LAI0022

Written evidence submitted by London Councils

Introduction

1. London Councils represents London’s 32 borough councils and the City of London. It is a cross party organisation that works on behalf of all its member authorities regardless of political persuasion.

2. We welcome the opportunity to provide evidence to the Public Accounts Committee’s inquiry into Local authority commercial investment as our member authorities have been adversely affected by the associated increase in the Public Works Loans Board’s lending terms.

3. We also welcome the opportunity to provide further evidence concerning the response to COVID 19 as London has been particularly badly affected. As at 3rd May, the death toll from coronavirus in London stood at 5,156. This is the highest of any region in the UK[1].

4. Overall we argue that financial sustainability of local authorities must be considered in totality, and that both access to lending for capital programmes and covering the cost of responding to COVID-19 need to be understood as adding to the enormous financial pressure on local authorities created during the last decade.

5. This submission is split into two sections: Section one covers our response to the report from the National Audit Office (NAO), Local authority investment in commercial property; and Section two looks at the initial financial implications of the response to COVID-19 in London.

Section 1: Local authority investment in commercial property

Context

6. Before responding to the details in the report it is important to consider that local authorities have long invested in property for the benefit of the local area and have been investing in a range of property types, including “commercial” holdings, to that end for decades mainly using legislative powers conferred in the Local Government Act 1972[2].

7. Local authorities have successfully used these powers to facilitate core objectives around economic development, regeneration, infrastructure delivery and housing, with many projects containing a blend of such objectives. As such, most authorities hold and manage commercial property as an adjunct to other functions”[3].

8. Local authorities have developed considerable experience and expertise in making property investments. These acquisitions are usually an integral part of the overall strategy for the area, the development of which is ultimately subject to regular direct democratic approval. With portfolios well established, associated skill sets are considered core and staffed accordingly, with authorities regularly “buying in” any additional skills or expertise that they consider necessary to support in-house capability on a case by case basis.

9. There is also an array of checks and balances on an authority’s property investment strategy. This includes the prudential framework provided by MHCLG and the relevant professional body, CIPFA, and the authority’s own systems and processes which include due diligence and democratic oversight. External auditors provide a further layer of scrutiny and challenge.

10. For the most part, these acquisitions pass unremarked and demonstrate the commitment of local government to making the most of the taxpayer resources. The ability to harness commercial income for public gain can make the difference between a project being financially viable and not, as well as helping to release funds for investments elsewhere.

Reflections on the NAO report: Local authority investment in commercial property

11. Turning to the specifics, London Councils welcomes the publication of Local authority investment in commercial property – hereafter, the report – by the NAO as it makes several very important points.

12. Firstly, the report recognises that investing in property that can be operated on a commercial basis has been part of many authorities’ response to the immense financial pressure on the sector created by significant increases in service demand during a decade of substantial funding cuts.

13. The surge in commercial acquisitions identified in the report – £6.6 billion over 2016-17- 2018-19 and 14.4 times increase on the preceding three years – occurred during the SR15 period. This followed two spending reviews (SR10 and SR13) that had resulted in a reduction in core funding of around 43 per cent in real terms on a like-for-like basis and confirmed the trajectory for a full decade of austerity. Having already experienced the harsh realities of the first tranche of austerity settlements, and knowing that more was to come, it is unsurprising that some authorities concluded that property investment would have to be part of their funding strategy going forward.

14. Secondly, we also welcome the recognition in the report that the majority of commercial property investment in the period 2016-17 to 2018-19 was undertaken by a relatively small number of authorities with 80% of the spend in the sector being by only 49 authorities (13.9%), and the conclusion that the scale of activity is not having a distortionary effect on overall property market activity (less than 5% of activity nationally) which it found to be especially true in London where local authority purchases represent only 1% of overall activity.

15. This is important as the evolving response from the Department, CIPFA and HM Treasury to some local authorities’ commercial property investments affects the sector as a whole. Care must be taken to ensure that all are not punished for the perceived excess in a minority of authorities.

16. It is further questionable whether the issue at hand presents a sufficient risk to justify major policy changes. While we accept the Treasury’s formal position that “the intention of raising rates on new PWLB loans was to slow all borrowing from the PWLB, not just borrowing for debt-for-yield activity”[4], the Treasury’s subsequent consultation, Public Works Loan Board: future lending terms, which explicitly states the intention “to develop a proportionate and equitable way to prevent local authorities from using PWLB loans to buy commercial assets primarily for yield, without impeding their ability to pursue service delivery, housing, and regeneration under the prudential regime”[5], suggests this may have been a factor in the decision.

17. As such, London Councils believes the adjustments to the PWLB rate were a relatively blunt tool for addressing this issue, and are concerned about the proposed further changes being consulted on by HMT.

18. Evidence from London Boroughs immediately following the 100 basis points increase suggested that overall borrowing would be significantly more expensive as a result, costing nearly £52m million over 2019-20 to 2022-23 across 13 boroughs (a 29% increase in the revenue cost of borrowing). In practical terms, the main impact was expected to be on the types of projects boroughs are planning, with borrowing for housing projects expected to decrease by 17% after the rate rise. The most at risk projects included regeneration and housing schemes, especially those that rely on social rental income to finance borrowing costs and or had marginal financial viability before the rate increase was announced.

19. The third area of the report that we welcome is its acknowledgment that that many purchases of commercial property will have multiple objectives. This makes for considerable difficulty in successfully separating investments focussed on yield from those projects whose primary objectives are around place shaping and regeneration.

20. The NAO opted for a broad definition when setting the scope for its research but looking ahead there will need to be a degree of consistency between HM Treasury, the Department, CIPFA and auditors on how commercial properties are to be defined. The Treasury’s approach to defining debt-for-yield in practice will be particularly important considering their consultation proposals and the pivotal contribution of commercial property to the viability of many regeneration projects. We would not want to see a scenario where the legitimate commercial income generation parts of a regeneration project were replaced by PWLB borrowing just to protect that authority’s access to PWLB loans in that year.

21. The consequences of a blunt approach in this area were already impacting on regeneration and housing projects prior to COVID-19. All capital programmes will now need to be reviewed in light of the new financial realties created by the crisis, and many will need substantial reengineering to get off the ground.

Section 2: Responding to COVID-19

22. Even before the coronavirus outbreak, London boroughs were facing significant financial difficulty following the last decade of funding reductions in which overall resources were cut by more than a quarter in real terms. Over the same period, the population grew by a million people, and policy and legislative changes added unfunded burdens of around £1 billion. Despite the real terms increase in core spending power of over 4% in 2020-21, boroughs were planning to make £400m of savings this financial year.

23. London boroughs have been at the forefront of the response to both the public health and economic crises caused by COVID-19. They have mobilised rapidly and played a central part in coordinating the emergency response across public services in the capital.

24. They have supported social care providers to continue to deliver vital care for vulnerable and elderly adults under incredibly difficult circumstances. They have housed over 3,100 people, including over 700 with no recourse to public funds, and have led the way in ensuring 1,200 vulnerable rough sleepers have been housed in hotel rooms across the city. They have established local hubs to ensure that those who are being shielded receive the food packages and other supplies they need. Through their contributions to information campaigns, boroughs are also helping people receive the guidance they need to live and work safely throughout this period.

25. In response to the economic crisis, boroughs are supporting businesses through the administration of billions of pounds worth of business rates reliefs, and the distribution of the two business grant schemes established by BEIS, with over £1.2 bn already distributed by London boroughs to businesses since the start of April. As of 4th May, London boroughs had distributed 74% of the overall funding: more than any other authority type. In addition, they are supporting local residents through local council tax hardship relief schemes, whereby around £90 million will be distributed.

26. The crisis has dramatically increased the pressure on the financial resources of local authorities in three main ways:

1. By creating additional spending pressures: The initial survey exercise undertaken by MHCLG in April suggested boroughs require over £600 million of additional spending this year. Almost half of this will be incurred in adult social care. In addition, it is likely that a significant amount of the £400 million of savings that had been planned for 2020-21 will not be delivered. 

2. By reducing income: The MHCLG survey returns indicate that London Boroughs’ income will fall by c.£850 million. This excludes business rates income, whereby it is too soon to know with any clarity what the scale of the impact could be on retained income, but this is likely to be hundreds of millions of pounds. The early estimates suggest that the reduction in income from Sales, Fees and Charges (c.£400 million) will be significantly larger than the drop in Council Tax revenues (c.£250 million).

3. By impacting on authorities’ cashflow: The first MHCLG survey returns indicated nine boroughs were expecting cash flow difficulties: three before end of April and six before the end of June. However, measures announced by HMG on 16 April will have eased some of this pressure. The pressures are particularly acute in inner London for the large tariff paying authorities within the business rates retention scheme, who are simultaneously seeing significant reductions in fees and charges income.

27. With London boroughs receiving around £500 million in emergency funding (from the first two tranches totalling £3.2 billion nationally) so far, the initial estimates suggest that there could be a potential funding gap in 2020-21 of over £1 billion after the initial emergency funding has been taken into account.

28. It is quite clear, therefore, that further funding will be required if the Government is to make good on its promise and ensure local government is supported through the crisis. Authorities will have to significantly revise their medium-term financial plans and capital programmes based on a completely different financial reality to the one in which these plans were set.

29. Revenue budgets will need to take into account a sharp spike in demand, increased costs of delivery and will probably have to produce a balanced budget without the use of savings form service transformation, the delivery of which will have been brought into question by the need to allocate so many resources to the COVID-19 response.

30. Capital programmes will also need to undergo major revisions. Social distancing is difficult to deliver on construction sites and, with lockdown continuing, the only certainty is that the delays will have significant cost implications. Furthermore, with construction’s reliance on migrant labour and with material supply chains disrupted, inflation is likely to be another cost pressure as we move into the recovery phase of the crisis. It is particularly important to keep capital programmes on track. Not only do they deliver vital housing and infrastructure for local communities, but also vital economic stimulus for the local economy. Construction is labour intensive and provides employment across a wide range of skill sets.

31. This point underlines how important it is that local authorities are supported to keep delivery of their capital programmes on tack and why there must be a rapid return to discounted lending through the PWLB.

32. Looking beyond 2020-21, the postponement of the Fair Funding Review and 75% business rates retention reforms is broadly welcome and was somewhat inevitable given the reduced capacity of MHCLG to deliver these complex reforms. As with last year’s Spending Round, local authorities will require as much certainty as soon as possible regarding the funding settlement for 2021-22 and we would urge the Government to consider rolling forward the current settlement, notwithstanding additional C19-related funding that is required.

33. More broadly, the crisis now raises even bigger questions about the sustainability of the local government finance system as it has amplified a number of pre-existing issues, not least: the ability of councils to deal with growing demand within adult social care; the fragility of business rates as a tax and sheer complexity of the retention scheme as a viable funding system; and the fitness for purpose of council tax.

34. As well as providing funding in response to the crisis for the remainder of 2020-21, and certainty for 2021-22, we strongly urge the Government take the opportunity afforded by this fundamental shock to the system, to rethink local government funding and provide a coherent long term strategy for funding the sector over the remainder of the parliament and beyond.

35. Overall, we welcome the support provided so far by MHCLG in response to COVID 19 and its continued dialogue with local authorities. However, the sector will need MHCLG to continue to champion its cause through the reminder of the crisis and to support it as local authorities help their communities into recovery.

May 2020