Councils should consider disposing of investment properties if they are unable to set aside enough reserves to cover potential losses, according to new guidance.
The Chartered Institute of Public Finance and Accountancy (CIPFA) this week released long-awaited guidance on investment in property, prompted by concerns over the levels of risk being taken by local authorities in recent years.
SAVE THE DATE – LATIF NORTH
March 25th, 2020, Manchester
Council treasury investment & borrowing
The guidance – which is not mandatory – suggests a detailed model for how authorities could calculate whether their property investments are proportional to the size of their revenue budgets.
Don Peebles, head of policy and technical at CIPFA, said: “In a landscape still reeling from a decade of austerity, we would not expect commercial investments in property to be abandoned in full.
“However, we must ensure that responsible decisions are made with transparency and financial sustainability in mind.
“In the end, the most important consideration is how taxpayers will be affected by decisions made at the top, and they should not be left in the dark about the process.”
CIPFA’s suggested proportionality calculation says that, as a minimum, authorities should set an indicator for the ratio of commercial income to net services expenditure.
However, it also outlines a more sophisticated methodology, which would involve authorities starting by calculating “substantial loss events” that could hit each property – such as rent defaults – that could have a revenue impact.
Councils following the model would then use an “appropriately qualified and experienced person” to assign a probability that each loss might arise.
After councils summed the weighted average expected loss for all of the authority’s investment properties, they would compare the figure to their earmarked revenue reserves.
The guidance said: “Where the revenue exposure is greater than the maximum sustainable loss, steps will need to be taken to limit the losses that might arise or remove or reduce the probability of loss events taking place.
“Alternatively, earmarked reserves could be increased. If these steps do not reduce the revenue exposure to an acceptable level, consideration will need to be given to disposing of the properties.”
Speaking about the methodology last month, Peebles told a CIPFA conference: “For those who want something formal – the trainspotters out there – we will have a scientific methodology for you to think what proportionality looks like.
“However, it is not prescriptive and you don’t have to follow this.”
The guidance also deals with the thorny issue of the externalisation of internal borrowing – the taking of loans to cover historical expenditure that created a need to borrow but which was initially funded by internal borrowing.
The guidance says: “If externalisation of internal borrowing is being proposed, then it should be clear that the new external borrowing has a historical justification – i.e. in support of capital expenditure that has already been incurred and previously funded by the internal borrowing, not for the funding of future capital expenditure where there are substantial commercial returns.
“The new borrowing should satisfy an existing underlying need to borrow for capital purposes, as measured by the capital financing requirement.”
Last year, CIPFA promised the guidance, prompted by the failure of the government’s revised investment code, to curb some instances of councils borrowing to invest in commercial property.
However, the recent hiking of the Public Works Loan Board interest rate by one percentage point is seen in the sector as being likely to severely dampen this activity.
Earlier this month, Room 151 revealed that the rate of Public Works Loan Board borrowing fell to its lowest level for more than a year immediately after the Treasury hiked the loan rate.
The Room151 Weekly Newsletter covers local government treasury and pension investment, funding, development, resources and technical finance. Register here.
The LGPS Quarterly Briefing focuses purely on pension fund investment. Register here.
