The commercialisation of Uttlesford District Council’s revenue stream, through £300mn of real estate investment, radically alters the nature of the local authority’s relationship with residents – and exposes public services to massive commercial risks at a time of economic crisis.
Authorities like UDC are looking to offset the devolution of austerity from central government to local government through making commercial investments funded by massive borrowing. UDC is targeting borrowing of £250mn in this year alone on a desperate spending spree with little transparency or accountability – or any training or guidance in commercial investment.
Local government as a whole is facing an existential crisis with the double-whammy of Tory austerity measures and the diminishing of revenue streams – such as business rates and parking charges – due to the coronavirus pandemic. Piling on top of these national problems is the £3mn cost of restarting UDC’s local plan process and setting aside the council’s £1.66mn strategic investment fund fight Stansted Airport in a planning appeal that it has a risk of losing.
The council has responded, like so many others, by taking out enormous loans to invest in real estate, with no guidance or training and no oversight. The risk of councils going bankrupt is very real.
Uttlesford Embraces Rentierism
The council’s “investment fund” is a misnomer. It is not a fund, it is a commercial portfolio that is intended to pay out dividends in lieu of funding from the tax-payer. This is a very unusual method of public sector financing that is largely seen in rentier states like Nigeria, which rely on income from one commercial resource.
Rentier states are characterised by poor standards of governance, corruption and bad economic management. Yet, rentierism is the path local authorities are embracing with evangelical enthusiasm – and some prodding by central government.
The council is ignoring the normal practice of building an investment fund. An institutional investor would seek to hedge risks, it would set a benchmark that it would seek to beat, it would be looking at how to reinvest excess returns, and would know when to liquidate an asset to achieve maximum dividends and overall AUM.
A sovereign fund would have a mission and around that it would establish its strategic asset allocation across fixed income, public equities and alternatives – not one sovereign fund in the world has a real estate allocation above 25% of assets under management. It would give mandates to external asset managers, invest in mutual funds, and look to generate in-house expertise. UDC has not carried out any such exercise, because this isn’t an investment fund – it’s the commercialisation of revenue.
The council’s “investment board” is not a board at all, it is a cabinet working group comprised almost entirely of local politicians and reflecting a political mix – it is a political creation. For residents, this means a small number of unskilled amateurs are making crucial decisions on the council’s funding source over the next 40 years – in total secret and with no public discussion.
You Might as Well Face It, UDC is Addicted to Debt
The strategy of leveraged investment is high risk even for institutional investors, let alone rural councils long dominated by small town Trumpton blowhards.
American tycoon Warren Buffet, in his 2010 Berkshire Hathaway shareholder letter, summed up the risks of this model of investment: “When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade — and some relearned in 2008 — any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.”
UDC is addicted to leverage. After a couple of years of earning a fairly modest return from a £50mn investment in the Chesterford Research Park, it is now rapidly snapping up shopping centres, warehouses, hotels and other commercial real estate – at the beginning of the deepest economic crisis since the Great Depression.
If the strategy pays off, it can cushion public services from economic headwinds and the axing of central government support. The Covid-19 pandemic demonstrates that there are no certainties in life and trends will radically alter over the 40 plus years investment period UDC has committed to.
Moreover, the projected income from the assets the council has so far agreed to invest in will not bridge the yawning deficit created by the perfect storm of austerity, pandemic and local planning policy failure – problems that were not, in fact, caused by the current administration. So, the council has set an eye-watering target of £300mn of leveraged investment – 20 times its annual income, which far exceeds income multiple that lenders insist for a household mortgage.
R4U’s Asset Allocation: More of the Same
The trajectory taken by the R4U administration contradicts the stance it took before winning the May 2019 local elections
The previous Conservative administration started the council’s investment drive by lending tens of millions of pounds to a special purpose vehicle, Aspire CRP, to acquire a 50% stake in the Chesterford Research Park. The objective was to earn an income from the spread between the low-interest loans it took out at a fraction of a percent to lend to Aspire and the 4.5% interest paid by Aspire CRP.
The arrangement was not without controversy with critics, including R4U as well as myself, pointing out the severe risks and the significant lack of accountability and transparency.
Ahead of last year’s local elections, R4U drew attention to the £3.3mn loss incurred in Aspire’s stake in the Chesterford Research Park as a result of asset revaluation. Cllr Neil Hargreaves, who now oversees the council’s finance portfolio, said at the time, “The same property company owned by UDC was also insolvent last year and UDC had to issue a formal statement saying it had enough cash to carry on trading. This is not the way a council should be run. It is time for a wholesale change at UDC, with stronger governance over the council’s investments and better transparency.”
Pointing out the risks to local public services, Cllr Hargreaves said the focus on real estate investment was “a very large concentration in one asset and in one business sector. Commercial property generally provides a stable income, but it is illiquid. If you need your cash back quickly you can’t have it.”
Cllr Paul Fairhurst – then an R4U councillor – went further, saying the investment scheme “exposes the council and residents to huge financial losses … The way the current UDC administration has managed its current investment portfolio is risky and unacceptable. They are gambling with residents’ money.”
With a gearing ratio dangerously exceeding 100% and a new administration elected on the basis of its scepticism over the council’s commercial investments, you would expect some thought leadership, some critical evaluation and improved stewardship.
Yet, UDC under R4U is still wedded to direct investment in one asset class, regardless of the massive risks facing the economy and potentially bigger losses in asset value than incurred with the CRP. Although the council is banned by the government from borrowing to invest in public equities due to the speculative nature of such investment, the range of opportunities being presented to council by the “investment board” is limited perhaps due to the lack of experience and limited horizons of local government officers and councillors. UDC has not followed other councils in appointing an investment officer, instead drawing on the time of the finance director when he also faces multiple challenges posed by Covid-19 and economic crisis.
In its leveraged real estate buying spree, the council agreed in July to plunge £39.5mn of our money into logistics property in Gloucester, a £20mn property in Bracknell and a £5.5mn property in Rotherham. Together, these are projected to earn annual revenue of more than £3.7mn. The exact details, even the type of properties, are being kept from the public due to “commercial confidentiality”. I understand that not one councillor has visited any of these properties and the council is heavily reliant on market information provided by the brokers that are selling the properties. It is a leap into the void.
The only nod to diversification has been in allocating investment to other parts of the country, in order to prevent council finances from being overwhelmingly tied to the local economy. But industrial estates and shopping centres remain a municipal obsession.
Private equity, infrastructure, co-investments with other local authorities, investment in mutual funds with exposure to different asset classes, and perhaps moving towards a fund-of-funds or sovereign investor have not even been explored. An example Uttlesford could pursue with other authorities is an entity such as the Local Pensions Partnership which last year began pooling the real estate assets of UK local authority pension schemes into a fund that is expected to reach £2bn.
There is also no attempt to hedge positions to limit the impact of any decline in asset performance or value in the core portfolio, which opens up the fund to sectoral shocks. Perhaps it all comes down to a matter of pride among councillors and officers who enjoy the opportunity to become amateur investment bankers and don’t like to talk beyond a cosy club of councillors.
Investment “Board”: A Political Concoction, Not a Strategic Investor
R4U has not only stepped away from its pledge of diversification of the council’s commercial portfolio, it has reneged on its pledge of appointing a committee of independent advisors.
After winning control of the council after the May 2019 election, UDC leader Cllr John Lodge created the “Investment Board” – in reality, a working group of councillors – “to specifically increase governance and transparency. It is also tasked with reducing the risks associated with the Council’s investment activities.”
While it is a step-up from nothing, the board falls short of the “much stricter controls, an independent investment committee, and a properly balanced portfolio of investments” promised ahead of the election. Just two independent members have been appointed.
Despite a pledge for one of the independent members to head the investment board, council leader Cllr Lodge remains the “interim” chairman – perhaps until all the capital is deployed!
As the then-R4U councillor for Newport Joanna Parry stated in relation to the council leader’s chairmanship of the local plan working group under the previous Tory administration, “it does not seem good practice for the Leader of the Council to be a member of a working group (which reports directly to the Cabinet), let alone Chairman of it. He will be reporting to himself!” The investment board’s management is “more of the same”, rather than a new approach promised to the electorate last May.
When capital is fully deployed, the group will have no strategic function as there is no political desire for active management that would entail exits from investment on maturity of asset value (which is not the same as maturity of the loan used to buy it). It will be like every other local authority working group – a place for councillors to bloviate and puff their chests over free tea and biscuits while officers do the actual work.
Bankruptcy and the End of Local Government
While the UDC investment board’s governance and strategy could be vastly improved, it may never be enough to stave off a financial crisis that is set to spread throughout local government in England. The Treasury gives little guidance, support or training.
The Treasury has said: “Our starting point is that local authorities should invest public money in regeneration, housing and delivering services, not in speculative commercial investments which can put local and national taxpayers at risk.”
Yet, UDC and other councils continue their dangerous and risky investment programmes, risking a Northants situation being replicated across the country, because they don’t have the skills, experience or support to do anything else.
But what does it say about local democracy? With reliance on one commercial sector, a rentier state looks away from the people. The fiscal bond between tax-payer and authority is summed up in the American Revolutionary battle cry “No taxation without representation”. The equation can be turned around – no representation without taxation. Privatisation of the council finances, requiring important decisions to be taken in secret, removes citizens from the process.
Who are councillors answerable to: the people they were elected to serve or the businesses whose performance determines council income?