A stretch too far: council commercial investment

14 Apr 20

The framework governing capital investment by local authorities has been tested to breaking point by councils borrowing cheaply to invest in commercial property, according to a recent NAO report.

 

During the past three years, local authorities in England have invested significant public money in buying commercial property. Much of this spending has been financed by borrowing.

The National Audit Office report, Local Authority Investment in Commercial Property, examined trends within the sector, as well as highlighting the risks involved, and made recommendations for the Ministry of Housing, Communities & Local Government.

We estimate that councils spent £6.6bn on buying commercial property from 2016-17 to 2018-19 – around 14 times more than in the preceding three years – and that 40% to 90% of this spending was financed by borrowing.


Read more: Alarm bells ring over 14-fold boom in council commercial property investment


Local authorities spent an estimated £3.1bn on offices; £2.3bn on retail property, including £759m on shopping centres or units within them; and £957m on industrial property. The location of purchases varied – shopping centres were almost always within an authority’s own area, but nearly 40% of all spending in the past three years was outside the local area.

Local authorities buy commercial property to support local regeneration or boost economic growth, but also to generate rental income to offset reductions in funding. We have reported previously that local authority spending power has fallen by 28.7% in real terms since 2010-11.

The marked upswing in local authority investment in commercial property is concentrated in the South East, and district councils are disproportionately big spenders (51% of commercial property spending from 2016-17 to 2018-19).

Borrowing has increased for many authorities as a result, with a small group seeing significant increases in debt and repayment costs.


“Some authorities, perhaps inadvertently, will test the limits of compliance”


Commercial property investment is risky, particularly if councils are dependent on rental income to repay debt or fund services should there be an economic downturn. Scale matters. The bigger the spending and borrowing, the greater the risk.

MHCLG is responsible for the prudential framework that governs local authority borrowing and capital spending.

Authorities should “have regard to” the statutory codes or guidance. But recent investment trends raise questions about aspects of the framework and its oversight.

Affordability - a key duty underpinning the borrowing arrangements at the heart of the prudential framework - is no longer effective in constraining each authority’s overall borrowing by keeping it linked to their ability to fund borrowing costs from government grant or local tax.


Read more: Council investment in shopping centres predicted to reach £1bn mark


Some authorities are taking on general fund debt in high multiples of core spending power and view it as affordable because of the income generated.

Equally, the framework’s permissive nature is now being tested. In the context of sustained financial pressure, some authorities, perhaps inadvertently, will test the limits of compliance. This shift in borrowing for income-generating opportunities requires greater changes than we have seen to date to MHCLG’s oversight of the effectiveness of, and compliance with, the framework.

The nature of the framework means it can be slow to change. Commercial behaviour changes emerged in 2016-17, but codes and guidance changes didn’t start to come in until 2018-19.

To address these issues, our study recommends that MHCLG should ensure that authorities’ actions are in line with the principles underlying the framework. To support this, it should strengthen oversight, improve its data and develop methods for more timely, flexible and targeted intervention. 

Image credit | Alamy
  • Aileen Murphie

    Aileen Murphie is director of MHCLG and local government value for money at the National Audit Office

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