The Government’s decision at the beginning of October to raise PWLB loan rates by 1.8% to 2.8% was widely assumed to be aimed at putting the brakes on Council’s borrowing to fund commercial property investment, which rose from around £1bn in 2012 to over £4bn in 2018/19.
The immediate impact was a reported fall in PWLB borrowing from £2.0bn in August and £1.6bn in September, to just £469m in October– the lowest since September 2018. Of course, not all of this was for commercial property purchases, but there have been a number of reported instances of Council’s pulling out of investment deals as a direct result and others are sure to have reassessed the viability of deals that they would otherwise have pursued.
So, does this signify the end of the Council buying boom?
Many commentators have highlighted the risks from the concentration of local authority investments in commercial property, given uncertainty over the future financial prospects of such investments due to global economic slowdown, Brexit, and structural changes in retailing. Indeed, much of the concern is focussed on the retail sector, where the rash of business failures and CVAs is finally playing out in plunging values for shopping centres and other retail assets in which many Councils have invested heavily.
It was reported in June that the value of Shropshire Council’s three shopping centres in Shrewsbury had fallen by over 20% in the 12 months since purchase and other Councils will no doubt be nervously awaiting their next portfolio valuation. This kind of headline doesn’t play well with voters, and for that reason as much as any we can probably expect to see a significant slowdown in activity. One County Council who has invested over 0.5bn in a nationwide investment portfolio has already applied the brakes completely and is refocussing capital investment on regeneration schemes within its own boundary where returns may be lower but there are wider social and economic benefits to be delivered.
Beyond the negative public perception, possibly the risk lies less in the valuation itself as most local authorities see these as long-term investments, especially when the driver is the regeneration of their own town centres, and any losses would only be realised upon disposal. Furthermore, most historic PWLB loans will have been at fixed rates, so whilst Council’s will be increasingly concerned about more tenant defaults squeezing net returns, the recent PWLB rate rise is not a factor.
But the impact could be more significant on Councils that are planning significant capital investment to revitalise tired assets and bring fresh footfall to town centres. If higher borrowing rates mean these schemes can no longer be funded within normal prudential borrowing, it may undermine the entire rationale for some investments.
For many Councils, commercial property investment has become a vital plank of their medium term financial plans in the face of ever diminishing Central Government Grant, and the rate rise will drive renewed focus on securing revenue streams from different sources including rates retention, CIL and wider commercialisation.
Those Councils, often in less affluent areas, for whom these strategies will not plug the funding gap and who still have the appetite and political support for property investment may now have to turn to commercial funding markets for value. But with this levelling of the playing field with private investors we are likely to see far fewer instances of Councils bidding against each other and perhaps unhappily for private investors and funds holding struggling retail assets, a much less promising exit route.