that was the start of further property investment. It was a semi-vacant office space that we bought for £1.9m and the asset, which is now largely occupied, generates around £300,000 of income per annum. It is worth around £3m in value at the moment, so has risen in value fairly substantially," he explained. 

The council originally set aside £10m for property investment, but later increased that to £20m, of which £13m has been invested so far. It tries to keep its investments geographically close, but has invested in some properties around 20-30 miles outside of its boundaries. Still close enough that they can be attended easily if necessary. 

"You want to get the biggest bang for your buck but also manage the risks for the taxpayer and we have not borrowed to invest in property but used our own resources. We have a risk strategy and look to have a balanced portfolio. Balancing risk in terms of the sector, the type of property, the credit worthiness of tenants and location helps manage property risk," Linfield added. 

Keeping a close eye on the market and portfolio is also key."We need to be on our toes all the time. Being ever vigilant and looking out for the warning signs is key, working with our professional colleagues, particularly in the property and legal sectors. The environment is  fluid - and there will be a point in time when we might have to make a decision to dispose of an asset - we are not solely focused on property acquisition," he explained. 

Like Heydon, Linfield also finds criticism levelled at local authorities regarding property investment somewhat frustrating. "A lot of people forget that councils have been investing in property for a long time and we need to continue to do it, complying with professional standards and good practice  effectively managing the risks. We can't just sit back and do nothing, we aim to be both proactive and proportionate with all types of investments." 

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