Local authorities are trying to make up for funding cuts by speculating on property markets and car showrooms. But what will happen when the cycle turns? Simon Wilson reports.
What’s been happening?
Over the past two years, dozens of local authorities in England have gone on an unprecedented debt-fuelled spending spree, buying up around £1.7bn worth of commercial property assets – shopping centres, office blocks and so on – using cheap loans from an obscure Treasury offshoot known as the Public Works Loan Board. The PWLB has been around since 1793 (though is shortly to be abolished and its functions formally swallowed up by its parent, the UK Debt Management Office). The Board’s job is to help finance capital spending and infrastructure investments by local government. So far, so uncontroversial. What’s got observers worried is that so many councils have been using cheap PWLB loans (which track UK government debt, and are currently very cheap) not to build things, but to invest in commercial property assets that yield far more than the interest rate needed to buy them.
What’s their motivation?
Turning a profit in order to plug the gap in their central government funding (there was a 37% real-terms cut in funding between 2010 and 2015) and allow them to carry on providing essential services. It’s not surprising the commercial property opportunity looks attractive. The interest-rate charges by the PWLB reflect the UK government’s borrowing costs in the gilt-edged market. So the collapse in government bond yields has made the Board a hugely attractive lender to councils, offering 45-year or 50-year loans at around 2.5%.
If councils then re-invest that money in buying shopping centres, office blocks and so on – investments that might yield 6%-8% or more – they are up on the deal. In effect, they have become carry-trade speculators, taking advantage of what John Plender in the FT ridicules as an “absurd circularity” in local government financing. With one hand the Treasury has “imposed austerity on local government; while with the other it facilitates arbitrage that helps mitigate that same austerity”.
What are the figures?
Last year some 49 local authorities spent a total of £1.3bn on property assets – a massive jump from the £142m total for 2015. A further £221m had been spent by the end of March 2017. Councils are buying up about a third of all regional property assets that come up for sale, according to an agent, close to some of the deals, quoted by the FT. “It’s slightly bizarre. I have never seen them come on so strong. They are outbidding mainstream commercial players,” he said. Shopping centres are most in demand. Last year Surrey Heath council spent £86m on The Mall in Camberley, Canterbury bought a 50% chunk of the Whitefriars centre for £79m, Stockport bought the Merseyway centre for £75m, while Mid-Sussex council spent £23m on a shopping centre in Haywards Heath.
What else have they been buying?
Other assets snapped up include offices, retail warehouses, industrial parks, solar farms, garages and country clubs. Easily the biggest single purchase, however, was by Spelthorne borough council in Surrey, which bought BP’s office park in Sunbury-on-Thames for a reported £360m. Spelthorne took out 50 separate PWLB loans to buy the vast site, on maturities ranging from one to 50 years, immediately leasing it back to the oil giant on a minimum 20-year lease. The council’s total borrowings were £377.5m, which dwarfs its net assets of £39.7m and gross income last year of £73.9m. In balance sheet terms, the BP deal means that Spelthorne is in effect “now a property company with a sideline in providing local government services”, reckons Plender. “Even for the best of motives, it’s a highly risky bet.”
Any leveraged investment is risky. In this case, most of the deals are 100% debt-funded, leaving both councils and ultimately the UK Treasury exposed to immediate losses if property values fall, or if the envisaged yields do not materialise. Moreover, other market participants report that councils have been overpaying, amplifying the risks to them – and their local residents – of a future bust. More broadly, local councils do not necessarily have the expertise or experience to act as major property investors, leading some to claim that they are merely pumping up prices – the “dumb money” in the market.
“Local authorities have a long and inglorious history of gambling in the financial and property markets,” the former business secretary Vince Cable told The Guardian. For example, in the 1980s Hammersmith & Fulham, a local authority in west London, was one of several councils that landed in financial chaos after getting involved in complex bets on interest rates. “In some cases they may succeed,” reckons Cable, “but there is a very high risk of bankrupting their local authorities” if the property market turns and the investments turn sour. That, in turn, could threaten a serious systemic risk to the property market and UK financial stability.
Act local, buy global
In addition to making money from the arbitrage opportunity, councils have a secondary interest in buying commercial property in their own area: stimulating economic growth to expand their business tax base (from 2020 they will keep 100% of local business taxes, compared with just 50% now). Some councils, however, are investing both at home and further afield. Portsmouth, for example, has accumulated shops in Redditch in Worcestershire, a luxury car showroom near Southampton and a warehouse in Gloucestershire, as well as a local ferry terminal – prompting Baroness (Patience) Wheatcroft, the journalist-turned-peer, to remark:“I am prepared to believe that local authorities know a lot about social housing, but I am not convinced of their knowledge about Mercedes showrooms or ferry terminals.”