Highly Leveraged Commercial Real Estate Bets that UK Local Authorities Took to Meet Budget Shortfalls Begin to Unravel

With impeccable timing.

For the last two years, KPMG has refused to sign off the accounts of Spelthorne borough council, a tiny local authority on the outskirts of London that has taken on huge amounts of debt to buy more than £1 billion of commercial and residential property, it has been revealed. The council has an annual budget of just £22 million, yet it has amassed more commercial property than just about any other local authority in the UK, all of it debt financed.

Between 2016 and 2018 Spelthorne borrowed £1.17 billion from the Public Works Loan Board (PWLB), an arm of the UK treasury that is supposed to offer relatively cheap loans to councils for building new schools and other civil projects. But many councils have begun tapping the funds for speculative property investments instead, as a means of supplementing their income.

In correspondence seen by the London Times, KPMG raised “material concerns” about three purchases Spelthorne made in 2017-18 in which it allegedly ignored rules that forbid councils from borrowing purely to make a profit on subsequent investments. These investments significantly increased the council’s exposure to risks in the property market, though it insists it is not endangering funds, with this flawless argument:

The Council is not risking council taxpayers’ cash to buy commercial properties; the low cost government funding for this strategy comes from the financial markets.

KPMG is not convinced and has said it may even take the council to court. Spelthorne recently replaced the big four firm as its auditor with BDO, which rents office space in a building that Spelthorne bought in September 2018 – a purchase that BDO was supposed to assess as part of the council’s 2018-19 audit. According to the auditor, auditing its landlord poses no conflict of interest.

Spelthorne’s investments include a research center in Sunbury it bought from BP for £385 million in 2018. It was the most expensive property investment ever made by a UK local authority. Its second most expensive asset is 12 Hammersmith Grove, an office building in West London that cost £170 million. The building’s tenants include WeWork, which recently persuaded Spelthorne to defer its rent for 18 months, resulting in a £4.5 million short-term loss to the council.

But that’s a drop in the ocean compared to the scale of the losses Spelthorne could face if KPMG were to take the “nuclear option” of taking the council to court. If the court were to rule in KPMG’s favor, Spelthorne would probably have to divest its properties. That could end up bankrupting the authority, a senior figure within the council told the Bureau of Investigative Journalism:

“Supposing the council has to sell the properties and repay the Public Works Loan Board. The cost of [early] repayment is massive – someone told me it’s as much as 30% on top of what we borrowed. And then you’re trying to sell properties into a Covid-related commercial market. It would bankrupt the council. There’s no doubt about it.”

A ruling against Spelthorne would not only put at risk the council’s entire £1 billion investment portfolio but could also have serious knock-on effects for dozens of other local authorities across the UK that have also borrowed heavily to fund property purchases, as well as other speculative investments.

Many of these cash-strapped councils invested in the commercial property market in order to offset recent spending cuts forced upon them by the central government. In 2018-19 alone, councils across England and Wales spent £6.6 billion acquiring offices and struggling shopping malls nobody else wanted – more than ten times the amount spent in the previous three years.

A recent inquiry by the Public Accounts Committee into local authority property acquisitions accused the government of turning a blind eye while councils ignored the rules and borrowed heavily to fund property binges. The Treasury said it would put an end to such practices, but has yet to deliver on the threat, reports the Bureau of Investigative Journalism.

Many other councils now face the prospect of big losses on their property bets. The Office for Budget Responsibility (OBR) has warned that the price of offices and commercial buildings across the country will fall by nearly 14% this year.

Continue reading the article on Wolf Street

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