News this week that Spelthorne Borough Council is nearing completion on deals to buy two £100m-plus properties in London reflects a wider public sector gamble on real estate.
Spelthorne is in talks to acquire 100 Cheapside, EC2 (pictured above) from Aberdeen Standard Investments for around £140m. It is also eyeing up One Embassy Gardens, SW8, which owner Ballymore has put on the market for circa £160m.
The Surrey council is the top local authority investor in UK commercial real estate, investing close to £950m over the past five years – while these two London deals could see Spelthorne breach £1.2bn by the end of this quarter.
Overall, total public sector spend on property peaked at £1.9bn last year, according to Radius Data Exchange, beating the 2017 record of £1.8bn.
EG also revealed this week that Woking Borough Council has bought Aviva Investors’ 66,415 sq ft Victoria Gate building in Woking for around £40m. The purchase of the McLaren Group let office brings the council’s total spend on commercial property since 2013 to £160m.
Woking Council’s deputy leader, councillor Ayesha Azad, said: “The council has purchased strategic commercial property within the borough. These long-term investments allow the council to directly influence employment, development and the attractiveness of the town to potential new investors and employers.
“Additional income generated by the purchases will allow us to maintain and improve services to the public, despite ongoing reductions in government funding.”
Spelthorne Council declined to comment on the rationale behind its purchases, the bulk of which have been outside its own borough boundaries.
Why are local authorities gambling on property?
Councils have been buying property since the Localism Act came into force in 2011, which encouraged local authorities to find alternative sources of income.
These efforts have increased in recent years as central government funding has fallen. Almost half of all councils — 168 — will no longer receive any core central government funding in the 2019/20 budgetary year, according to the Local Government Association.
Councillor Steve Curran, leader of Hounslow Council, said: “With the unrelenting squeeze on budgets, councils must look at other ways to generate income to counteract the loss in grants from central government. Like any investment there are risks, but I am sure councils identify, understand and mitigate against those risks before they decide to invest.”
Several councils have therefore turned to real estate as a source of income as the government offers them cheaper borrowing rates.
Anthony Martin, head of investment advisory at CBRE, explained: “Local authorities have the option to finance property investment, in part or whole, through the Public Works Loan Board.
“Councils can borrow for up to 50 years. They can apply for a fixed-rate loan at rates that are typically between 1.7% and 2.8% per year. They are recourse loans, so the councils have to pay them back. They also have to demonstrate they can actually pay the money back.”
Increasingly, councils are turning towards deal-making outside their boundaries. Between 2017 and 2018, council spend on commercial real estate outside their own jurisdictions more than doubled from £389.1m to £875.3m. In contrast, spend inside their boundaries has fallen around 30% from £1.4bn to £1bn.
Since 2013, around 60% of Spelthorne’s investments have been outside its borders. The largest of these to date was the 500,000 sq ft Thames Tower office acquisition in Reading for £285m. But the council is also well known for purchasing the BP International business centre in its own borough, for £360m, its largest-ever property acquisition.
On balance, real estate may be a boon for cash-strapped councils, but Martin warned they must be wary of the risks involved. “If councils set a robust investment strategy and have a balanced and diverse portfolio then that’s fine. But if it is more ‘ad hoc’ and they are buying a smaller number of buildings in a similar area then it is harder to get an appropriate level of diversification,” he said.
He pointed to the risks associated with property investment such as “tenant insolvency, buildings falling into disrepair and changing working practices, such as flexible working for offices”.
It remains to be seen whether Spelthorne’s £1bn gamble will work, given these risks, but it has certainly taken a brave step to boost its income.
EG analyst James Child concluded: “The assets Spelthorne has purchased signal investment for return over refurbishment. Big-ticket office acquisitions in London and the South East will continue to command high rental returns and positive yield margins on disposal.
“Challenges include reducing average lease lengths from office occupiers and falling demand from tenants to recommit to ageing stock. The costs of refurbishment may be the sting in the tail for Spelthorne.”