Commercial property purchases: Bizarro ft. Brassneck

I’m a fairly placid guy, most of the time. But last week I did get a touch fuming about an off the cuff comment from the Leader of the Liberal Democrats. This one is going to get a little bit technical at times, but stick with me, because it is worth thinking about the changing nature of local authorities and the choices and risks they have little option but to take.

What wound me up was Sir Vince Cable’s statement about councils purchasing capital investments out of their areas, labelling this activity ‘utterly bizarre’. Even more, he seems concerned that some councils are exercising their right to borrow from the public works loan board in order to buy these investments.

So let’s take a few steps back and state the bleeding obvious. Councils are under intense financial pressure, with a combination of reduced spending power and significant demand on statutory services. More people need help from social care, especially as the population ages and there are more conditions that are debilitating but no longer fatal. The Public Accounts Committee last week stated that councils with social care responsibilities overspent their service budgets by £1 billion in 2016/17. To be clear, in the vast majority of cases this is after significant attempts to balance a budget, cutting back as far as is possible and making sacrifices that would have seemed unthinkable even a few years ago.

I’ve written elsewhere on social care funding and some options. We’ll keep waiting to see what the social care green paper says. Given we now have a new secretary of state we don’t know if there will be yet further delays for this. But the key message is that councils are having to make hard, tough-headed decisions, in terms of shrinking non-statutory services, using up revenue reserves or doing things to create an income.

What Sir Vince will definitely know is that councils have, since 2011, had the power to do anything an individual can do. If a council wishes to start a company, it can do. If it wants to buy and rent houses for profit, it can do it. If it wants to buy a building, wherever it is located, it can do. If it wishes to instruct contractors to start building a rocket ship without not quite knowing the purpose behind it, well, that one is probably out. There are plenty of things that councils cannot do- almost all cannot franchise buses (neither can an individual), raise new taxes (nor can an individual), print money (nor can an individual) or declare war (you get the idea).  Sir Vince will know all of this because he was the business secretary in the government that gave councils this power.

The thing that puts these powers in check is that councils, collectively and individually, are democratically elected and responsible for their actions. They can and will be held legally responsible, just like an individual, if the company pays below the minimum wage, if a building is poorly maintained and the tenant sues them, if a commercial building is empty and in void, or if the rocket ship falls into a ditch. Councillors of major authorities are not co-opted school governers choosing what colour the tea towels should be: they are elected politicians, often with slender majorities looking to make hard decisions in hard times.

Moving on the the public works loan board, this is a fund established by central government that loans to “major” local authorities (as well as town and parish councils) at rates similar to those the government can itself borrow at. There are guidelines to what councils can borrow, as set out in CIPFA’s prudential code (a steal at £260) but crucially this is really a decision for the local authority to ensure it is not breaking the code. As the PWLB website says:

“The PWLB does not require information on the purpose for a loan. Responsibility for local authority spending and borrowing decisions lies with the locally-elected members of the council, who are democratically accountable to their electorates.”

Precisely. Once again, the key players here are the councils themselves, those locally elected politicians making hard decisions based on officer advice. They have a source of credit for capital decisions and are empowered to decide what to do with this, subject to their local mandate and wish to remain in post. This isn’t dewy-eyed romanticism but the decision of central government to give powers to local government and, rightly, to expect them to be held to account if they use them poorly.

But why would councils wish to buy commercial property? It comes back to the financial question I started the blog with. You are unlikely to have got this far in this if you don’t know the difference between revenue and capital. So hopefully it won’t be a huge surprise to know that letting a commercial property generates an income. As long as that income is greater than the loan repayments (if indeed a loan has been taken) and other costs, then you can use that surplus income to pay for other capital spending. Things like repairing buildings, replacing broken machinery, improving physical infrastructure. Not having to fund capital spending from revenue means you can spend it on improving services, paying frontline staff, collecting bins, helping people. You know, the things we all (Sir Vince included) want to see councils doing.

Now if I was a private commercial landlord I might be a little nonplussed at this. Councils are able to borrow at a lower rate than them to compete for the same properties, isn’t that unfair? Well, it certainly isn’t a brilliant outcome of a complex system, but it also certainly isn’t bizarre. There are plenty of things councils can do, often because of economies of scale, that a smaller business cannot. But that certainly doesn’t add up to bizarre- there are certainly enough situations where a private company can outmanoeuvre or work policy, law or tactics in the other direction. If councils are investing in existing buildings then they are only competing against other rentiers and most likely doing something more worthwhile with the surplus. If they are investing before completion and helping the building come forward then they are helping bring investment to the area (whether it is in the region or not). Finished buildings with tenants pay business rates, which is doubly good for the council where the building is based.

An alternative approach would be for councils to use up their capital reserves to fund revenue expenses; selling off land and buildings and using up cash reserves quickly. You don’t need an advanced finance degree to know that would be a bad, temporary idea.

Perhaps this rankles more than it should, but in essence, Sir Vince is complaining that councils are looking for novel ways to safeguard services (using powers given to them by a government he was part of) in the light of huge cuts to spending power (forced upon them by a government he was part of). No, this wasn’t part of patronising the 50 ways to save document sent out in 2012; councils have tried to do something that would bring in much more money than opening a cafe in the library.

Nothing that I’ve said here means I would support every commercial property decision made by councils. There are risks, but they have to be managed and understood, not ridiculed out of hand before they have been considered. But that’s the point- if local authorities make mistakes they are responsible for it. To their auditors. To their audit committees. But mostly, to their residents.

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