James Routledge 05 July 2017

How councils can create a property portfolio

With central government funding changing, local councils have been given greater autonomy to raise their own funds. With this change concern has been raised over whether local authorities have the knowledge to invest taxpayers’ money wisely.

Although local authorities have owned property as part of operational, strategic and regeneration projects for decades, since they have begun purchasing property for purely investment and income generating purposes, there has been some backlash.

Most notably, Matthew Oakeshott, a Lib Dem Peer and investment manager reckons that councils are investing in ‘all sorts of provincial property’ without any ‘coherent investment strategy’ and that this will end in tears. If this was the case, he’d probably have a point, but the reality is that the majority of councils are being savvy, taking advice and making solid choices to benefit their local areas.

Firstly, it’s important to highlight that local authorities have not begun investing in property without a cause. As local authorities have been granted more autonomy, they have become more innovative and commercially minded in order to continue to support their communities. Councils could opt to invest in other asset classes, such a stocks or shares, but property tends to come with a greater amount of income certainty, which means it can be a safer option for tax-payers’ money.

Although investments could be made out of internal reserves, the majority are turning to the Public Works Loan Board (PWLB) to borrow funds long-term. The PWLB provides local authorities a lower interest rate, around 2.5 to 3%, giving them an edge against private sector counterparts who have to borrow from commercial lenders at a higher rate of say 5% at the current time.

Portfolio Strategy

Once a council has secured the funds to create an investment property portfolio, it is essential to ensure it remains separate from its operational buildings. In line with recognised best practice, it’s always best to have a balanced and diverse portfolio in order to spread the risk.

This means purchasing a range of asset types, a locational spread and a mix of tenants with sufficient covenant strength relative to the specific asset. Ideally, councils should also invest in a combination of lease types to provide security; some with a higher yield and shorter leases for properties with strong residual values, and some longer leased properties. This will help to cope with market cycles and ensure there is always a minimum income covering the cost of the outstanding debt.

Many investors are currently looking for longer term investment security and thus competition for these properties is fierce. However, because of the current political landscape there is less competition for short term leases and prices can be noticeably lower. This is a bear trap – whilst “mispricing” can be an opportunity for seeking out stronger investment returns, a lower price doesn’t necessarily mean a sound investment in the long run. The first thing to consider when investing in any property should be the suitability of location, occupational demand, needs of the user and risk of building obsolescence, regardless of the price.

Another common mistake is to commit to a property and not continuously review the performance of the investment against a pre-agreed asset plan. Ongoing performance should be continually monitored as part of an Active Portfolio Management strategy, whereby in-house or third party advisors can manage asset plans, examine lease restructuring initiatives and protect against loss of income to ensure the local authority is maximising the yield of its investment.

Having clear conditions also means when new property options arise unexpectedly, it’s easy to identify the ones you are and are not interested in.

Active Portfolio Management should embrace knowledge of trends and markets and keep up to date with new investment options, as well as efficiently execute day to day imperatives. Some councils have opted to use in-house expertise by employing property professionals; their sound advice has resulted in investments flourishing, which in turn has benefitted their community. The problem comes when local authorities fail to seek any property advice and think they can go it alone, this is when as Oakeshott terms it the investment will ‘end in tears’.

External property advisors are a good choice for authorities that are unable to afford to employ a whole property team, they can work hand in hand with the investment team to provide research, build the key criteria, complete property searches and assessments as well as negotiate the best deal and provide ongoing strategic advice.

External advisors provide independent advice and always have their finger on the pulse of private property buying trends.

Whether an advisor is in-house or external, they should always look not only at the day one suitability of an asset, but explore the future opportunities each presents by assessing a range of possible scenarios involving future vacant possession, reletting and income prospects.

Regardless of the opinions of those like Oakeshott about whether councils should or should not invest in property, ultimately, they do have to find another source of income to traditional central government funding. Because of the lower interest rates and the reliable nature of property’s income returns, it is a sensible investment.

However, the best way to ensure your local authority is getting the most bang for the tax-payers’ buck is to take professional advice from experts, whether internal or external, and invest in a diverse portfolio.

James Routledge is head of investment at property consultancy firm Matthews & Goodman

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