Property fire sale triggered by new prudential code could ‘shatter’ confidence in local economies
Leaders and experts continue to debate the revised Prudential Code. Some now fear an inflammatory property sale that could undermine private sector confidence.
As the debate continues to rumble over local authorities’ investments, new fears about the unintended consequences of the latest version of the prudential code have arisen.
While some fear the code could damage mutual fund investments, others fear it could trigger a discount on commercial real estate assets and thus undermine confidence in local economies.
The fear was exacerbated by David Hodgson, Section 151 officer and chief financial officer of Exeter City Council, at the recent FD Room151 summit during a discussion of the code. Hodgson said Exeter owns 600 commercial properties and asked panelists if CIPFA, the authors of the new code and the Government Upgrade Department (DLUHC), understood the implications of a sudden sale of property.
“If we started selling commercial properties,” Hodgson said, “it would absolutely shatter private sector confidence in the city.”
Hodgson added, âThe private sector in areas like Exeter expects the board to give it that confidence to allow it to invest. And it would be gone. Do you think this is understood correctly? “
Hodgson’s concern came to light as part of an ongoing debate on the latest draft prudential code released for consultation in late September.
Paragraph 53 of the new code is at issue: âAuthorities anticipating the need to borrow should consider options for exiting their financial investments for commercial purposes in their annual cash management or investing strategies. Options should include using the proceeds of the sale to pay down debt or reduce new borrowing needs. They should not take out new loans if financial investments for business purposes can reasonably be made instead, based on a financial assessment that takes into account the financial implications and the benefits of risk reduction.
This has been interpreted by many as targeting mutual fund investments as well as commercial real estate investments for return.
And despite efforts to allay fears of a clearance sale, at least one expert believes the code, as it stands, could cause such an event. Dan Bates, financial specialist at LG Improve, a consultancy firm, said at the summit that the code could cause “a hell of a lot … so that’s a big deal.”
While the prospects for a fire sale may be questionable, one thing that seems obvious is the advice movement towards real estate investing as a means of generating much-needed income for service spending. This increases the sensitivities surrounding the proposed code, not least because few people expect the central government to increase funding for the councils anytime soon.
Bates said analysis has shown that income from commercial real estate now exceeds some local authority parking lots as a source of income.
This makes property a cornerstone of council funding.
Monthly online briefing on Room151’s cash flow
January 28, 2022
Public sector representatives – register here
As compelling as it may be, many observers are concerned about the volume of money that has been borrowed and invested by the boards, especially at a time when the economy appears to be in a state of transition. But Bates suggests that the capital invested may not be at great risk. His analysis is that the council’s real estate portfolios may have lost a few percentage points in value during the pandemic, but even at that level, he said, real estate outperforms most Treasury investments.
There are other concerns about the property, including a concern that it will eat away at council reserves. But Bates argued that among authorities with more than Â£ 150million invested in property, reserves have risen. âTheir financial resilience at the moment does not appear to be affected by their investing activity. He added, âFar from being a problem, the data suggests that for some it has been part of the solution and an alternative to managing the decline. “
The content of the code raised concerns among other speakers at the conference. Joseph Holmes, executive director of the West Berkshire Council, echoed concerns about the code’s emphasis on property while ignoring other forms of capital investment, including regeneration programs.
Due to their complexity, given that they often involve several partners all with different objectives, regeneration projects are potentially much more difficult transactions to manage. âThe risks around that are a lot more complicated and I think that’s the area we need to start looking at more of,â Holmes said.
It is possible that the code’s concern about commercial property is a reflection of widespread negative commentary in the media and in real estate investment policy. But panelists at the top suggested the councils may not have defended their investments.
âWe have a limited number of hours in the day,â said Holmes, âwhere we choose what we want to do; we can choose, as a sector, to say that some of our trade investments are a very good thing.
âBut instead, at the moment, we’re sort of choosing not to. Instead, we say, “I have this really good regeneration scheme here locally, and I’m going to talk about it.” Holmes added, âWe have an opportunity out there that we don’t necessarily seize as a sector. I think this may be one of our problems.