by Chris Brain FRICS, Senior Advisor, CIPFA Property
Much has been made in the mainstream media of late around the risks that some local authorities are taking by entering the commercial property investment market. Some of the language has appeared rather extreme, even suggesting that local authorities have been effectively playing the ‘casino tables’ with public funds.
Fair enough, one or two headline grabbing property transactions may seem a bit eye watering to those sitting outside those organisations. This can create a perception that local authority property investors are all running amok and taking huge risks that will come back to bite them.
As always, context is everything. Councils have been involved in commercial property for many years. But the twin drivers in more recent times, of continuing cuts in government funding and the exhortation from government for councils to be more self-sufficient in their income sources, has seen many more councils looking even more intensely into the potential of commercial property yield to help offset the impact of the grants cuts.
Very logical, as long as it is done sensibly and is not expected to be the panacea for all the council’s funding ills. And it is only right that CIPFA is reviewing both the Prudential and Treasury Management Codes to ensure that they provide a suitable framework within which investment strategies are developed and actions decided upon.
As the private sector knows only too well, sometimes these investment can go wrong. In the main though it is a robust sector, built around well-established assessment of market risk and due diligence procedures.
Indeed, local authority pension funds have always held significant investments in the commercial property sector to help pay for their pension promises.
Can local authorities go further and take risks with public funds to help pay for their service promises?
Yes of course they can but providing they all apply best practice in understanding risk and apply the right due diligence. But it is commercial risk and with the clue in the title that means it can go wrong sometimes, which means it is even more important that local government is seen to have undertaken all the right checks.
So there is no reason to take a simplistic cemented position that property investment by local authorities is wrong.
What matters is the extent to which local authorities taking this journey are:
- availing themselves of the right market knowledge and skills, partly independent and partly in-house
- assessing the potential risks in the short and long term
- not taking on undue or disproportionate risk in aggregate
- continually monitored the risks, are ensuring that they build a balanced investment portfolio
- well informed on the potential impacts of those decisions.
Not sticking by all these top tips is when things could go wrong. Our work with local councils suggest many follow these best practice tips as a matter of course but it will be important that best practice is common practice across all councils. It will just take one council to get it badly wrong to create problems for all councils. Perhaps understandably, eyebrows get raised when a local authority acquires property investments well outside its locality. From a property perspective it’s all about the motive.
Clearly, it is not helping their local economic regeneration but there is some irony in raised eyebrows, if the motive is diversification. A property investor is going to be more exposed to far more risk if investing in one single acquisition, one single market or one single location. Conversely if the motive is primarily about securing additional yield, investing well outside your locality does mean by definition you have less local market knowledge of the area concerned. The big rule should always be to spread risk and ensure there is an appropriate balance of investments.
Managing risk should not just be at the acquisition stage. When acquiring a property investment you are to a very large extent investing in the tenant that will be paying you their rent and to an extent that future economic circumstances mean the property continues to be attractive to future tenants. While understanding the strength of the covenant at the investment stage is important, so is keeping abreast of the business and market sector of that tenant and their financial health during the lease term so that you can continually assess your risk exposure. But it is vital that you have a ‘plan B’ for the asset if things don’t work out – indeed you should take that commercial risk into account when deciding to buy or not in the first place.
Some local authorities make property investments in the name of economic regeneration. It is critically important that you understand your motives as this will shape what and where you buy, the price you are prepared to pay, your risk exposure, and the performance management framework. You shouldn’t confuse pure property investment with economic investment in the area. These are very different things altogether and carry different intended outcomes and risks.
There is nothing wrong with local authorities making property investment acquisitions. It is about taking measured proportionate risks and never shirking on the right due diligence. You shouldn’t be put off by the risks, but you should understand them.
- The Prudential Code for Capital Finance in Local Authorities (2017 Edition) will be published in December 2017. Find out more and pre-order now.
- Commercialism, investments and public assets: make property part of your organisation’s strategy with our new Strategic Assets Network.
- Property consulting – help with commercialism and property. Get tailored help for your portfolio – find out more.