A recent report from the National Audit Office (the NAO) published on Local Authority Investment in Commercial Property in England highlights that the framework governing capital investment has been severely tested by councils borrowing cheaply to invest in commercial property.

During the past three years, councils in England have invested significant public money in buying commercial property. Much of this spending has been financed by borrowing.

The NAO report highlights the risks involved and makes recommendations to the Ministry of Housing, Communities & Local Government (the MHCLG) which include improving the relevance and quality of data and analysis it has on councils' acquisition of commercial property.

What did the report find?

The report estimates that English councils spent £6.6 billion on purchasing commercial property from 2016-17 to 2018-19, 14.4 times more than in the preceding three years. Many borrowed to finance these purchases. The NAO estimates that between 38% and 91% of spending on these purchases across the sector was financed by prudential borrowing - this includes external borrowing, and also 'internal borrowing'; a treasury management practice whereby a council temporarily uses cash it is holding for other purposes.

Between 2016-17 and 2018-19 councils spent an estimated £3.1 billion on acquiring offices; £2.3 billion on retail property, including £759 million on shopping centres or units within them and £957 million on industrial property.

Why the jump in borrowing?

Councils purchase commercial property for a range of reasons, such as to support community regeneration or economic growth. However, a key motive of some councils' recent investments has been generating rental income in order to offset reductions in funding. Local authority spending power (a combination of government grants and council tax) has fallen by 28.7% in real terms since 2010-11 in England. In a review of 45 councils' strategies for investment, the NAO found that all but three identified generating income as a significant objective.

Local authorities located in the south east of England are highly active, accounting for 53% of commercial property spending in the last three years. District councils are also disproportionately represented in this area, accounting for 51% of commercial property spend from 2016-17 to 2018-19, but with only 6% of the sector's spending power.

What are the risks for Councils across the UK?

Councils in England now face serious investment risks given the current economic climate, particularly where they are dependent on their commercial rental income to keep up with debt repayments or fund local services.

Whilst there is evidence of councils mitigating these risks, such as recruiting specialist staff, undertaking due diligence, drawing on external expertise and establishing contingency funds; nonetheless, local external auditors indicated to the NAO that there was room for improvement in the governance and risk mitigation arrangements of some councils.

Councils in Scotland will no doubt take heed of the English experience and consider the long-term sustainability risk implicit in becoming too dependent on commercial income, or in taking out too much debt relative to net service expenditure.

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