Where is the real risk?

Maybe you are a local authority Finance Director. And maybe you have been investing in commercial property the past few months in order to build a fresh income stream to make up for funding cuts.

Maybe you thought you were doing the right thing spreading your risk geographically by buying outside of your local authority boundary, as well as across market sectors.

Then CIPFA produces its new guidance on commercial property investment, which suggests this is not allowed if you are using external borrowing. If you intend to borrow externally then the 'borrowing in advance of need' rule says you should only acquire commercial property investments within your local authority boundary.

You might now be asking yourself where you go from here?

That was the very conversation I was having only this week with one Finance Director in a UK Local Authority. He was questioning the thinking behind this new guidance, and asking what CIPFA expected local authorities to do. After all, a balanced budget has to be set. Despite the recent local government funding announcement, local authorities remain under as much financial strain as ever. So finding new income streams are essential for some.

It seems that the risk of the borrowing is seen by some as greater than risk of the individual investment or the market within which it is located. For many people I speak with, this is a skewed perspective.

Many appear not to be convinced about that 'borrowing in advance of need' rule, or quite certain of its source or provenance. And many are questioning the increased risk that this creates, and whether those that wrote the guidance have sufficient knowledge and experience of property investment markets to understand the full impact of the advice.

Let us assume you are Bridgend CBC and you have invested only in commercial property in your area. How might the risks associated with those acquisitions have been affected for example by the announcement by Ford last summer that their 60-acre car plant was to close this September.

What is the impact of that plant closure on the supply chain, which occupy commercial space within the area? Will that see other locally based companies go to the wall or relocate? Will that see a negative impact on property values in the vicinity?

Bridgend is of course not alone. We have seen similar circumstances arising with Honda in Swindon and recently with the Michelin tyre plant in Dundee, where a large local employer makes a seismic business decision that has the potential to send shock waves through the local property market.

Not every local town or city relies on a single large employer of course, but plenty do. And the loss of any large employer in any area creates a property risk. Is the chance of an employer closing or relocating increased because of Brexit? I don't profess to know the answer to that.

Some talk of a looming global recession, suggesting that the US economy is over-leveraged on commercial unsecured debt. Some talk about Corvid-19 contributing to a global economic downturn. Then there are the threats of global trade wars. There are all manner of things that could happen to impact property markets.

It must remembered that changes in the global economy are not some far off thing that you never see. It affects local employers and supply chains - and as a consequence local property markets.

When I talk with local authorities or give advice about how they might develop their commercial property investment strategies, I often ask them to think about the money as if it were theirs. When faced with a potential investment, would they put their money into it. When faced with decisions about spreading risk, would they be happy about the risk spread they are adopting, if it were their money. I think this is a pretty good test of risk. Would you want all your property investment 'eggs' in one local 'basket?

Of course there are local authorities that are investing in their local area because they want to use their position to turn an area around, to inject some life into their high street for example, or to influence how their town develops.

There is absolutely nothing wrong with that of course, and if the investment is partly for economic impact and partly for financial return, then this has to be within the local authority's boundary, or at the very least its economic area. One might expect to have a different attitude to risk and return for such investments.

Clearly the risk exposure is different depending on the nature and location of each investment. There are some local authorities (many by accident) that own large parts of their town or city centres. Some of those have identified their over-reliance on property rental returns in their area, and are looking to diversify or re-balance their investment portfolios by shifting to a wider market range and geographic spread. Who could argue that this is not sensible?

So what is the answer? The choice is a stark one, follow the guidance or don't follow the guidance. Both choices contain risks. Your difficult task as a Finance Director is to advise your members and management team, which you think is the most acceptable risk.

Recent reports from the Overview and Scrutiny Management Commission at West Berkshire suggest they have changed their property investment policy, and the new CIPFA guidance has been cited as one of a range of reasons.

Finance people are clever people and I know they will find a way to do what they all know needs doing.