The media has thrown a spotlight on investment in property by local government. David Green argues the safer route is to pool funds for investment rather than going it alone.
There has been much media interest recently in local authorities’ property market activities. While many councils have held investment properties since the dim and distant past, these were once seen as a safe home for surplus investments, rather than a home for newly borrowed money.
Government statistics show that local authority net borrowing increased by £3.7bn in 2016/17, a record if you exclude housing reform in 2011/12. Anecdotal evidence suggests much of this found its way into the purchase of property for income rather than service purposes, although this is one area where DCLG does not collect data, so we cannot be sure.
The potential pitfalls of a debt-funded rush into commercial property are well-known, just ask the members of the now-defunct Dunfermline Building Society. Rental income and capital growth are never certain, but the debt costs are always payable; try asking the PWLB for an interest holiday because your investment property is empty and you now have to pay the business rates!
Relatively small investors are inevitably going to have a relatively small portfolio, with returns reliant on the performance of just a few properties. Local authorities also find it easier to keep members on board if all their purchases are local, adding to concentration risk. But buying outside the local area often leads to several authorities outbidding each other, pushing up the final price.
New investors will never have the experience of the old hand, and will always be at risk that the seller knows more than they do. Learning by your own mistakes can be a very costly business with multi-million pound investments.
Investment property is, of course, another form of capital expenditure, meaning that increases in property values are realised as capital receipts. And given the absence of government grants towards this activity, it is likely to attract a charge for minimum revenue provision (MRP). A gross rental yield of 6% may look attractive, but once the revenue impacts of loan interest and MRP have been deducted, and allowances for voids made, the net yield may be rather nearer 1%. And buying £100m of investment property to generate a £1m revenue benefit opens you up to big risks.
What local authorities really need to do is to club together and reduce some of these risks by pooling their resources into a single entity. With its much larger resources it could buy commercial properties across the UK, sharing the gains and the risks to income and capital growth among all the participating authorities. It could afford to employ a team of property experts with decades of experience in the market. And it would end the bidding war between authorities that is pushing prices skywards.
Even better, such a mutual investment fund could gain the support of the Local Government Association. It might even convince the government to change the rules on capital expenditure, so that investors needn’t charge MRP, and can take capital growth to revenue.
If this all sounds a bit far-fetched, don’t worry, I’m not the first person to come up with this idea. The Local Authorities Mutual Investment Trust was founded in 1948 exactly for this purpose and is today owned by the LGA and other local government organisations. Along with similar bodies for churches and charities, LAMIT jointly owns a fund management company that manages over £1bn of local authority money in three pooled investment funds, including one specialising in commercial property, none of which are capital expenditure.
I’d much rather my local council earned a £1m extra in revenue income by investing £22m in a diversified fund paying 4.5%, rather than investing £100m in a few local properties for a net 1%. Same return for much less risk. Wouldn’t you prefer the same?
David Green is Strategic Director at Arlingclose Limited.