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District Councils and Commercial Property Investments: 5 things to take away from the 19/20 accounts
A lot has been made recently about local authorities investing in commercial properties. The Government's recent PWLB consultation has raised the possibility of withdrawing the borrowing facility from Councils which plan to invest in commercial properties and many have taken the view that local government shouldn't be using public money to 'speculate' in property.
In my view the debate on this subject has been heavy on opinion and light on actual fact. So I have put together some analyses from my review of local authority accounts to add to this debate and any views I offer are based from this information. I am focusing on districts in this article.
Before I start, there is a lot of information on this subject, some of which I think is unhelpful, but for a balanced view of the subject I would recommend the February 2020 National Audit Office report, Local authority investment in commercial property.
1. 147 out of 167 districts have Investment Properties on their 19/20 Balance SheetThat's 88% of district councils which have published their 2019/20 accounts - 8 out of every 9! Like it or not, commercial property investment is now a significant component of local authority funding. A lot is made of a small number of authorities with significant portfolios but my accounts review reveals that larger numbers are making significant investments.
2. Investment Property balances have increased significantly over the last five yearsLocal councils have looked after and made a return from commercial investments for years now, often as part of economic development efforts. However, it is the last five years which have seen significant year on year increases in investment property acquisitions as shown by the graph below.
The y axis should be labelled £thousands. So in 2019/20, there is more than £6.5bn worth of investment properties held by district councils. More than 2 and a half times the level of 2014/15. Significant increases which correlate with decreases in central Government funding of local authorities: coincidence? I think not!
3. The accounts provide us with an insight into returns from commercial property investment. The Investment Properties note in the accounts should provide an analysis of rental income from, and direct expenditure on, investment properties. It should also provide a breakdown of property valuation analysed by brought forward balances, additions, disposals and changes in valuation. I have looked at all of these notes and from these can make an estimate of yield. So here it is, in aggregate, from the 147 districts with investment properties.
The above shows aggregate totals for all districts and hides a significant range in performance of portfolios. For members of our financial resilience benchmarking service, we will provide an analysis of how you compare with this district average and with your neighbours.
4. Commercial income is now a major source of district council funding. I knew this was the case prior to analysing the accounts but even I was surprised by the extent to which commercial property income has become an important component to a balanced budget for many authorities. The graph below compares income from commercial property investments with more established sources of funding.
Y axis is in millions this time. Couple of things to note. First, the blue bars for council tax, retained business rates and RSG are aggregated for all 188 districts but the red bar for investment properties is based only on the 167 districts which have released accounts. So, in actual fact, the red block will be slightly bigger when the remaining 21 accounts are published. Second, in terms of future changes, it is clear that the red bar will continue to grow as more councils invest further whilst council tax will continue to be capped, business rates retention is unlikely to rise significantly and RSG will totally disappear!
So investment property income will become a bigger part of the funding picture. In my view, efforts spent on trying to curb this type of expenditure might be better employed on first accepting that this is now an important area of income and then supporting authorities to effectively manage acquisitions, risks and the management of commercial properties.
5. Commercial properties have fallen in value by 2% in 2019/20
Another thing that the accounts reveal is the latest valuation of investment properties. Accounting rules require all commercial properties to be valued annually and this provides a 'fair value' view of changes in valuation. So the aggregate valuation of investment properties as at 31/3/20 of £6.578bn includes an aggregate 'fair value' reduction of £145m which is just over 2%. In my view, not surprising in a very tough economic climate and a long way from the catastrophic scenarios that are offered up in some articles!
Again, this aggregate valuation conceals a large variation between individual districts - members of our financial resilience benchmarking service will get to see how they compare in respect of valuation changes.
In concluding, I hope you find that this article sheds a bit more light in respect of this important area of local government funding. I could go on to opine that the annual reporting requirements for Investment Properties in the accounts should be boosted. I would further offer a view that the prudential framework relating to these investments might also be improved but both these views probably deserve a separate article.
About the author (Dan Bates): I am a CIPFA Accountant who works as part of the LGImprove partnership. I have worked with a number of authorities on local authority financial resilience and fair funding. At LGi, we have recently launched our financial resilience benchmarking service (mentioned in the article) which as well as providing analysis of investment properties also looks at reserves, borrowing and capital expenditure and financing.
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Last weekend (21 June), the Government released #localgov figures on COVID expenditure and income losses for March to May. With June returns now complete and more headlines revealing Councils considering S114 notices, the clamour for more Government support is growing.
I've taken a look at the figures released last week and here are my five main observations.
1. The £3.2bn support to date has already been used!
In actual fact councils have utilised 102% of their funding according to the Government return. COVID expenditure of £1.249bn and income losses of £1.987bn amounts to £3.236bn or £77m more than allocated.
The returns show monthly losses (expenditure and income) of about £1.5bn in both April and May and so it is likely that June will see a similar magnitude with the probability that July onwards might see reduced losses as lockdown measures start to ease.
Clearly, if the Government is to stand by Robert Jenrick's original promise to reimburse councils for 'whatever it takes' then a third round of funding should be on the cards.
2. Expenditure on social care and housing increasing whilst other expenditure falls
Perhaps it is a bit early to draw definitive conclusions from two (and a bit) months data but it does appear that additional expenditure on vulnerable groups might be incurred for some months to come. The graph shows that expenditure on social care and housing was higher in May than April whilst other expenditure reduced.
It comes as no surprise then that the authorities reported as considering S114 notices tend to be upper tier authorities. The social care funding gap and its impact on the financial resilience was already a hot topic before the pandemic and the Government figures show an immediate and ongoing financial impact which will exacerbate already unsustainable demands on social care.
3. Significant income losses expose the frailty of local government funding
For every £1 of additional COVID expenditure, councils have also lost £1.59 in income. I suspect that the magnitude of income loss has caught the Government by surprise and has undoubetdly exposed the frailty of the funding system. Years of funding reductions have seen Revenue Support Grant disappear leaving councils almost entirely reliant on council tax, business rates and fees and charges all of which have been hit hard during the COVID crisis as the graph below shows.
Two important points here. First, there is not only the immediate hit to councils as shown by the above figures but a more significant long term impact on council incomes. The Government has designed a funding system where additional funding arises from economic and housing growth but a prolonged recession will likely wipe out most of this growth.
Second, the analysis shows the importance of fees and charges to councils and particularly to district councils and London boroughs. Income from culture and leisure will continue to be hit through July as establishments remain closed whereas car park income and commercial income might recover as the economy re-opens. Ironically, it is these latter two incomes that the Government has attempted to restrict in recent years!
4. Levels of losses and Government COVID grant have had a disproportional impact on different types of authority
The graph below compares the impact from March to May with the COVID grant received from the Government for each type of authority. I have adjusted the figures for council tax and business rates to reflect respective shares between counties and districts.
The analysis shows that districts and London Boroughs appear to have lost significantly more than they have received in grant so far. This has more to do with their relative reliance on fees and charges and business rates income and as time progresses and the economy re-opens, losses might decrease as fees and charges recover. Counties and Mets which do not appear to have utilised all of their grant so far are less reliant on fees and charges and business rates income but are likely to incur additional expenditure associated with continuing social care pressures as time goes on.
5. Unless the Government provides further support soon, it is probable that a number of authorities will experience significant financial difficulties
It isn't just the local government media that are reporting the likelihood of financial failure of councils but the national media has caught on as well.
As things stand without additional support, most, if not all, authorities will experience significant budgetary overspends. The size of these overspends will become clearer as more returns data becomes available. However, taking account of statements from councils to date, it is not unreasonable to predict that losses might be as high as a quarter of net revenue expenditure, and maybe up to half of net revenue expenditure for districts, particularly those with high levels of fees and charges.
A look at usable revenue reserves levels reveals the vulnerability of many councils to the COVID losses. The graphs below show the upper tier authorities with 25% or less of net revenue expenditure (NRE) in usable revenue reserves and districts with 50% or less.
The graphs suggest that there are 27 vulnerable upper tier authorities and 8 districts (with a further 22 districts with less than 75% of NRE in reserves). Worryingly, over a third (59) of upper tier authorities have less than a third of their NRE in reserves and more than two thirds (104) have less than half a year's NRE in reserves. It is therefore no surprise that local government financial sustainability has been the subject of recent headlines. The Government must surely have to act and provide more financial support to councils, as was promised at the start of the pandemic, if it is to avoid catastrophic consequences.
LGi will shortly be launching its financial resilience benchmarking service which will include bespoke analyses such as those in the above article. We are currently offering a free one-page comparative analysis of usable revenue reserves. If you would like to receive this for your authority, please apply using this link.
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Local Government is on the frontline in responding to the COVID-19 crisis and will have an equally important role to play in recovery when we come out of lockdown. However, in order to continue to be effective councils will need enough resources to do the job – and these are currently being strained by the crisis. In this series of articles, I will look at the impact of the crisis on all types of Councils, starting with the London Boroughs.
Financial Resilience was already an issue before COVID
The analysis below shows individual levels of usable revenue reserves expressed as a percentage of 2019/20 budgeted net revenue expenditure. Each bar is an authority with Outer London Boroughs shown in light blue and Inner Boroughs in dark blue.
A number of Outer London Boroughs have little more than 4 months of net revenue expenditure in reserves. This is worrying given the level of additional costs and lost income associated with the COVID crisis and it seems certain that more Government support will be needed to protect all authorities but particularly those with low levels of usable revenue reserves.
Will the £3.2bn of funding to date cover COVID costs?
The Government has, to date, provided £3.2bn in financial support to Local Government. For London Boroughs, this is worth between 6% and 11% of Net Revenue Expenditure. But is this enough?
MHCLG has requested returns from all local authorities on the additional costs and lost incomes arising from the crisis and, in time, we will have a better idea of the impact on Councils' financial health. But for now, using 2018/19 revenue outturn data and 2020/21 council tax information, I have estimated potential annual losses using the following assumptions:
The graph below compares these estimates of additional costs/lost income with the financial support received to date. The grant received (shown in white), expressed as a percentage of net revenue expenditure, is shown above the x-axis and this is compared with the estimated losses shown below the x-axis (shown in shades of green).
In most cases, the estimated costs of COVID are about three times the level of support received to date from the Government. This would indicate that unless there is further financial support for local authorities, there will be greater depletion of usable revenue reserves and a greater risk to financial health. How will this impact London Boroughs?
What will be the impact of COVID be on London Boroughs' reserves?
By combining the above analyses, we can get an estimate of the impact of the crisis, all other things being equal, on the financial health of Local Government in London. This time the graph adds the usable revenue reserves as at 31/3/19 to the grant received to date and compares this with an estimate of the costs of COVID. As with the other analyses all the figures are expressed as a percentage of net revenue expenditure. The results are worrying and show that those authorities with low levels of usable revenue reserves will come under significant financial pressure unless further financial support is forthcoming.
The analyses are taken from the Pixel Financial Resilience service which provides benchmark analyses of statement of accounts information from the last seven years. Next week, I will look at a similar analysis for Metropolitan authorities.
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A short piece for Room151 (Longview Productions Ltd) on the further Government support that will be needed by councils if they are to help in the post- COVID recovery of their areas without having to worry about their own financial collapse.
Local government minister Robert Jenrick. Photo: Pippa Fowles, Number 10, Flickr.
Whitehall has offered another huge tranche of funding to councils but it may prove too little as Covid-19 reveals the vulnerability of local government funding structures.Financial resilience is already a big subject in local government with a significant number of councils holding dangerously low—and falling—levels of revenue reserves. The Covid-19 outbreak has effectively pulled many more authorities closer to the brink, and it is little wonder that S114s are making the news again.
So, it was right that the government stepped in at the weekend with the promise of a further £1.6bn of financial support for local government. However, the additional financial pressures are massive and, I suspect, more support will be required to ensure that councils remain able play a key role in their area’s post-pandemic recovery without having to worry about their own survival
Those pressures are not just about the additional costs of looking after vulnerable people and protecting essential services but significantly arise from lost income. It is recent changes in local government funding that have made the sector more vulnerable to this crisis.
Since revenue support grant was all but scrapped, 60% of council funding now comes from council tax—twice as much as ten years previously. Council tax support claims are already rocketing as collection rates come under pressure, and it is not unreasonable to forecast 10%, or more, losses in council tax income.
Business rates incomes will come under similar pressure whilst some fees and charges, such as car park and leisure centre incomes, have been wiped out completely in lockdown. Most other incomes have also significantly reduced.
Taken together, additional costs and lost income will have a devastating impact on already depleted reserves. A quick graphical analysis of the ten district councils with the lowest reserves shows that reductions in council tax and six months loss of car park income, plus other fees and charges, will take most to the cliff edge without significant government support.
Although upper tier authorities tend to have less relative reliance on fees and charges, many have critically low levels of reserves. All are susceptible to council tax losses and demand pressures, particularly in respect of vulnerable groups.
Robert Jenrick was right to refer to local government as “unsung heroes” as all over the country councils have stepped up to respond to the crisis. Councils will be at the forefront of the recovery process helping to rebuild communities and economies from the shattering impact of Covid-19.
There is a lot the government might do in the medium term. Delaying and reconfiguring the fair funding review, so that it really is fair, would be a good start. Providing significant PWLB discounts for capital projects so that councils can stimulate local economies would also help. First and foremost though, councils need to be recompensed for the costs of Covid-19 so that they can continue to focus on community health and well-being without fearing for their own financial health.