LAI0041

Essex County Council’s submission

May 2020

Overview

Our response to this PAC inquiry covers two key areas – 1, Essex County Council’s (ECC’s) approach to commercial property investment and 2, our views on the immediate and medium-term challenges for local government finance arising from the COVID-19 pandemic.

1. The ECC commercial property investment approach

Background

Between 2010-2017 ECC, in common with the LG sector, ECC saw significant reductions in government grants. We looked to find new sources of sustainable income. Our decision in 2017 to explore commercial property acquisitions outside of our geographical boundaries was set against this backdrop. ECC has sought to minimise passing on tax rises to our residents holding Council Tax levels flat for 6 out of the last 10 years. We have done so in part through creative approaches to sustainable income streams. 

Before 2017 ECC already invested in commercial property. The Essex pension fund has a significant property portfolio; ECC has a diverse investment portfolio for Treasury Management including a property fund; and we hold and manage a rental portfolio within the Essex geography of around £2m per annum.  We use independent professional advisors for the investment and management arm of these portfolios.

The ECC approach

In 2017 we extended our investment beyond the Essex boundary. The commercial investment into three properties of £34m was deliberately modest. Both the asset holding and the income return represent a small percentage of our balance sheet and turnover (the income is around 0.2% of our net operating budget). We agreed a cap at Cabinet of no more than £50m as an investment tranche, given full consideration to our portfolio spread and risk exposure.

It is essential not to see Commercial Property asset acquisitions in isolation – during the same 3-year period ECC disposed of assets in excess of £41m including income generating commercial assets; some of the proceeds of which were invested in new commercial assets to improve our commercial revenue streams. The acquisition of commercial assets by local authorities must be seen in the context of their disposal activity, it is not an inert portfolio.

Our approach to acquiring commercial assets was guided by three very clear success principles approved by Cabinet:

• A clear portfolio strategy
• Rigorous evaluation of potential investments, that will stand up to scrutiny, independently evaluated by a competent agent, against a set of pre agreed criteria
• Credible professional independent advice.

There are further key features of the commercial investment strategy at Essex that ensured we took a measured and conservative approach to growing our commercial property portfolio, without exposing ourselves to unacceptable risk:

1. The investment in commercial property was one element of an overall portfolio approach to investment overall ensuring we were not overly exposed to one asset class.
2. The property investments followed sound investment best practice. Investments were made on a portfolio approach that spread risk between different market sectors and different locations in the UK to mitigate the risk of any market failure in a sector or geographical area. There is also risk mitigation in that ECC does not take the ‘double hit’ of a loss of rate and rental income if a property becomes vacant when it is not within ECC boundaries.  There was also a cap size to any single investment within the portfolio.
3. ECC used external professional investment advice and internal financial and legal expertise on each acquisition, with a set of pre-approved minimum criteria. This is transparent and open to scrutiny. Only following extensive due diligence on the opportunity were investment decisions made - with the majority of opportunities declined at due diligence.
4. We have strong expert lead performance management of the commercial portfolio: ECC receive regular updates on ongoing performance against industry benchmarks.
5. We adopted a prudent approach to our revenue budgeting of the rental income: we set aside monies from the rental income in a reserve to mitigate against fluctuations in the rental base & possible voids, recognising that in any long-term investment there will be economic cycles.  This helps avoid shocks to the revenue base.
6. We invested for the long term. In making an informed decision to expand our commercial portfolio, we were clear that the asset value can decrease as well as increase. We reviewed benchmark information over the last 15 years, that illustrated years of capital and income decreases as well as growth, against a backdrop of a long-term growth record of this asset class. This asset class has been a long-standing element of Pension Funds and Treasury Strategies.

The portfolio is, and always has been, fully tenanted and performs well against industry benchmarks. Given volatile economic conditions, it will not be expanded. It generates £1.9m per annum of rental income.

2. The COVID-19 pandemic – financial implications for local government

-          Short term funding shortfalls – HM Treasury has acted swiftly and made significant emergency funding available to local government in response to the COVID crisis for which we are grateful.  At ECC we have made immediate spending commitments of over £100m, primarily to Social Care, of which £2 in £3 is expected to be met from the emergency funding. 

However, that does leave a funding shortfall unresolved & we look forward to further conversations with MHCLG & Treasury to support the immediate COVID response.

-          The medium-term implications arising from COVID for local government funding could be very significant.  A notable area of focus is the impact of unemployment and slowed housing growth on business and council tax levels. 

These movements can have a material impact on the tax base – an illustrative scenario would see a 6% rise in unemployment coupled with a 1% fall in housing growth, causing a loss of £50m off the annual tax base for ECC. 

More work is being done locally and nationally to look at the emerging data on tax base and projections. 

The development of a ‘bridging strategy’ to support the sector funding as it rebounds from the economic fallout of COVID is key; until such a time as the Economic Growth enables the recovery of a sustainable tax base.

ECC calls upon the PAC to examine this issue as part of its inquiry, exploring options for bridging this local government loss of income. Clearly, being commercially innovative is part of that solution – but we also look to government to assist in overcoming this challenge.

May2020

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