On 5 September, Birmingham City Council issued a section 114 notice under the Local Government Act 1988. Europe’s largest local authority found itself questioning its ability to balance its budget, anticipating a deficit between its income and expenditure of approximately £87m for 2023/24.
With the potential for other authorities to follow suit, this shock is understandably focusing minds and, given the crucial role many councils play in the wider real estate sector, has significant implications for investors and other key stakeholders, including developers and universities.
A section 114 notice not only affects a council’s ability to deliver on agreements, but also its ability to acquire and retain strategic land and assets – constraining future regeneration and development – as well as its ability to attract central government grants.
What is a section 114 notice?
The issue of a section 114 notice is, or historically was, an extreme measure taken by a council’s section 151 officer (the chief financial officer), indicating that the council may be unable to meet its expenditure from income and moving it into potential ultra vires territory.
The CFO will usually only issue such a notice after consultation with the council’s monitoring officer (or chief lawyer) and chief executive. It’s not a step local authorities will wish to take given the negative reputational impact, let alone the potential reassessment of its financial covenant, its ability to contract and, vitally, its ability to deliver.
A section 114 notice means a council cannot commit to new spending until it has met to decide on its response and on what financial steps it can and must take. No new expenditure can be made without the approval of the CFO, unless for statutory services.
What is its impact?
In broad terms, this means a council can only spend where it has a statutory duty to discharge – for example, social services and education – and where it is subject to certain existing contractual obligations. All non-essential spending is suspended, and the budget gap must be dealt with. External commissioners are likely to be sent in to manage the council, which has now happened in Birmingham. It is likely that the decision makers will change and the council’s priorities will be scrutinised with spending reallocated.
This process is likely to lead to protracted delays, a refocusing of priorities, possible challenges over future actions, and may even unsettle plans for devolution.
As councils also play a key role in regeneration, the development of new and repurposed buildings and the construction of new infrastructure and services – all areas in which the real estate sector drives economic growth, particularly outside the South East, where viability has always been an issue – we’re likely to see delays in these areas too, as well as levelling up.
Should the situation in Birmingham become more commonplace, we could now be facing a double whammy of financial distress in the local authority sector, with unprecedented structural challenges facing real estate – working from home and online retail being two obvious, irreversible examples – and permanently higher funding and build costs, all of which represent a powerful inhibitor to growth.
The recent challenges facing the real estate sector are well known – ranging from substantially increased funding costs, construction inflation, a rapid drive towards net zero, a shift in investor sentiment to favour super-prime assets with substantial sustainability credentials, structural changes in the way we work and shop, and a significant drop in tenant demand.
In short, there is a growing disconnect between cost and income, exemplified by the gap between market rents and construction/holding costs.
Looking to the future
So what are we likely to see happening over the next 12 months? There will probably be a fire sale by some authorities of (mostly) secondary assets, the loss of some strategically important sites, more central government oversight and restrictions, a reduced acceptance of risk by councils, and a reduced capacity to complete existing capital programmes.
In turn, this will affect the wider real estate market, and compound value destruction – particularly if we see a glut of secondary private sector office and retail disposals. Developers will also need to shoulder more of the funding costs and risk on future developments – Public Works Loan Board funding is no longer cheap even if it is available, further impacting viability.
All this increases the risk that large investors and developers will simply sit it out and do nothing. Unfortunately, our secondary towns will bear the brunt, further increasing the cost of providing social welfare and compounding the financial problems of councils.
Since the financial crisis of 2008/09, the real estate sector has ridden a wave of growth, created by cheap money and asset price bubbles. That wave has now passed and the plight of Birmingham City Council, if extended to other councils, may have eroded a further driver of real estate growth.
That said, many councils have been very successful in implementing a coherent plan for regeneration and growth – and we must not allow the current situation to derail this.
Stephen Chalcraft is a partner at Davitt Jones Bould
