LAI0017

Written evidence submitted by South Hams District Council

Local Authority commercial investment

 

Summary Evidence Submission

In response to the call for evidence, South Hams District Council has compiled the following overview of its Commercial Investment Strategy.

South Hams District Council is located on the south coast of Devon. The area contains the towns of Totnes, Kingsbridge, Salcombe and Ivybridge and also has some of the most unspoilt coastline on the south coast. The District Council area has a population of 85,000 and 38,000 households. South Hams has a high proportion of holiday homes and the area has the third highest proportion of second homes in the UK. Many of these properties register for business rates and are eligible for small business rates relief and therefore they pay no business rates and no council tax, leaving a consequential loss of council tax income for the District. The Leader of the District Council, Cllr Judy Pearce, is a member of the Finance Sub-Committee of the District Councils Network.

Overview

1.1            In September 2018 (Minute C30/18) the Council approved a Commercial Investment Strategy, which included multiple objectives: (a) to support regeneration and the economic activity of the Council (b) to enhance economic benefit (c) to grow business rate income (d) to assist with the financial sustainability of the Council as an ancillary benefit and (e) to help continue deliver and/or improve frontline services in keeping with its adopted strategy and objectives. The key drivers to the Commercial Investment Strategy are the wellbeing of the District and investment within the Local Authority area.

 

1.2            The Council approved an overall Borrowing Limit of £60 million for the commercial investment strategy. This was informed by a report commissioned from Arlingclose treasury management advisors which looked at the overall financial standing of the Council, so as to suggest prudent borrowing limits. The Net Revenue Budget of the Council is £9.4 million.

Commercial Investment Strategy

1.3            Recently the Council has prioritised tackling Climate Change by moving a motion to declare a Climate Change Emergency and targeting proactive measures to meet these challenges. As a result of this, in December 2019 the Council approved (Minute C53/19) a revised Commercial Investment Strategy in order to enable the Council to invest (and to borrow to invest) in renewable energy.

 

1.4            Each acquisition or development opportunity within the Commercial Investment Strategy will be assessed on its fit with meeting the objectives stated above and should deliver one or more of the following outcomes (benefits):

              Job creation or safeguarding

              Health & Wellbeing

              Town centre regeneration

              Tourism / increased footfall / Business rate growth

              Improved asset utilisation

              A minimum yield of 2% is targeted. However, in some circumstances, e.g. where community benefits are likely to be achieved, a lower return may be acceptable

              Climate Change Mitigation

 

1.5            The opportunity for the Council to invest, off market, in shovel ready renewable energy generation assets (large-scale solar) will deliver multiple benefits of:

 

 

 

1.6            This Strategy will be achieved by acquisitions and developments within the South Hams District. This will include the focussed acquisition of existing commercial property assets and the development of new properties which are to be let to third parties. This strategy will also consider investments in the renewable energy sector which will not be constrained geographically. Renewable energy is the only exception to the key driver of investment within the local authority area because the power can be imported back within the Local Authority area for its benefit.

 

Risk Management and Due Diligence

 

1.7            The Council accepts there is a higher risk on commercial investment than with treasury investments. Financial risk will be weighed up against social and economic benefits of the investment. The principal risk exposures include variances resulting in a disruption or fall in income streams, fall in capital value which is either site-specific or due to general market conditions, deterioration in the credit quality of the tenant.

 

1.8            The Council assesses the risk of loss before entering into and whilst holding property investments/property opportunities by carrying out appropriate due diligence checks and implementing mitigation measures in managing risk:

 

 

 

1.9            Risk of loss shall be assessed on a case by case basis as part of the acquisition due diligence and will be a criteria considered throughout the approval process. Risk of loss during the management phase of the investment shall be reported in accordance with the criteria below. In accordance with Para 23-25 of Statutory Guidance on Local Government Investments, quantitative indicators or risk and portfolio performance will be reported to Audit Committee. The frequency of this reporting to the Council’s Audit Committee is every 6 months and includes the following indicators (as applicable):

 

Governance

 

1.10       Acquisitions must conform to the adopted Commercial Investment Strategy.  Any deviation from the agreed Strategy will require Council approval.

 

1.11       The Council’s Senior Leadership Team will initially consider each proposal (development or acquisition of property or renewables) as an initial step and recommend that the proposal proceeds in principle.

 

1.12       When any decision to proceed with a development or acquisition is being considered, local Ward Members (where applicable) will be briefed at the earliest opportunity and be able to share their views with Executive Members and be consulted before the final decision is made.

 

1.13       Executive Members, along with the Head of Paid Service and S151 officer, will consider each and every proposal on its own merits and specifically how each proposal meets the Council’s multiple objectives and desired outcomes.

 

1.14       Executive Members will consider debt proportionality (the amount borrowed to date against the net service expenditure ratio) on a case by case basis for each acquisition as part of the decision making process, with information provided to them and the S151 officer, the Head of Paid Service and the Leader of the Council. Investment indicators are set out within the Council’s Treasury Management Strategy.

 

1.15       The Council undertakes sensitivity analysis of the interest repayments on its borrowing requirements as a percentage of its available reserves to ensure there is sufficient coverage in the event that rental income is below forecast, or if energy prices are below that forecasted in the case of a solar farm. The Council also sets aside 10% annually of all rental income and income from energy prices into a Maintenance, Management and Risk Mitigation (MMRM) Reserve. This is part of the Council’s contingency arrangements.

 

1.16       Officers, working with their specialist advisors in the market will sift opportunities and only present to Executive Members, opportunities that closely meet the Strategy. They will then lead the Executive Members into debate over specific benefits and risks of each opportunity before the Executive Members make a decision. In this way, risk will be transparent through the process.

 

1.17       Projects and their outcomes will be kept under constant review by officers and reported to Executive and Audit Committee. So far the Council has purchased one commercial investment for £5.03 million.

 

 

Commercial Investment Acquisitions within the South Hams or renewables out of area

 

1.18       The Council will delegate the authority and decision making function relating to ‘Commercial Investment Acquisitions in the South Hams’ or renewables out of area to the Head of Paid Service and Section 151 Officer, in consultation with Members of the Executive, assuming that the proposed expenditure complies with the Council approved total borrowing limits.

 

1.19       In the event of three or more Executive Members expressing their opposition to the proposal, then the matter will proceed no further.

 

1.20       Any project will be subject to Due Diligence and Legal Searches and occasionally other data as need arises.

 

1.21       Assuming the bid remains as per that authorised at the time of sign off, the final sign off prior to exchange and payment of deposit (typically 10%) is made by the S151 officer and Head of Paid Service in consultation with the Leader of the Council. If anything material has changed, the Executive Members will need to vote again in order to proceed.

 

1.22       This process of delegated authority is required because there is often very little time (a number of days) to secure a bid on a property, especially if it is off market. Off market bids avoid price inflation caused by competing bidders.

 

1.23       The Executive Members have been made aware that they will be required to process and respond to information in a very quick timeframe (minimum two working days) so as to provide their decision. They may also be asked to attend meetings on similarly short notice. These meetings may be held virtually to expedite decision making.

 

1.24       When South Hams District Council acquire a Commercial Investment in line with this strategy, a report is presented (for noting purposes) to the subsequent meeting of the Executive.

 

Debt Proportionality

1.25       The NAO’s report ‘Local authority commercial investment’ found that there has been a significant increase in out-of-area commercial property acquisition. Firstly, the commercial investment strategy adopted by South Hams does not permit out-of-area investment, except if this was for the acquisition of a renewable energy investment. Secondly, the key to this in our opinion is that Councils should ensure that the level of debt they are undertaking is proportional to their Net Revenue Budget and level of Reserves. If the Government wanted to strengthen this aspect, they could set individual limits of debt proportionality which Councils have to adhere to.

1.26       The South Hams commercial property strategy considers the risks of investment and the Council engaged Treasury Management advisors to analyse the level of debt proportionality to the Council’s finances (e.g. levels of reserves, asset base and level of interest costs as a percentage of income). In order that commercial investments remain proportionate to the size of the Council, borrowing for the Commercial Investment Strategy is subject to an overall limit of £60 million. Interest payments would equate to approximately 18% of available reserves.

 

1.27       Commercial property acquisitions expand the Council’s balance sheet and interest costs will form a higher percentage of locally derived income. It would absorb a high level of reserves if there are shortfalls in or disruption to the income stream required to meet the additional expenditure.

 

1.28       Sensitivity analysis on the level of debt interest against the Council’s level of reserves is considered as part of the Medium Term Financial Strategy and as part of the budget proposals each year. This ensures that the Council has the available reserves to enable service delivery to be maintained in the short to medium term, whilst alternative solutions are implemented.

Liquidity

 

1.29       Compared with other investment types, property is relatively difficult to sell and convert to cash at short notice and can take a considerable period to sell in certain market conditions. To ensure that the invested funds can be accessed when they are needed, for example to repay capital borrowed, the Council will spread its liquidity profile across its portfolio and also have a spread of the sector in which the Council invests. The Council also documents potential exit strategies as part of its due diligence checks.

 

1.30       Liquidity will be a factor in determining the amount of rent set aside in the Maintenance Management and Risk Mitigation Reserve for each investment. This will be reviewed with the same frequency as the risk reporting procedure set out in the Council’s Commercial Investment Strategy.

 

1.31       There are clear links from the capital strategy to both the treasury management strategy, prudential indicators, authorised borrowing limits and the revenue budget. These are also subject to review and oversight by Members at the Audit Committee and Council.   For any new borrowing, and this is a greater risk as the value of borrowing increases, this does increase the Council’s overall liabilities that will need to be repaid in the future.

 

1.32       In addition, this increases the Council’s level of fixed interest and repayment costs that it will incur each year. In 2020/21 the borrowing liability is estimated at a maximum of £34m with ongoing financing costs of the borrowing of approx. £1.3m.

1.33       However this risk for assets is mitigated by a robust business case and a MRP that will repay the borrowing costs over a (prudent) asset life. Any variations from this are set out in the MRP Policy (section 2.5 of the Treasury Management Strategy). Any variation in expected income is an issue, however given the wide range of operational assets and different income streams this helps to mitigate this risk.

 

1.34       As outlined above in the position statement, investment properties have a different type and level of risk. Risk arises from both variations in income streams (tenant non-renewal etc.) and from asset values (impact economic conditions and retail trends etc.). The Council has established a clear strategy, criteria and a governance route for these purchases which has included member training, second opinion on asset values, due diligence, site visits, surveys etc.

Commercial Skills in Local Government

 

1.35       The Call for Evidence seeks views on how the Council ensures it has the commercial skills for Local Authority commercial investment. The Council employs professionally qualified and experienced staff in senior positions with responsibility for recommending capital expenditure, borrowing and investment decisions to Members which is supplemented by Members’ knowledge and experience.

 

1.36       The Director of Place & Enterprise is a Chartered Civil Engineer (MEng, CEng, MICE) with 17 years of experience. In addition, the Director of Place & Enterprise holds an MSc in Construction Law. The Corporate Director of Strategic Finance (S.151 Officer) is a Chartered Accountant (ICAEW) with 16 years of experience of being a S151 Officer (Chief Finance Officer). In addition, the Corporate Director for Strategic Finance holds a BSc in Mathematics and has previously worked in the private sector for accountancy firms.

 

1.37       The Estates Specialist is a Chartered Surveyor, qualified for over 14 years, with an Estate Surveying degree. In addition they are a Registered Valuer. The Monitoring Officer is a qualified solicitor with 21 years public sector experience and private practice prior to that.

 

1.38       Where Council staff do not have the knowledge and skills required, use is made of external advisers and consultants that are specialists in their field. The appropriate expertise is always resourced in relation to any financial, legal and asset related due diligence required. A list is below:-

 

1.39       This approach is more cost effective than employing such staff directly, and ensures that the Council has access to knowledge and skills commensurate with its risk appetite.

 

1.40       In 2018 some external training from a LGIU (Local Government Information Unit) Associate on Local Government Finance (including commercialism) was arranged for all Members as well as some internal training events facilitated by the S151 Officer and the Group Manager for Business Development on the Council’s Medium Term Financial Strategy which included an update on commercial property investment. The Council’s Members’ Services are consulted when organising all training in order to maintain training and development plans for Councillors.

 

1.41       Following the District Elections in May 2019, a comprehensive Members’ Induction Programme was undertaken in May 2019. This included specific financial and treasury management training. External treasury management training (by Link Services) was arranged for all Members in March 2020 to ensure Members have up to date skills to continue to make capital and treasury management decisions.

 

1.42       The purpose of this training was to ensure elected Members involved in the  investments decision making process have appropriate capacity, skills and information to enable them to: 1. take informed decisions as to whether to enter into a specific investment; 2. to assess individual assessments in the context of the strategic objectives and risk profile of the local authority; and 3. to enable them to understand how the quantum of these decisions have changed the overall risk exposure of the local authority.

 

The impact the pandemic has had on local government finances

1.43       The Call for Evidence asks what impact the emergency is having on our               finances. Just the loss of income from car parking, some business unit               rentals, harbour fees and the Dartmouth Ferry income will be very significant.               The Council’s estimate is that we could see a reduction in income and               increased expenditure totalling over £6 million in 2020/21. The Council will receive £0.9 million from the COVID19 funding announced by the Government.

 

 

1.44       Whilst this funding is much appreciated, it is less than one sixth of what we estimate we might need. Our Net Budget for 2020/21 is £9.4 million. The allocation of funding to Councils has been made partly based on population and as a rural Council we are always going to miss out on this basis. We will continue to lobby the Government so that we receive the appropriate level of funding to be able to plan confidently for the future.

 

1.45       We remain ambitious for our communities and we want to stimulate growth               and jobs as the economy begins to open again. To date we have paid out £32               million in Government grants to over 2,700 businesses. Local Government is               a frontline service and we want to ensure our voice is heard among the calls               for financial support.

 

1.46       South Hams District Council has sent a briefing paper on the Covid19 pandemic to our local MPs which includes the following recommendations:-

 

-          That Councils are fully compensated for their loss of key income streams such as car parking income, planning income, ferry income etc.

-          A specific Government rescue package is put together for Leisure operators, over and above that already announced

-          That the Local Government Finance Act 1992 is changed for 2020/21 so that Billing Authorities only pay out to the major precepting authorities (such as DCC, the Police and the Fire) the amount of council tax actually collected, rather than that precepted for.

-          That Councils can access a zero interest rate on short term PWLB borrowing in the short term to assist with the economic stimulus package

-          The rules on MRP ‘Minimum Revenue Provision’ (the accounting for capital repayments on borrowing) are relaxed for the 2020/21 year to enable Councils to defer these capital repayments for one year

-          That the Government makes an early decision on what is happening with the New Homes Bonus scheme for 2021/22

-          That the Government announces a deferral of negative Revenue Support Grant for 2021/22. This will enable Councils to more effectively plan their 2021/22 Budgets.

 

Summary

We hope that the information we have provided has been useful for the Call for Evidence for the Public Accounts Committee on local authority commercial investment.

 

Cllr Judy Pearce, Leader of South Hams District Council

Chris Brook, Director of Place and Enterprise

Lisa Buckle, Corporate Director of Strategic Finance

 

5th May 2020