The commercial trend revisited

Money is tight – and local authorities have been under an incredible amount of pressure to provide the same quality of local services with budgets that are stretched to the maximum.

This has meant that local authorities have undertaken projects to generate revenue through investments in commercial properties to compensate for reductions in government funding.

We’ve previously addressed this commercial trend, particularly when funded by local authority borrowing that places public funds at high levels of potential risk. We’ve expressed our concern that such activity is not the appropriate way to relieve the financial burden weighing on local authorities.

CIPFA’s Prudential Code is clear that authorities must not borrow more than or in advance of their needs purely to profit from the investment of borrowed money. When engaging in acquisitions of commercial property, authorities are walking a fine line between necessary and avoidable risk. We urge local authorities not to cross this line.

It is understandable that authorities are seeking out new ways to continue funding the provision of vital local services. But, such activities should not be undertaken without awareness of the risks to long-term sustainability involved. Local authorities should remain cautious about whether or not the assets acquired through these investments will provide the benefits they envision and if cost projections and income generation estimates will be reliable. Borrowing to invest in property may very well still take place despite the implicit risks - though we acknowledge that the recent increase in PWLB interest rates might impact on this trend.

Decisions around properties acquisitions with substantial commercial income are difficult. They require careful planning, a balance between risk and reward and an understanding of the legislative framework. While we accept that innovative approaches are needed to address the new challenges that local authorities are facing, councils still need to operate within the prudential framework and ensure that public money is used in the most effective way possible.

To that end, in addition to the Prudential Code, we have released additional guidance, titled Prudential Property Investment: CIPFA Guidance on the Application of the Prudential Framework. 

The new CIPFA guidance seeks to ensure that local authorities are asking the right questions about whether they can and should proceed with commercial property investments and whether this will fit with their corporate, property and investment strategies. To put it bluntly, just because an authority has the ability to invest in these assets, does not mean that it is advisable to do so.

All decisions to spend and to borrow must be backed by effective legal powers, which will also need to allow the authority to act commercially. The next stage is to decide whether the exercise of these powers is reasonable and in accordance with the prudential framework.

The prudential framework requires that local authorities exercise sound judgement when engaging in potentially risky commercial transactions. It requires that the decisions they take are proportionate to a local authority’s revenue budget and as a part of a properly diverse, risk managed investment portfolio. Decisions to make investments in commercial properties must be deemed as prudent, and in the best interest of the local community.

This guidance also aims to ensure transparency and democratic accountability in all areas of local government finance. Commercial investments do not necessarily sit well with the primary focus of local authorities. However, it is imperative that we ensure public bodies are properly scrutinised and that the risks of any commercial transactions are effectively managed. If not, we put both the role of local authorities, the services they provide, and the wellbeing of local residents at risk.

This article first appeared in the Local Government Chronicle.