LAI0023

 

 

Written evidence submitted by South Somerset District Council

 

Summary

  1. South Somerset District Council’s submission is made to provide direct evidence of council property investment programmes developed as part of the response to sharp reductions in funding, and vital within the range of considered responses that have been successfully delivered to protect core services.  Risks arise across all council activities and are met with managed response.  Robust risk management is fundamental to our property investment programme and has been successful.  ‘Systematic risk’ does not provide a reason to avoid property investment.  There are significant differences between councils which should be recognised and allowed for.

 

Introduction

  1. South Somerset District Council (SSDC) has responded to the sharp reduction in Government funding for local government services by developing a Commercial Strategy to help it continue the services it provides to the people in its area.  In 2010, the Council received £11 million per year in revenue support grant. In 2018 this went to zero. On top of this there are inherent weaknesses in Council Tax – a property tax that has not seen a revaluation since it was introduced in the 1990s and has become increasingly regressive as a result. For many years this has been capped at levels that do not reflect the true inflation in council costs. In addition, the business rate system of which the council retains 50%, which is clearly broken and the short-term competitive grants that successive governments have offered, not only has led to massive reductions in funding for the council but an increasing picture of uncertainty.

 

  1. As a result, having followed the path of most councils since 2010 of cuts year on year to staffing levels and services, the council adopted in 2016 a Transformation Plan and in 2017 a new Financial Strategy. This aimed to ensure the council was as efficient as possible, utilised technology to improve services whilst securing efficiencies, and maximised income from across its services and from a new commercial investment strategy.

 

  1. There have been efficiency improvements across the council leading to a reduction in head count of 25% since 2017 but without reducing services; and together with the Commercial Strategy this has enabled the council to avoid salami slicing.  We are making this submission as an example of the good practice which exists in relation to commercial investment by local authorities which should not be curtailed as a response to any councils whose approach is judged to be outside such standards.

 

  1. The position of the Council’s political leadership has been and remains that there was no overwhelming desire to develop and implement a commercial strategy. However, this was an absolute necessity if services were to be protected, particularly for the most vulnerable, and initiatives to improve quality of life and develop the economy were to be advanced. Transforming our business and becoming more efficient was not enough in the context of severe financial challenge and uncertainty.

 

Protecting core services

  1. Councils have faced major reductions in their funding.  This has been met by efficiency improvements and transformation but the reductions, and the prospect they have not yet ended, threaten core services that support local people. 

 

  1. Commercialism is part of the response to this and covers various elements.  Many of these involve evolution and culture change.  The development of returns is gradual.  Commercial property investment stands apart as it can be responsibly grown quite rapidly while maintaining reasonable control of risks.  It offers the early response to the vital need to protect core services while other progressive changes are being built up.  The NAO report suggests a concern that there may be a degree of dependence on commercial property income.  We submit that this is a reasonable response to the priority of protecting core services.  The nation’s pension funds have depended for many years on investment returns as the essential means to meet that vital provision.  It is no less reasonable for such returns to help support local public services when Government has found it necessary to reduce its support.

 

Risk

  1. SSDC emphasised to members when presenting its original Commercial Strategy that, while a more commercial approach was considered the only viable option to counter the sharp reduction in funding and thus limit the reduction on the services that could be provided to local people, commercial activity does involve taking risks.  However, those risks would be managed and mitigated.   Activities such as housing companies or energy businesses arguably involve more risk (and return) than property investment, which is a mature and evidence based market, well understood by professionals.

 

  1. The steps taken to mitigate commercial investment risk are discussed below.  All activities of councils involve types of risk and it is part of management activity to assess and mitigate those risks.  Covid-19 has brought a level of challenge to all, including councils, from a crisis which is beyond a once in a generation experience.  At the end of April 2020, we had received 80% of our March quarter rents, and expect to receive more during the quarter.  Our car parking revenue, which is of broadly comparable scale to the net revenue from property investment, is running at about 90% reduction from form normal levels and will not be recovered.  Our theatre venues and leisure centres are closed and delivering no revenue.

 

Risk Management

 

We manage the risks involved with commercial property investment in number of ways:

  1. Team skills, expertise and capacity – we have recruited experienced specialists with significant commercial sector experience to manage and deliver our acquisition work and the asset management of the portfolio.  This has been funded as a cost against the income returns and capacity is protected by segregation of the small team from other areas of work.

 

  1. Decision making; evidence and assessment – all acquisition opportunities are considered by our Investment Assessment Group which is provided with property valuation advice and financial modelling.  The group decides if it supports an acquisition before any formal decision to proceed is made. The group represents commercial, property investment, political, legal and financial expertise for a rounded view, debate and challenge for every opportunity brought before it.

 

  1. Due diligence – each acquisition is subject to best practice acquisition due diligence provided by external professional firms with appropriate expertise.  Any significant concerns lead to further review by the Investment Assessment Group before deciding if we can proceed.

 

  1. Portfolio diversity – our aim is always to have a balanced portfolio – relative to the target size of portfolio we are assembling. We achieve portfolio diversity by means of geographic spread, control of lot sizes enabling risks to spread across a number of properties and tenants, property and tenant sectors spread, and assessment of property fundamentals. We are a council that invests outside of our area and that is a reflection of our local economy, the lack of commercial property, the dependence on a few number of large employers and the risk investment only within our boundary would present.

 

  1. Risk reserve/sinking fund – we build in to our approach an allocation to a risk reserve/sinking fund so that we build a reserve against future vacant properties or other periodic costs. Full MRP is also being provided.

 

  1. Scrutiny and reporting – Transparency and the role of Members in understanding what we do are very important. We present regular review reports to our District Executive, as public reports, and also present to Scrutiny meetings.  This is supported by internal and external audit where we seek to identify any areas we can improve. 

 

Systematic risk

  1. The NAO identifies that systematic risk exists citing the fall in capital and rental values in the credit crunch recession.  It is true that capital values fell sharply during the credit crunch.  They also recovered within a relatively short period.  The negative ‘total returns’ presented for retail property funds a specific area of risk.  Local Authorities are investing for the ‘income return’ so the short term capital value change is not relevant where the asset can be retained.  All property fall in rental value was 10.9% despite the seriousness of the recession, and still generally recovered in a reasonable time.  Investor risk exposure was mitigated by general provision of upwards only rent reviews.

 

Differences between Councils

  1. Some councils such as historic major city councils have long established large property investment portfolios.  Some are also ‘asset rich’ enabling them to structure arrangements using property assets to generate either capital or revenue returns, sometimes in joint venture arrangements with partners.  Many other councils do not have these assets to work with.

 

  1. Councils also have widely differing local economies.  These change the scope for all commercial activities but specifically impact on the potential for prudent commercial investment within the district.  In portfolio terms, investing only in one geography would always be seen as an increased risk.  The long term economic expectations for that geography affects the level of risk if investment is concentrated within that geography.  It is prudent for investing councils to spread beyond their area.

 

  1. There are also differences in the investment strategy adopted by councils, and the relative scale of investment undertaken.  The NAO report specifically refers to the small proportion who have taken on large exposure to property investment.  It is our submission that the question of whether procedures or MHCLG monitoring should be reducing the limits for those largest investors is not a reason to challenge the activity of others who can demonstrate that their programmes are proportionate, well balanced in relation to risks and essential to protecting core services for the people they serve.

 

May 2020