Essex County Council has never taken much interest in Manchester: why should it? The city is an exhausting four-hour drive from the shire hall in Chelmsford, and has about as much impact on Essex life as butterfly on the orbit of the Moon. Yet a few weeks ago, Essex County Council bought a 84,000 sq ft Manchester office block for £29.15m in a deal with Redefine International, a net initial yield of 3.6%.
Until recently the acquisition of 201 Deansgate would have been regarded as an eccentric outlier in the property investment scene. Now it has become standard, as local authorities prepare to spend an estimated £1bn-plus on out-of-area investments. Recent buys range from Sutton’s £29.9m purchase from Aviva of Oxfam’s 87,000 sq ft HQ on Oxford Business Park (a yield of 5.28%) to Bury’s £2.56m acquisition of a ground-floor bar and upper-floor dentists in Manchester’s Northern Quarter, in a deal with local operator PJD Property.
Meanwhile, councils have massively stepped up investment within their own boundaries: Spelthorne’s £360m purchase of BP’s 620,000 sq ft Sunbury campus, and Surrey Heath’s £86m purchase of Camberley’s Mall shopping centre from Capital & Regional, are striking examples.
According to Charlie Barke, head of shopping centre investment at Knight Frank, local councils accounted for 12% of the UK’s £3.2bn shopping centre investment market in 2016. “They came from nowhere, and now look at them,” he says.
The sudden emergence of local councils as property investors inside and outside their own areas has a simple explanation. Their motive is to secure (by creating a kind of loan-funded endowment) the reliable income stream a modest commercial property portfolio can provide. Their immediate inspiration are abundant, super-cheap, long-term loans from the Public Works Loans Board (PWLB, see sidepanel). And the imperative is to find ways to replace government grants, which will be severely reduced as part of an effort to make councils more self-reliant from next year.
Ashford Borough Council in Kent demonstrates the local authority thought process as it moves from regeneration-inspired property purchases in its own territory to more strictly commercial purchases outside its boundaries.
The council says that the shrewd acquisition of a number of valuable assets is delivering a strong return on investment – including Ashford’s biggest office block, 79,000 sq ft International House, which is now virtually full, and Park Mall, a 34-unit parade in steep decline, but now flourishing and providing healthy rental income. Ashford also funded the 100,000 sq ft Elwick Place leisure scheme.
Chief executive Tracey Kerly says: “We haven’t yet bought outside the borough, but that’s not to say that we won’t, but we want to exploit local opportunities to drive income streams before going outside. But there will come a point when we need to drive returns, and that will mean investing elsewhere. We can’t keep council tax down without those extra income streams.”
Ashford is not a big authority like Essex or Sutton, and it is telling that the borough is talking up its investment plans. But what makes Ashford particularly interesting is that, from its point of view, property investment isn’t just about raising income from rents – it’s also about creating a profitable trading operation. Ashford set up its own lettings agency and ABC Building Consultancy – and it would love to sell its property management skills to other councils who might, perhaps, be their partners in commercial property investment.
“Buying commercial property as part of a consortium is exactly the kind of thing we would like to do. We can roll out the skills we have to share with other councils, and buying with other councils reduces our risk and means we can afford a better class of out-of-area asset,” says Kerly.
According to Stuart Cunliffe, head of shopping centre investment at BNP Paribas Real Estate, this kind of consortium purchasing and cross-selling of management services is likely to be the next big thing in council property investment. He is already talking to a group of councils in the East of England.
“We are going to see a local council which is well-skilled in property management selling its skills to neighbouring councils. The larger councils are beginning to acquire the expertise you need – and I’m aware that a few are looking at opportunities where they could add value.”
Cunliffe says this kind of co-operative arrangement is likely to be the way ahead for local council purchases of out-of-area shopping centres, because management risks and local politics make it desirable to proceed with caution. There are likely to be tie-ups with local authority pension schemes, too, he suggests.
“We won’t see councils buying out-of-area shopping centres just for profit – yes, the income will be important, but it will also be about cross-selling knowledge.”
Tony Martin, head of investment advisory at CBRE, agrees. “Cross-selling services, and investment consortia, are almost inevitable,” he says, pointing to the lower risk and higher probability of buying into a more impressive and diversified portfolio.
In the meantime, Martin says, administrative changes affecting the PWLB will not choke off the supply of loans, nor does he expect the government to clamp down on lending – at least, not yet. “Only the Chancellor of the Exchequer could be an obstacle in the path of more local authority loan-led property investment,” he says, rating the risk of intervention as low.
Chris Lewis, partner at Cushman & Wakfield, and one of those advising on the Sutton/Oxfam deal, is working with a number of councils now moving from within-boundary property investment to their first beyond-boundary investment. He says local authorities need to proceed with caution – a point made by the House of Commons public accounts committee, which warned in November 2016 that the government was “complacent about the risks” of this new approach to investing with public money.
“Like any investment, councils need to look at the residual value of the property they are buying. Loans of 50 years may exceed the economic life of the building, and it’s about paying attention to all this basic investment stuff. Maybe some councils need to think about this more, but I don’t think many will get in trouble,” says Lewis.
Town Hall fingers are crossed hoping Lewis is right.
Political headaches
Buying out-of-area assets raises a host of potential political problems.
Sutton got burned in the local press and by political opponents when it attempted to buy Reading Link Retail Park for £18m in a deal with Lumina Real Estate Capital. It pulled out after a due diligence investigation and opted instead for what looked like the moral high ground and political safety of buying Oxfam’s 87,000 sq ft Oxford HQ for £29.9m. This time it ran into criticism for taking rent money from a charity.
When Surrey County Council bought an £11.8m Vue cinema and 37,715 sq ft leisure scheme in Worcester, the local reaction in Worcestershire was far from ecstatic. Opposition councillors in Worcestershire quickly drew blood, saying their county council had missed an opportunity. The vendor was Avignon, BNP Paribas Real Estate advised.
PWLB
The PWLB – part of the Treasury’s Debt Management Office – has spent the past 223 years making discreet, barely-noticed and very low interest loans to local authorities.
Yet look at the most recent returns and an interesting story emerges and gives a good indicator of investment deals soon to be completed.
For instance, January’s list reveals that Essex County Council applied for £50m in 12 loans over shortish periods (the longest was 12 years) at interest rates ranging from 1.81% to 2.24%. The same month it completed the £29.15m purchase of 201 Deansgate, Manchester, a building with a relatively short existing lease.
Meanwhile, something is going on in wealthy Surrey, where large sums are being borrowed ahead of investments: £10m by Mole Valley (2.72% over 50 years), £20m by Runnymede (2.62% interest over 50 years) – and it came back for another £20m in January. So keep your eyes on Runnymede.
