Leveraging council land value: the joint venture approach
0Last year, London Borough of Haringey made national newspaper headlines after scrapping controversial proposals to regenerate a major housing estate through a joint venture with developer LendLease. However, since then, at least three other councils have committed to similar proposals – aiming to use the value of land they own to lever in cash from developers. So how does the model work, and why does its appeal to some local authorities remained undiminished?
Councils first became interested in the model more than a decade ago. At that point, the structure was known as the Local Asset-Backed Vehicle (LABV) – a term that has now all but disappeared. According to a Centre for Cities report in 2007, “unlike other models, LABVs are arrangements where local authority assets are used to lever long-term investment from the private sector for a stream of development projects”.
2nd Housing & Regeneration Finance Summit
County Hall, October 31st, 2019
The basic premise of the model rests on a local authority entering an equal partnership with private investors. The council transfers property assets into a new joint venture company, with the JV partner – a developer or housing association – matching the value of the portfolio. The partnership uses these joint assets as collateral to raise finance for regeneration projects. Development profits are split equally between the parties.
For councils, the model is attractive for a number of reasons. In March, Room151 reported that Royal Borough of Kingston Upon Thames had voted to set up a Limited Liability Partnership (LLP) with Countryside Homes to regenerate a 1970s council estate. In a statement to Room151, the council explained its reasons for pursuing the model, saying it allowed it “equal control over the development going forward and an appropriate balance of risk and reward. “It also enabled the council to access skills and experience in regeneration that it did not have in-house.”
“There is a great skills shortage in local authorities that consistently comes up,” says Justin Mendelle, head of construction at law firm Sharpe Pritchard. “To deliver affordable and non-affordable elements in a large regeneration scheme requires both the development process and long-term stewardship to be run coherently. It is a long-term project and not many councils understand how to do this.”
Swindon Borough Council, last year entered a joint venture with BDW Trading, a subsidiary of housebuilder Barratt/David Wilson, to deliver a new community of 2,750 homes on 250ha of land at Wichelstowe to the south of Swindon. Council leader David Renard tells Room 151 the model allows the council to get back the investment it has put in, as well as returning a profit to fund services. He says: “None of the other models we looked at delivered the same benefits.”
The fact that the council is an equal partner in the JV also allows it more control over the shape of development as it is planned, Renard says.
“We are building a genuine community. We can get type and look of the houses that we want, right down to the choice of bricks,”.
So how does it work?
Councils generally put their land into the joint venture in return for a loan note, guaranteeing the company will repay the value of the land, plus interest, from the profits made. Repayments come into the council’s accounts as investment income and hit the revenue account, meaning it can be spent on services. The model thus provides an effective way of enabling a revenue receipt to be produced from a capital asset.
With their own initial funding committed, the partners generally need to find the rest of the money needed for development costs from external borrowing. “External lenders usually need to see that the JV owns 40% of the equity of the company, says Ishdeep Bawa, director within the public sector team at advisory firm Avison Young Real Estate Finance.
Earlier iterations of the model – such as Croydon’s CCURV company – ran into problems because land valuations were done at the point the JV was set up, says Chris Shepherd, director at housing finance consultancy 31ten. “By the time some of these JVs had gone out to the market and secured the extra funding they needed, land values had dropped so the model fell over,” he says. “That is not to say that it is a bad model – it is just the structuring wasn’t very good initially.”
To deal with this issue, more recent versions of the model see land fed into the JV company in gradual tranches, with valuations taking place at the point of each transfer, according to Shepherd. The method of valuing the land differs from scheme to scheme, depending on the council’s aims from the vehicle.
Most councils set up a subsidiary company to become the legal joint venture partner. Set-up costs range from £20,000 to £30,000. “Setting up a susbsidiary can help attract higher-paid staff – often the managing director can earn more than the chief executive. A subsidiary can also give a leaner structure and is more free from political interference,” says Shepherd.
Receipts from the company can start flowing from day one, through repayments on the loan notes. The model can be moulded to provide returns earlier or later, depending on the aims of the company. At Wichelstowe, the council stipulated that it had to receive a £1m receipt early in the process, and the structure was built around that outcome.
The flexibility of the model extends to whether companies decide to hold and manage the property assets they build. Some in the sector identify a trend towards companies keeping ownership of assets and taking rental income, compared to early versions where they were sold on. In some cases, parent councils choose to use Public Works Loan Borrowing to purchase tranches of homes to hold them within the housing revenue account.
In other cases, councils might take a head lease in one of the phases of development. Paul Greenhalgh, professor of real estate and regeneration, and head of built environment at Northumbria University, says: “This means the development has a local authority covenant and allows the company to get finance and helps the development go ahead.”
Once development, interest and administration costs are paid, rental and sales profits from the joint venture are split equally between the partners. Greenhalgh says: “It works a bit like the old development models where you have an overage – a top slice you can split. If some assets are of lower value then you won’t pull in so much and it might just take longer. However, some of these sites might not be developed otherwise and profit is not always the primary aim.”
What are the risks of the model?
Of course, no property scheme is without its risks. As the Haringey episode demonstrated, political risk is high up on the list. The scheme was scrapped after an organised campaign of opposition by trade unions and far left political groups, along with a number of residents, that led to the deselection of Labour Party councillors who supported the scheme.
However, Morrison says the case – perversely – provided a boon to the property joint venture model. A court challenge to the council’s decision to pursue the scheme was thrown out by the courts. “One of the grounds was that local authorities don’t have the powers to participate in limited liability partnerships – and the vast majority of these partnerships have been set up in that way. One positive outcome of the case is that authorities now have the confidence they have the legal power to create such joint venture arrangements.”
However, the market in private sector partners is not as wide as it once was, according to Shepherd. “There is less and less commitment from the private sector to these schemes. Morgan Sindall seems to be winning a lot and Countryside is active. Kier was once a big player but it has some financial issues. Some housing associations such as Swan and Places for People are also doing these. We are looking at how to reinvigorate the market and considering whether it is procurement issues that are putting some companies off.”
Other risks can come from the 50/50 board membership which is a hallmark of the model. According to Greenhalgh: “I am aware of both sides calling in lawyers because there was deadlock in the decision making.” However, Shepherd plays down this factor. He says: “You can put lots of deadlock provisions into the contract. In some cases, each partner is able to buy out the other’s share.”
The length of the partnership can also provide some challenges. “The private sector is often looking for a long term interest in the land,” Mendelle says. “If the leasehold arrangements run for at least 120 years, and the partnership is limited to 30, it can be a challenge to square the conflicting time frames.”
However, Innes says that timeframes of the joint venture model are helpful in riding out property cycles and changes in political leadership. He says: “Regeneration schemes tend to be complicated and last a while. They might include decanting residents, decontaminating brownfield sites or providing infrastructure. Schemes of this scale require a long-term approach and a patient investor approach to capital. There is still risk, but it is a shared risk.”
The pros and cons of a property joint venture versus a development agreement
Development Agreement
Pros
- Single site approach more straightforward procurement exercise than JV;
- Passes development risk to developer.
Cons
- Returns generated less than JV model, including the loss of profit to developer;
- Difficult to vary, structure less flexible in market cycles/multiple site schemes;
- Loss of control of detailed aspects of development.
Joint venture
Pros
- Possible to structure so council/partner have equal incentives/disincentives;
- Greater level of council control over development/timing;
- Greater level of return to council;
- Access to private sector skills/finance;
- Flexible structure re market change;
- Capable of delivering future/additional sites if required;
- Potential to structure so construction supply chain available for further community projects.
Cons
- Higher procurement and set up costs;
- Clarity required on different council roles in governance terms.
Information provided by Pinsent Masons
