Risk & Economy » Public Sector » Controversial council raises debt ceiling to £1.5bn

A Surrey council that has become the most high profile local authority investing heavily in property assets reveals it has the mandate to increase its debt capacity to £1.5bn.

A spokeswoman for Spelthorne Borough Council, which currently has debt of £1bn compared to a net annual budget of £22m, said: “In July 2018, the full Council voted overwhelmingly to extend the maximum borrowing limit of the Council.

“That provision is not just to cover the acquisition of commercial investment assets but also to fund future housing developments and regeneration projects within the Borough,” she said.

Spelthorne BC has become the best-known example of councils acquiring portfolios of assets to ensure a revenue stream, offsetting the effects of cuts in funding from central government in recent years.

After the local authority’s 2016 purchase of oil giant BP’s office park at Sunbury-on-Thames for a total borrowing of £377.5 million, some commentators dubbed the authority “a property company with a side line in providing local government services.”

The increase in debt capacity is expected to be in readiness for more imminent acquisitions. Properties cited as being possible targets include two London sites, 100 Cheapside for £140m and a £160m development in Nine Elms, Battersea. The council declined to comment on these developments.

Spelthorne BC confirmed that although it regularly cites a 4-5 gross return on its £1bn property portfolio, the actual net return is closer to 1%, or £10m from the £1bn of investments.

The Spelthorne BC spokeswoman said: “A gross yield of 4-5% is entirely consistent with high quality commercial investments in the market. We do achieve this rate of return on our investments.

“Acting as a prudent investor we set aside interest, capital repayments, management costs and substantial sinking funds for future unforeseen events. The Council typically budgets on a net yield of 1%. This accounts for the difference.

“This means that we allow ourselves to typically take 1% of the gross rental income from the investments into council funds for supporting services for residents or developing affordable housing.  This is the money which is protecting services and delivering new homes.  This is the money which has protected residents from cuts to services and given homeless families their first real home.

“The Council follows the same investment model as a typical prudent pension fund. After all the capital has been repaid as above, these assets will be owned outright by Spelthorne residents,” she said.

Splashing out

Making big investments in shopping centres, ferries and car showrooms may not seem the most appropriate way for local authorities to be spending their budgets. But many councils are acquiring commercial projects to improve their financial position, in a bid to boost funds.

Baroness Wheatcroft, a member of the economic affairs committee of the House of Lords, referenced Portsmouth City Council’s asset purchases, when she said: “I am prepared to believe that local authorities know a lot about social housing, but I am not convinced of their knowledge about Mercedes showrooms or ferry terminals.”

Since the 18th Century local authorities have accessed capital from the Public Works Loan Board to fund projects, a source of funding that has been available at exceptionally low rates of interest since the financial crisis of 2007-08.

With this approach, local authorities are effectively employing a carry trade —borrowing at rates of around 2.5%- much lower than private sector borrowers- to invest in property typically yielding 6-8%.

In recent months there have been increasing concerns about the effect of a no-deal Brexit economic disruption could have on property investment. On its website the council said: “Clearly there is a great deal of uncertainty surrounding Brexit, and the Council has no better insight than any other commentator on what may happen in the next few years.

“We are investing on a long-term basis and we fully expect to hold these assets through a number of economic cycles. We have made allowances for things such as refurbishment costs and void periods and we are building up sinking funds to ensure the money is there when we need it. We currently have £11m set aside and by April 2023 this will rise to £35m.

If offices become empty as a result of tenants going bust, the Council has funds set aside to cover this until the offices are leased again to new tenants. Similarly, if rental values decrease we have funds set aside to cover the shortfall.”