Don’t try to catch a falling knife, the saying goes.
Unfortunately, local authorities (LAs) have not heeded the advice, not when it comes to investment in commercial property, anyway – and, as retail values and rental income plummet during the coronavirus pandemic, many are now nursing deep wounds that may take years to heal, if they ever do.
The warning signs were there when they continued to spend big on retail even when values started to tank. In March 2010, UK Commercial Property Trust bought three shopping centres in Shrewsbury for circa £61.1m. Seven years later, the centres were bought by Shropshire Council for £51m. In its 2018-19 accounts, the council revalued the assets at £40.5m and in its recently released draft accounts for 2019-20, this figure had fallen to £19.8m.
This is not an isolated example. In 2007, Landsec sold the Whitefriars Shopping Centre in Canterbury for £253m. Canterbury City Council took a 50% stake in the centre in 2016 for £79m and acquired the remaining 50% in 2018 for a further £75m. A spokesperson confirmed to Property Week that it would report a “significant decrease” in the value of the centre in its next set of accounts.
Both LAs argue that these investments were strategic and support the economic growth and regeneration of their town centres. They add that any loss would only be realised if the assets are sold and that they do not intend to sell. However, the two investments underline two worrying trends: the dramatic fall in retail values and the huge exposure that LAs have to commercial property. According to figures from the National Audit Office, LAs spent a colossal £6.6bn on commercial property between 2016 and 2019, fuelled by low-interest loans from the Public Works Loan Board.
Many of these investments were sensible plays. In some instances, LAs were stepping in to acquire key strategic sites in their boroughs and unlock development and regeneration opportunities. Other LAs bought prime office stock let on long leases to companies with AAA covenants to generate rental income, as encouraged by the government to make up for the loss of central government funding.
However, some councils did not invest so wisely. Some overpaid for assets, some bought assets miles outside their jurisdictions and some bought retail assets at a time when the economic headwinds and rise of online were already wreaking havoc on the nation’s high streets. “Dumb money” is how one former head of shopping centre investment describes it.
The scale of the fallout from these ‘dumb money’ plays is only just starting to become clear as LAs release their annual accounts for 2019-20. Ominously, as startling as some of the revaluations look, they do not reflect the seismic impact Covid-19 has had – and not just on valuations. As we report, councils that own hotels operated by Travelodge face a 38% fall in rent payments in the next 18 months, totalling £6m. The loss of rental income is a bigger blow than nosediving values. After all, it is the yield that most councils bought the property for in the first place.
With little income being generated by their property and portfolios now worth a fraction of what they once were, it is little wonder that one UK investment agent says councils are in a “horrible place” at the moment. Those particularly exposed to retail are likely to be there for some time. They bet big in a high-stakes game – and could well lose big.