The risks involved in councils investing in the property market are underlined in a research report for MPs which has only recently come to light.
The House of Commons research report, issued earlier this year amid mounting concern over record sums being spent by councils on commercial property, says there has been an increase in commercial property investments in the current decade.
It says councils have shifted away from selling off surplus property and turned instead to using assets as sources of revenue, while big cuts in central government funding have forced them to look for other sources of income to maintain services to their communities.
Recent figures revealed by LocalGov showed council investment in commercial shopping centres has reached record levels, totalling £324.6m in the first half of this year alone - more than the previous highest annual figure for the whole of 2016.
The new report by respected academic Mark Sandford outlines three major areas of risk in a ‘commercial property-based revenue strategy’.
First, it says there could be a downturn in the market, leading to falling income from rents, a higher number of vacancies and a fall in property values. This could mean the asset would not produce enough money to cover the council’s costs, leading to negative equity and ‘financial pressures.’
In other words, tenants could push for lower rents or quit altogether, leaving the council with half-empty shopping centres producing less income than the council has to fork out in repayment costs.
And it would be stuck with a shopping centre which it would have to try and sell for less than it cost in the first place.
Second, the impact of public sector investment in shopping centres could produce such an impact on the commercial sector that the Government would step in and place restrictions on the activity.
This, it seems clear, could also have a downward effect on the market price of a shopping centre because a potential buyer would know the seller - the local authority - was in a weak position.
Finally, the research paper warns of the danger that council teams may lack expertise in the commercial sector, leading to ‘poor investment decisions’. Some councils, the report says, may have the necessary experience. But, quoting the Centre for Cities, it says having a ‘clear commercial mindset’ is vital.
‘There must be a clear focus on the gap in the market that they are looking to fill, who competitors will be, and the potential for and scale of risk,’ it said.
The point is emphasised elsewhere by financial experts. Reacting to the record shopping centre figures, Mike O’Donnell, associate director for local government at CIPFA told LocalGov recently that each investment should be judged on a case-by-case basis.
‘What is crucial is that councils understand the risk they enter into and apply the right level of due diligence,’ he said. ‘To do so councils need the right commercial skills in place to evaluate, communicate and manage the risk.’
The Government is keen to encourage entrepreneurialism in the public sector, but also naturally wants to ensure the necessary safeguards are in place - the regulatory changes earlier this year were aimed at increasing accountability and transparency in local government investment strategies.
But there are still concerns. A report by the parliamentary public accounts committee quoted in the House of Commons report warns that the Department for Communities and Local Government ‘appears complacent about the risks to local authority finances, council tax payers and local service users resulting from local authorities increasingly acting as property developers and commercial landlords with the primary aim of generating income’.
The months and years ahead will show whether such concerns are justified or whether local authorities buying up shopping centres and other commercial property is an effective way of making much-needed money to pay for services.