Between 2010 and 2015 we have seen a real terms cut in central government funding to local authorities in the region of 37%. The politicians will argue over this figure but there is no doubt there has been a significant reduction in central government funding. In many ways the ability to borrow funds at very low interest rates from the Public Works Loan Board (run by the Treasury) and invest in areas such as commercial property makes sense on the surface.
However, you only need to look back over the years to see the disastrous investment record of many local authorities who had to be bailed out by the UK government when they were on the verge of bankruptcy.
Heavy exposure to the commercial property market
The simple idea for many local authorities is to borrow funds at extremely low interest rates and invest in commercial property where sometimes returns of 8% are available. On particularly large investments this can significantly add to the flow of funds into the council coffers at a time when they are desperate. The problem is that the commercial property market at the moment is coming under some pressure with concerns about Brexit and the future of the UK economy.
At this moment in time we have no definitive figures regarding local authority investment in commercial property but it has grown to in excess of £1.5 billion. This has all been highlighted by Sir Vince Cable who was the former business secretary in the coalition government. He believes that local authorities are looking for “more exotic” solutions to their financial constraints which effectively mean greater risk.
Surely local investment is good?
Investment for investment sake does not make sense but if local authorities are making use of the low interest funding arrangements to improve their local environment then there are obvious benefits to everybody going forward. A busy local economy will attract new investment, workers and ultimately more money for the region. So, if managed correctly there is no reason why an investment in local commercial property should not pay for itself going forward.
One issue highlighted by Sir Vince Cable is the fact that rather bizarrely some local authorities are investing in commercial property outside of their own region. Why would they take on these additional risks? Are there no similar investment opportunities in their region?
Local authorities have a chequered investment history
As we touched on above, many local authorities across the UK have what can only be described as a chequered investment history. It is difficult to say why many of their investments failed to deliver to the levels expected but ultimately we have seen some disasters in years gone by. We may well see some local authorities taking on board third-party investment management companies but this just adds a layer of cost and reduces their ultimate return.
In many ways local authorities are better off working with local businesses with a history in the commercial property sector and “know what they are doing”. Trying to go it alone has proven difficult in years gone by and the current financial pressure has probably made a difficult situation even worse. Whether we see an “Icelandic style financial crisis” as predicted by Sir Vince Cable remains to be seen but local authorities need to know their place and not take undue risks with taxpayer’s money.