Local authorities are taking out loans to buy shop premises, offices and business parks despite having little or no investment experience, in an effort to replace revenue lost through government cuts. However, the level of investment is raising concerns that council services would have to be drastically reduced if commercial property prices were to crash.
Councils have paid £2.7bn for commercial properties since 2015, up from £500m over the previous three years. The level of investment is still rising and local authorities have spent over £1.8bn on commercial property in the past 12 months, according to property data firm Real Capital Analytics.
Heavy cuts in central government funding have left the authorities having to consider other ways of easing their financial constraints. Between 2010 and 2015, there was a 37% cut in real terms in central government funding to local authorities. One option has been to borrow from the Treasury-run Public Works Loan Board (PWLB) at very low rates of interest (2.5-3.0%) and then use the money to invest in commercial property ventures that offer returns of as much as 8%.
However, a lot of these property deals are generating far lower yields than that. For example, at the end of last year, Spelthorne Borough Council in Surrey bought one building for £360m, the equivalent of more than £3,000 per resident in the borough, as part of a sale-and-leaseback deal with BP, generating a 4.5% gross yield.