Commercial Property News May 2020 Compiled by Hayven Property Tax
Commercial property is always a very newsworthy topic. Here is a roundup of the latest news (May 2020) concerning commercial property and investments in the UK. At the time of writing, the UK is still mainly in “lockdown” with some restrictions being relaxed, so it is hardly surprising that the virus dominates the news including how COVID-19 Coronavirus is impacting property and rents.
Change ‘permitted use’ rules to help real estate survive, surveyors urge the Government
Surveyors’ professional body RICS has called on the government to relax the rules around commercial property use as real estate asset values tumble amid the ‘seismic’ impact of Covid-19 reports Investment Trust Insiders.
Commercial property has endured the headwinds of Brexit and the decline of the UK high street that has seen retail property values plummet and landlords forced to lower rents as retailers enter into company voluntary arrangements (CVAs).
After a brief rally at the beginning of the year, property then fell victim to the coronavirus as government restrictions shut down businesses and with it tenants ability to pay rent.
A RICS survey of its members showed demand has slumped over the past quarter, with a net, negative balance of -24%. Retail has been hardest hit, with a 67% slump in demand, office demand is tumbled 16%, though a shortage of industrial properties saw demand for them climb 6%.
However, demand has plunged since the government imposed social distancing restrictions last month to combat the pandemic.
Since 1 April, RICS says retail property demand has plummeted 82%, office demand tumbled 44%, and even buoyant industrials slid 7%, pushing up availability and landlords inducements to take up space.
Given the drop in demand, 29% of surveyors expecting commercial rents to fall, although there is a marked difference by sector, as 69% forecast retail rents will decline compared to 24% believing offices will become cheaper. Industrial rents are expected to remain flat in the near term.
The tough backdrop for property has prompted RICS to call on the government to support the commercial property sector by relaxing the rules around permitted uses for property. All commercial buildings have a ‘permitted use’ ascribed to them that requires planning permission from local councils to change.
Simon Rubinsohn, the chief economist at RICS, said the ‘seismic nature’ of Covid-19 and its impact on commercial property should not be underestimated as it will accelerate the shift to e-commerce and the decimation of the high street.
It will also lead to an ‘inevitable rise in agile working as businesses seek to build resilience against future pandemics’ and a ‘reassessment of demand for office space’.
‘Against this backdrop, it is critical that the government engages with the industry to build a collaborative approach to addressing the challenges and help to facilitate the transformation of the commercial property estate to something that better reflects the needs of a 21st-century economy and also the continuing shortfall of good quality housing across all tenures,’ he said.
Tony Mulhall, associate director of planning and development at RICS, said the use-class regulation was produced ‘in response to more static conditions’ and there now needs to be ‘greater flexibility’ as long as property is developed to ensure it is fit for a new purpose.
The outlook for commercial rents over the next 12 months are not optimistic regardless of sub-sector although retail will take the largest hit with secondary retail rents – typically shops that are in walking distance to a high-street – predicted to fall 12%. Although RICS said prime retail rents for a property on the high street and in shopping centres is likely to reduce at near the same level.
The property investment market is seeing the knock-on effect on asset valuations with capital value expectations for the next three months falling from -3% to -35% between the end of 2019 and now.
Real estate investment trusts (Reit) have already seen their net asset values come under pressure as surveyors place a ‘material uncertainty’ clause on assets. All RICS surveyors now include a ‘statement of highlighting material valuation uncertainty’ in their valuations of UK property to reflect the lack of visibility Covid-19 brings.
Commercial property landlords banned from demanding rent arrears
Temporary ban intended to protect UK retailers and other firms from ‘aggressive rent collection’ during coronavirus crisis
Commercial property landlords in the UK have been temporarily banned from taking legal action against tenants who have not paid their rent, to protect retailers and other businesses from “aggressive rent collection” during the coronavirus crisis, reports The Guardian.
Landlords are prohibited by the government until 30 June from sending their tenants statutory demands, a formal request for payment or winding-up petitions – a legal notice usually sent by a creditor to request that the courts close a company that owes it money.
The business secretary, Alok Sharma, said most landlords and tenants had been working together well, but he criticised some landlords for putting tenants under pressure to pay, urging them to show “forbearance”.
The government has previously allowed commercial tenants to delay rental payments for three months without fear of eviction. The extended measures will prevent landlords from using commercial rent arrears recovery, or sending in bailiffs unless they are owed 90 days of unpaid rent.
High-street retailers and other companies are being asked to “pay what they can” to their landlords.
Landlords believe certain tenants are exploiting the situation by refusing to pay rent and have begun to take legal action to recoup money owed.
The fashion and homeware retailer Matalan was issued with a winding-up petition by a landlord this month for failing to pay rent it owed. The retailer, founded by the billionaire John Hargreaves, has since settled with the landlord.
The indebted shopping centre owner Intu Properties threatened some of its tenants with a statutory demand at the end of March, and said it had “neither the desire or financial capacity to bankroll global, well-capitalised brands who have just decided they don’t want to pay their rent.”
Retailers and hospitality companies, many of whom have not had any revenue for several weeks, had been calling on the government to do more to protect firms.
The measures will provide firms with some “breathing room”, said Kate Nicholls, chief executive of UK Hospitality, which represents the cafe and restaurant business.
Nicholls said companies would find a way to work with their landlords, but added: “If social distancing measures are to be in place for some time, as we now believe they will, this measure may need to be extended to ensure that businesses can survive.”
Coronavirus and commercial properties: what do you need to know as a landlord?
Rebecca Cleal from the Commercial Property team at Ipswich law firm, Prettys, has looked at the wording of the Coronavirus Act 2020 to answer some of the most common questions. Please note that the content below is subject to change upon further advice from the UK government.
Will my premises be covered by the Coronavirus Act?
In terms of commercial premises, the important thing to note is the definition of ‘relevant business tenancy’ is one to which Part 2 of the Landlord and Tenant Act 1954 applies.
Whilst this clearly means that licences or commercial premises which form part of a larger residential lease will not be covered, it is not clear whether this applies to tenancies contracted out of the Landlord and Tenant Act 1954. We would anticipate that contracted out tenancies would be included in the definition of ‘relevant business tenancy’ on the basis that Part 2 applies to those tenancies in the first instance prior to the contracting out process taking place, however, we await further clarification.
I am a landlord and my tenant hasn’t paid the March quarter rent – I thought they had to pay?
Although the government advice is to close premises, the obligation to pay rent continues under a lease. If a tenant fails to do so, then the landlord is normally able to forfeit or terminate the lease on the basis of that breach, if they so wish. However, the government has announced that there will now be a 3-month moratorium on any forfeiture actions, with the Coronavirus Act stating that a right of forfeiture “under a relevant business tenancy, for non-payment of rent may not be enforced, by action or otherwise, during the relevant period” – the relevant period here means the period from 25th March until 30th June 2020. Even though the threat of forfeiture is no longer immediately available, our advice would be to try and speak with the tenant and agree to a formal rent deferment, with the terms clearly set out in writing. For example, the agreement should confirm if the landlord expects the amount to be repaid (with or without interest) and over what period. Without a written agreement in place, the terms of any rent deferment are open to interpretation. In that case, your tenant could argue that it was agreed there was no obligation on them to repay the deferred rent, so a written agreement is key here.
What if I have already commenced forfeiture proceedings against my tenant?
If forfeiture proceedings have already commenced, then the courts won’t be able to order possession until the 30th June 2020, even if the reason for the action related to rents due before the COVID-19 epidemic. Any orders for possession prior to 30th June 2020 can be postponed by application from the tenant.
Are there any other ways I can get my money from the tenant?
Please note that there is nothing to suggest that a landlord cannot still choose to exercise their rights under the Commercial Rent Arrears Recovery regime (CRAR) or issue a statutory demand for payment. But in practical terms many premises will be ‘locked up’ and the courts’ service will be on a much-reduced timetable, so there is little to be gained from taking this action at the moment. You may also still be able to forfeit for other sums due under the lease, such as insurance or service charge payments if these are not being paid.
I am in the process of making a dilapidations claim against my tenant but I cannot access the property because of the lockdown – what is the position?
If you are in the position where you need to commence or are in the process of making a landlord’s dilapidations claim, then there are a few key points you need to bear in mind. Whilst there is no prescribed period for a schedule of dilapidations after the expiry of a lease (other than the one imposed by the Limitation Act 1980), the purpose of a schedule of dilapidations on expiry is to record the state of repair of the property on the termination date. Access to properties may prove difficult for both parties in this scenario but, unfortunately, it would seem the absence of appropriate surveyors or dilapidations assessors to carry out an assessment will not act as a defence to a contractual obligation to keep a property in good repair. There is nothing in the Coronavirus Act which would give any leniency on the procedures to be followed under the usual dilapidations procedure. We can offer advice on the correct approach depending upon whether the end of the lease has already passed. We would also need to assess the wording of your lease to check specific time limits for service of the dilapidations schedule.
My tenant has a protected business tenancy which is about to renew but they have not paid their rent – does this mean I don’t have to agree to the renewal?
The Coronavirus Act goes further in respect of business tenancy renewal and confirms that a landlord will not be able to rely on ground 30(1) (b) of the Landlord and Tenant Act 1954 (persistent delay in paying rent) in relation to any rent which has become due under the relevant period. Therefore, you cannot use this as grounds to refuse a new lease. Given the timings around lease renewals, we would suggest you seek specialist advice on your options, as you may be able to postpone serving your section 25 renewal notice until after the agreed rent deferment period. But circumstances vary on a case-by-case basis.
Is there any way my tenant could argue that the lease has come to an end because of Coronavirus?
Some tenants may try to argue that the lease has been ‘frustrated’ and has, therefore, come to an end. The concept of frustration is where circumstances beyond the control of the parties and outside their contemplation make the contract impossible to perform. Whilst tenants may feel that the government intervention preventing them from operating their premises may amount to frustration, the general view is that this is unlikely to be successful, given the very high standard to which this doctrine is held by the courts. The recent case of Canary Wharf Limited v. European Medicines Agency 2019 held that a lease was not frustrated as a result of the Brexit vote. We have no doubt that this will be an area where multiple cases arise as a result of the current situation, but at present, we believe the principle of frustration is unlikely to be applicable. The only other possible way a tenant may be able to terminate their lease is if the lease contains a specific ‘force majeure’ clause. A force majeure clause is usually found in contracts but is not usually found in commercial leases. Even if you have a lease which does contain a force majeure clause, it would need to be specific enough to encompass the current COVID-19 scenario and, again, we believe this would be highly unlikely.
I own a multi-let commercial building and there are various common areas, such as a reception area and stairwells etc.. What obligations do I have in respect of managing these areas during the Coronavirus outbreak?
Where you have responsibilities for any shared or common areas of a commercial building, then it is your responsibility to comply with all government regulations applying to that part. If any of your tenants are continuing to operate on a reduced basis, then you will need to do a full risk assessment to ensure that social distancing measures are put in place for access to and from the let parts via the shared parts of the building. You should also issue your own policy document which echoes the government’s requirements for self-isolation and instruct the tenant their employees should not be allowed into the common parts where the recommendation is that they should be self-isolating.
Investing in commercial property amidst Covid-19
Since the austerity measures introduced in 2010, local authorities have been left to consider new and innovative ways in which they can generate income to fund vital public services. The acquisition of commercial property has been popular, with councils spending an estimated £6.6bn over the last three years on purchasing commercial outlets, mainly through loan finance provided by the PWLB writes Lucy Woods (A Partner at Ashfords LLP) on the localgov.co.uk website.
Local authorities have long had the power to enter into commercial arrangements which include the ability to borrow and invest in real estate. However, there is increasing tension in meeting the balance between acting in a way which furthers a local authority’s commercial interests whilst meeting the overriding public policy objectives.
And let’s not forget that these investments are subject to a number of constraints that would not concern a private investor. Any commercial property transaction must comply with the public procurement rules, the rules on State aid and the Best Value Duty. A council has to wear two hats: one considering the commercial interests and another its public sector duties and obligations. Taking enforcement action against failing commercial tenants, for example, has negative publicity implications that will not apply in the same way to a private landlord.
So, why do they invest? Primarily to generate income to plug the gap from reducing Central Government funding. However, often these investments have a regeneration policy underlying them which sits more comfortably with public sector policy. There has, however, been an increasing trend of out of area investment which are purely commercial in nature.
The Commons Public Accounts Committee has recently launched an inquiry which seeks to explore issues presented in the National Audit Office’s report on local authorities’ investments in commercial property, raising the following questions:
- Is commercial property a safe investment?
- Have local authorities fully considered the potential risks involved in such acquisitions?
- Are local authorities receiving value for money? Are councils are meeting their Best Value Duty?
- Do local authorities have the commercial skills and abilities to properly manage these investments in a way that yields a decent return? Local authorities are increasingly appointing consultants and agents to manage their property portfolios.
- In the light of COVID-19, will local authorities be able to meet their borrowing obligations or will the Government need to bail them out? In addition, will the pandemic impact on the markets they have invested in? There is a moratorium on evicting tenants and serving statutory demands where rent is unpaid. How will this affect service provision if income which is forecast to be received is significantly lower as all sectors struggle with the economic crisis?
The Government has already committed £1bn to help struggling councils during the pandemic amidst a fear that they will go insolvent. There is no doubt that advice from expert professionals is more important than ever to ensure that local authorities are not unduly exposed to market risk, ensuring that any such investments are part of a balanced portfolio to minimise the inevitable issues which will arise with market downturns.
LOCAL AUTHORITY INVESTMENTS IN COMMERCIAL PROPERTY – ARE THEY CASH GENERATORS OR DEBT BURDENS?
Since the mid-2010s some Local Authorities have been building up portfolios of commercial property – from hotels and farms to shopping malls and leisure complexes – putting the profits that are generated into their revenue budgets. With Government now consulting on the lending terms of the Public Works Loan Board – a lending facility used by many Local Authorities to build up their portfolios – and the coronavirus pandemic leading many tenants to close and forgo rent payments; will Local Authority property portfolios go from cash generators to cash draggers and what impact might this have on public services? Jessica Sellick of Rose Regeneration writes for the Rural Services Network.
Local Authorities have long owned buildings that could serve a commercial purpose. Indeed they often use commercial structures to advance their core activities of delivering public services, housing and regeneration for the benefit of their citizens. However, recent reports suggest some Local Authorities have started to use low-cost loans from the Public Works Loan Board (PWLB) to buy investment property for rental income. The Government is now consulting on ‘debt-for-yield’ activity – recommending that Local Authorities wishing to buy investments primarily for yield should remain free to do so but not be able to take out new loans from the PWLB to do it. What decisions over capital projects are some Local Authorities pursuing – and how are they financing them?
How much can a Local Authority borrow? Local Authorities are required to distinguish between capital and revenue funding in their accounting. Borrowing and investment are matters of Local Government Capital Finance, with practice in this area governed by The Chartered Institute of Public Finance & Accounting’s (CIFPA) Prudential Code for Local Authority Finance. In addition, Local Authorities must take account of CIFPA’s Treasury Management Guidance for Local Authority funds and the Ministry of Housing, Communities & Local Government (MHCLG) guidance on Local Authority investments and on Minimum Revenue Provision (MRP).
‘Capital expenditure’ is defined in the Local Government Act (2003) as “expenditure of the authority which falls to be capitalised in accordance with proper practices”. The government provides an annual allocation of capital funding to Local Authorities alongside the annual distribution of revenue funding set out in the Local Government Finance Settlement. While Local Authorities can access finance for infrastructure from a number of sources, the quantity of expenditure that is often required for capital projects means that most Local Authority capital finance is obtained through borrowing.
Under part 1, chapter 1, of the Local Government Act (2003) a Local Authority may borrow for any purpose relevant to its functions or for “the prudent management of its financial affairs”. Every Local Authority must set a total borrowing limit for itself in accordance with the principles of the Prudential Code. This borrowing limit is related to the revenue streams available to a given Local Authority, and the extent to which it can repay debt. Local Authorities are prevented (by law) from using their property as collateral for loans. However, there is some flexibility in exactly how individual Local Authorities set their borrowing limits. The Prudential Code, for example, does not contain a formula for Councils to make an exact calculation of prudential limits; with Local Authorities relying instead on the judgement of their chief finance officers and on ‘generally accepted accounting practices’.
The Prudential Code requires all Local Authorities to draw up rolling three-year plans for capital expenditure. These plans typically cover all capital spending apart from housing. While Local Authorities may borrow money from a number of different sources, they cannot breach the overall borrowing limit they have set.
Under section 32 of the Local Government Finance Act (1992), Local Authorities are required to maintain an appropriate level of reserve funding. As per the Prudential Code, the judgement as to an appropriate level of reserve lies with individual Local Authorities – there is no standard formula for identifying the correct level.
Guidance on Local Government investments issued by the MHCLG in 2018 requires Local Authorities to prepare an investment strategy annually (or include the required details in their treasury management strategy). Each strategy must explain how their investments (including commercial property portfolios) relate to their core purposes, and quantitative indicators to allow Elected Members and the public to assess a Local Authority’s risk exposure as a result of its investment decisions. Importantly, the guidance requires an explicit statement to be included in each strategy about the degree to which commercial income underpins the delivery of services – and that each Local Authority must set annual limits for the proportion of gross debt compared to net service expenditure as well as the percentage of net service expenditure that comes from commercial income. This follows up on the findings of a Public Accounts Committee (PAC) Inquiry in 2016 which found Local Authorities were investing less in physical assets such as libraries, museums and parks; and spending more on commercial investments such as property. The PAC called on the Department for Communities and Local Government [now MHCLG] to strengthen its understanding of the capital issues faced by Local Authorities, and to develop a cumulative picture of risks and pressures across the sector. This formed part of a call to change key aspects of the codes and governance in line with a view that Local Authorities should not borrow to invest solely for yield.
Who can a Local Authority borrow from – and how much are they borrowing? Local Authorities seeking to develop property portfolios do so using Statutory Powers that relate to their wider purposes – such as regeneration or economic development.
Section 4 of the Localism Act requires anything done for a purely commercial purpose must be carried out by a Limited Company. However, if a Local Authority is using powers related to regeneration or economic development to buy a local shopping centre, for example, it is not acting purely in a commercial purpose and can own it directly.
The Local Government Act 2003 permits Local Authorities to pursue certain forms of commercial activity through a company structure. The General Power of Competence, introduced in the Localism Act, permits a Local Authority exercising it with the (a) power to do it anywhere in the United Kingdom or elsewhere; (b) power to do it for a commercial purpose or otherwise for a charge or without charge; and (c) power to do it for the benefit of the authority, its area or persons resident or present in its area. Again, as Local Authorities are looking to manage commercial property as an adjunct to other functions rather than purely for financial gain a company is not required.
Local Authorities can fund commercial property acquisitions using money from capital receipts, by using revenue funding, or through borrowing and meet debt servicing costs from revenue funding. Local Authorities are able to choose between different sources of external borrowing.
In recent years the majority of loans taken out by Local Authorities have been supplied by the Public Works Loan Board (PWLB). The PWLB is located within the Government’s Debt Management Office (DMO), part of HM Treasury, and its funds are available at lower rates than the market. The PWLB publishes data listing borrowers, with the amounts advanced, the rate of interest, the term of the loan and length of time before the loan will be fully expended.
Alternative borrowing mechanisms include:
- Tax Increment Financing (TIF) which permits Local Authorities to borrow money for infrastructure projects against the anticipated increase in tax receipts resulting from the infrastructure – for example, Local Authorities might borrow against their income within the Business Rate Retention Scheme or against the rate within a specific geographical area such as an Enterprise Zone.
- New Development Deals (NDD) where a geographical area is not subject to future levies and resets thereby creating an area and stream of revenue outside of the Business Rate Retention Scheme.
- An ‘earn-back scheme’ which has been enacted in some City Deals whereby Local Authorities can make investment up-front if additional GVA is created relative to a baseline.
- Through bonds, which allow Local Authorities to raise substantial sums of capital immediately, and repay it at a specified point in the future. Some Local Authorities have obtained credit agency ratings, allowing them to borrow on the open market; and for smaller Local Authorities through the UK Municipal Bonds Agency which is owned by 56 shareholding Local Authorities and has offered to obtain a competitive price for bonds at a lower rate of interest than the Public Works Loan Board.
The MHCLG publishes statistics annually on Local Authority capital expenditure and receipts. The latest statistical release covers the financial year April 2018 to March 2019. This shows capital expenditure by Local Authorities in England totalled £25.9 billion in 2018-2019; an increase of £202 million (or 1%) in real terms compared to 2017-2018. When this figure is broken down by economic sector, acquisition of land and existing buildings totalled £4.4 billion, up from £326 million (or 8%) in real terms when compared to 2017-2018. The data also reveals how Local Authorities are financing a greater proportion of their capital expenditure from prudential borrowing and capital receipts rather than from capital grants and revenue resources. For example, the proportion of capital expenditure financed by prudential borrowing has increased from 22% in 2014-2015 to 38% in 2018-2019. Over the same period, the proportion of capital expenditure financed by capital grants has fallen from 45% to 35%. Actual debt held by local authorities was recorded at £104.46 billion at the end of June 2019. At the beginning of 2017-2018 Local Authority external debt stood at £110.1 billion – but at the end of 2017-2018 Local Authority external debt stood at £118.3 billion (an increase of 7.4%).
The data does not provide a clear indication of the type of acquisition made. Similarly, the PLWB does not currently keep defined records of the purpose of each of the loans it makes to Local Authorities.
In February 2020 the National Audit Office (NAO) published a report on ‘Local Authority Investment in Commercial Property’. This estimated that Local Authorities spent £6.6 billion on buying commercial property between 2016-2017 and 2018-2019 – this figure is 14 times more than in the preceding three years. 40%-90% of spending between 2016-2017 and 2018-2019 was financed by borrowing. Local Authorities spent an estimated £3.1 billion on offices, £2.3 billion on retail property [including £759 million on shopping centres or units within them], and £957 million on industrial property. 38% of all spending between 2016-2017 and 2018-2019 was outside of the local area. The NAO found the increase in commercial property investment to be concentrated in the South East, and also amongst District Councils (comprising 51% of commercial property spending between 2016-2017 and 2018-2019). For example, 49 out of 352 Local Authorities accounted for 80% of commercial property spending between 2016-2017 and 2018-2019. 17.5% of all commercial property acquisitions by value in the South East between 2016-2017 and 2018-2019 were made by Local Authorities.
Why are some Local Authorities investing in commercial property? Since the mid-2010s some Local Authorities have sought to build up portfolios of commercial property. Various reasons may account for this, including (but not limited to):
- A reduction in Government funding provided to Local Authorities. The National Audit Office (NAO) estimates a real-terms reduction in Local Authorities’ spending power [from Government funding and Council Tax] of 28.7% between 2010-2011 and 2019-2020. Analysis from the Local Government Association (LGA) found in one year, between 2016-2017 and 2017-2018, Local Authorities had to absorb a funding shortfall of £2.4 billion – with further analysis showing a potential funding gap of £7.8 billion by 2025. The government provides a Revenue Support Grant (RSG) to Local Authorities to finance revenue expenditure on services. According to MHCLG, while the RSG has declined since 2015-2016 this should be viewed in the context of increased funding from business rates retention and other grants such as the Better Care Fund.
- Changing approaches to asset management whereby some Local Authorities have shifted away from disposing of surplus land and buildings towards using them as assets and as ongoing sources of revenue – with this approach facilitated through the Government’s One Public Estate programme and in some devolution deals.
- As Local Authorities have been given more flexibility and freedoms (e.g. through the Localism Act) this has fostered a more commercial culture amongst officers and Elected Members, leading some Councils to be innovative and entrepreneurial in obtaining more money from commercial activities rather than relying on ‘traditional’ sources such as council tax and business rates. Interestingly a report on insourcing by APSE in 2019 suggested that a rise in insourcing was being driven by a desire to improve service quality and flexibility amid the need for greater control over-allocating resources, including commercialisation in order to raise revenue.
- Local Authorities have purchased commercial property to support local regeneration and economic growth – bringing unused or underused property back into use for the benefit of their citizens.
What are the benefits – and the risks? Some commentators highlight how Local Authorities have long-held large property holdings which they have used for social, economic and commercial purposes; and that the annual return rates on commercial property, and the spread between the loan rate and the return rate on letting out the property, generate profit for Local Authorities to use for the benefit of their citizens. For example, a report by the Audit Commission back in 2000 described how “typical non-operational properties include high street retail outlets, markets, industrial estates and shops on housing estates, held primarily to generate income or to stimulate economic or social development” (page 7). Some Local Authorities have bought commercial property to use the returns to deliver new homes and infrastructure, to respond to private sector withdrawal or market failure (e.g. high streets), to support social enterprise and community business and/or for wider place-making. In many instances, it is the spread between the loan rate and the return rate on letting out the property that enables the Local Authority to make a profit to reinvest in local services and activities.
In 2017 the Local Government Association (LGA) published practical guidance on how Local Authorities could turn their commercial plans into reality. The guidance described trading and commercial property activity as “a particularly specialist activity where advice should be sought, if necessary, from a range of experts such as lawyers, property experts and accountants. Councils considering investment activity should be clear around long term risk and benefit modelling, governance and what specialist capabilities may be required to support the activity. They should be aware of the accumulated effect of every decision they take as well as the risks of each individual decision” (page 36).
More recently, the NAO in its report referred to ‘specific risks’ associated with each individual property [such as the length of the lease or the financial strength of the tenant] and ‘systematic risks’ [such as movements in markets e.g. people shopping online leading to growth in vacancy and void rates of retail units].
Some of the key risks for Local Authorities using commercial property to generate revenue are around:
- A downturn in the property market – leading to falling rents, higher vacancies, falling property values and causing financial pressures.
- Any Government intervention setting limits on the commercialisation strategies available to Local Authorities.
- A lack of skills and expertise (commercial awareness) within Local Authorities about the market and making investments leading to poor acquisition decisions.
- Liquidity – if a Local Authority needed to meet immediate cash requirements, property cannot be as quickly realised in the same way as other financial instruments.
- Local Authorities are legally required to set a balanced budget – if commercial income is underpinning the delivery of services does not yield the required return, how will they overcome these broader losses of revenue?
On 9 October 2019, the Government announced it would raise the interest rate on new loans from the PWLB by 1% over gilts over and above the existing interest rates. This decision was explicitly linked to substantial borrowing for commercial investments: “Some local authorities have substantially increased their use of the PWLB in recent months, as the cost of borrowing has fallen to record lows”. For some Local Authorities, the rate rise was seen as making some large-scale regeneration schemes costlier, unviable, or requiring more time to obtain a return on investment – with some commentators suggesting it may lead Local Authorities to seek alternative sources of finance (e.g. private-sector lenders, Municipal Bonds Agency). At the same time of the announcement, Government increased the cap on the total amount Local Authorities can borrow from the PWLB from £85 billion to £95 billion.
Are we reaching a tipping point? The NAO has highlighted how some Local Authorities would be badly exposed in the event of an economic recession or property crash, describing how “in the last recession UK commercial property values and market rental values both fell. More recently, systematic risk is perhaps apparent in the performance of the retail sector with the shift to online sales, among other factors, leading to growth in vacancy and void rates” (page 41).
Analysts point to past examples of Local Authorities suffering financial difficulties – the interest rate swaps in the late 1980s/1990s, investments in Icelandic banks in the late 2000s, and LOBO loans in the mid-2010s. However, these episodes affected a small number of Local Authorities and none generated long-term financial strain or losses even though they led to serious concerns in the short term. Nor did they require Local Authorities to raise Council Tax substantially to offset a lack of funds.
Yet all of these episodes are very different from the novel coronavirus (COVID-19). Emerging evidence highlights the impact of the pandemic on bricks and mortar. Coutts reveals how the retail sector was already heading into recession before the pandemic due to the rapid adoption of online shopping and the change in shopping habits. They predict this downward trend in retail property is likely to continue with only retail-to-residential conversions and specialist event venues surviving; warehouses and logistical centres will continue to expand, and the period of people working from home may lead companies to change working practices and reduce office space. The real estate developer Hammerson revealed that it had only received 35% of second-quarter rent from its outlets – and it had also received requests from tenants for rent deferrals, monthly payments and waivers. Coronavirus is expected to create a hole in Local Authority income as a result of lost revenues from commercial property. This is further compounded by the loss of other revenue streams (e.g. planning fees, car parking).
In March 2020 the Government announced £1.6 billion package for Local Authorities to respond to service pressures including increasing support for adult social care and services that support the most vulnerable; a £500 million Council Tax Hardship Fund of discretionary support to help economically vulnerable people and households; £3.2 million of initial emergency funding to reimburse Local Authorities for the cost of providing accommodation and services to rough sleepers; the deferral of £2.6 billion in Local Authority payments of the Central Share of retained business rates; and brought forward £850 million of social care grants. In April 2020 the Government announced a further £1.6 billion of additional (and un-ring fenced) funding to support Local Authorities to meet additional pressures arising from the pandemic and to help them to continue to deliver frontline services.
While the impact of coronavirus on Local Authorities – including those with substantial commercial property portfolios – depends on how long the lockdown last for and the gradual steps to a ‘new normal’ that the Government will implement; scale really matters here. The bigger the spend, the bigger the borrowing, the greater the risk. And these risks become even greater where Local Authorities are dependent on income from commercial property portfolios to repay debt or fund services. They may also be tying up Local Authority money and resources that could be diverted elsewhere.
Because we do not have a clear picture of the scale of investment of public funds in commercial property, where it is concentrated and how it is being financed, considering the implications for rural residents and businesses is difficult. According to the Rural Services Network urban authorities in 2016-2017 received 40% more (£116) per head in the Government’s Settlement Funding Assessment compared to rural authorities. We also know that it costs more to deliver services in rural areas. What we do not know is whether this leads rural Local Authorities to borrow more than their urban counterparts, if and how much they are investing in commercial property, what the income from this investment has been used for, and what impact COVID-19 will have on these portfolios and Local Authorities now and into the future. The longer the pandemic persists, the greater the chance of a more prolonged impact on the economy including commercial property markets. In the meantime, we need to improve the data and evidence base: what are the trends in capital strategies, buying out of area, the contribution of commercial income to service expenditure, the scale of contingency, and which Local Authorities are vulnerable and what can we do to manage the risks?
When making any investment we are reminded that past performance should not be taken as a guide to future performance. The value of investments, and the income that we get from them, can go down as well as up and we may not recover the amount of our original investment.
Affordability is a key duty underpinning the borrowing arrangements contained in the Prudential Framework. In practice, some Local Authorities have taken on general fund debt in high multiples of core spending power and viewed it as affordable because of the income their commercial property investments generate. The experiences of coronavirus, seen within the context of already sustained financial pressure, may mean that some Local Authorities (inadvertently) test the limits of compliance.
As Local Authorities have built up their commercial property portfolios there has perhaps been a lag in governance and oversight from Government. In March 2020 HM Treasury launched a consultation containing proposals to (a) require local Authorities that wish to access the PWLB to confirm that they do not plan to buy investment assets primarily for yield; (b) publish guidance defining activities that the PWLB will no longer support; and (c) standardise the information currently gathered through the application process for the PWLB Certainty Rate to confirm with Local Authorities that their plans conform with the guidance. The consultation runs until 4 June 2020 and you can submit responses here.
As we have to get used to a ‘new normal’ Local Authority repayments to the PWLB and other borrowers may start to hurt. Will this lead some Local Authorities to increase taxes or reduce public services?
This is a re-set moment for creating value in retail property
Written by Alex McCulloch for Property Week
Take a moment to look at the havoc wrought in the past few weeks: Debenhams, Carluccio’s, Laura Ashley, Cath Kidston and more have all entered administration or are about to; £7.7bn has been lost in market capitalisation from the top four UK retail REITs; 66% of March’s rent was unpaid; 500,000-plus non-essential stores were banned from trading, and footfall was down 90%-plus.
The tide has gone out and left everyone exposed. The question is: can retail survive the coming months?
The evidence so far is that many companies will not. Of those that have gone under to date, a number had underlying issues, but in the coming weeks, we will likely see failures of businesses that were trading well pre-lockdown.
And do not think it is a case of weathering this storm before returning to normal: in the same way that lockdown has created a ‘new normal’, so the post-COVID-19 situation will be a step-change again, for ours is now a world in fast-forward.
The lockdown has accelerated many of the nascent consumer trends that were already underway; we have jumped forward five years in the space of two weeks. Now the genie is out the bottle, we will not be able to go back. Every aspect of our lives has changed and, with necessity being the mother of invention, we have seen huge upheaval matched by inspiring innovation, often driven by the smaller, more nimble operators.
That combination of consumer acceleration and economic fallout is now forcing retail property to face many of the challenges that had been repeatedly kicked down the road.
Some of these, like business rates, are political. The majority, however, are self-inflicted. Among these, the most glaring of all is how we value the store. A lease structure grounded in 1950s behaviours was already anachronistic, but now it is no longer fit for purpose.
The impact of Covid-19 has been to tighten the focus of consumers: into the local area, into what they put in their baskets and their mouths and which brands they allow into their lives.
Brands that can create that connection and immediate relevance will be the ones that survive and indeed thrive. The store remains the greatest portal to do this, and valuing it accurately should be the top of both occupiers’ and owners’ to-do lists, albeit from very different perspectives.
So how do you bring together two traditionally opposing points of views? Start by equally sharing risk and reward – the heated arguments between owner and occupier can only be resolved if both sides co-operate. This means agreeing objective, measurable terms of engagement and structuring a lease that reflects this with a larger proportion reflective of sales performance.
The owner must deliver both high-quality and high-quantity footfall and prove to the occupier that it is doing so. Evidence of who the shopper is, where they come from and how they are behaving should be fully shared.
In return, the occupier must be open on customer engagement by sharing sales data – not just turnover through the till but also returns, click & collect and online sales within the catchment.
In today’s data-rich world, the insight is available, and where it is not there are third-party alternatives. CACI works with both owners and occupiers, as well as high-frequency datasets, to provide that objective, neutral space where confidential data can be shared without commercial confidences being breached. Having an objective third party applying a pre-agreed methodology allows all concerned to reach a position where the store is accurately valued and future uncertainty and risk reflected.
The new normal will be a world in fast-forward. Those that move with the consumer, co-operate, innovate and engage with one another will survive.
Those that fight the tide are destined to fail.
About Hayven Property Tax
Hayven Property Tax is an independent commercial property tax consulting company who are experts and specialise in capital allowance claims for commercial properties.
Based in Cardiff, Hayven Property Tax are able to service clients across the United Kingdom.