Local councils in the UK are diving headlong into the commercial property market, acting as though they are private sector hedge funds – it’s a role they’re not set up for and they run huge risks.
The reason behind this commercial adventure is the need to fund gaps in their budgets after years of spending cuts from central government. But if the public sector were better at maximising property assets, perhaps it would not need to try such dangerous arbitrage to bridge the gap in funding.
The secret to success in such commercial arbitrage is the skill to manage commercial risk. Local councils are borrowing at rates given by the state funding vehicle that are much lower than private sector borrowers can obtain. Investing that money in property that supposedly will give a much higher yield means local councils are putting significant commercial risk on their balance sheets.
The issues with this kind of commercial activity are similar to those associated with public-private partnerships (PPPs) and private finance initiatives (PFIs). These mechanisms for the public sector to get in bed with the private sector have been criticised since their start in the early 1990s, not only because they have the ability to take what is essentially government debt off the balance sheet, but more importantly, because these arrangements lay bare the inadequacies of public sector accounting and the inability of the government to manage commercial risk.
This inability of the public sector to oversee, manage and negotiate long-term commercial contracts with unknown commercial consequences means that the government often loses considerably. This is followed by political criticism from the public about the use of taxpayer money to enrich the private sector.
Yet local councils have become major investors in shopping centres and other commercial real estate, including the largest acquisition so far when Spelthorne borough council bought BP’s office park at Sunbury-on-Thames for a reported £360m.
Local government is already one of the country’s largest property owners, but also one of the least efficient property managers. The fact that the value of most cities’ public assets exceeds their public debt has been overlooked, because governments seldom have a complete understanding of their portfolio.
Transparency is the key to better management. With a consolidated understanding of the value and breakdown of the portfolio of public commercial assets, it would easier to improve the yield and thereby supplement income from taxes.
Local councils are similar to giant retail firms such as Tesco and Ikea that own vast real estate portfolios. The stock market value of Tesco indicates that investors value it as a real estate developer with a retail operation attached. Just as with Tesco and Ikea, this is why institutionalising a professional management of such a vast portfolio should be the first port of call, including the capacity to manage commercial risk, prior to adding more risk to the balance sheet.
But there are ways manage existing government assets more professionally, and generate a higher rate of return.
Vesting all these commercial assets in an independent urban wealth fund (UWF) would make it possible to use the appropriate tools and framework of the private sector and apply professional management.
A UWF would require a ringfenced corporate vehicle owning all commercial assets at an arm’s-length distance from short-term political influence. However, the government maintains the strategic control of the portfolio, to ensure the economic benefits follow long investment cycles beyond individual election periods. Consolidating all commercial assets under an independent single entity allows the production of an integrated business plan for the assets as a whole and the introduction of transparency at the highest international standard.
Examples where this approach has yielded benefits include the Temasek in Singapore, Hafen City in Hamburg and City & Port in Copenhagen, as well as London & Continental Railways in the UK.
Finding a more efficient way for local government to managepublic commercial assets is clearly preferable to jeopardising the entire public sector balance sheet. Doing so would improve the yield of our vast, and under productive, portfolio of public commercial assets so we can address budget gaps and fund much-needed infrastructure investments, including residential housing.
Dag Detter is the co-author of the forthcoming book Public Wealth of Cities
Sign up for your free Guardian Public Leaders newsletter with comment and sector views sent direct to you every Thursday. Follow us: @Guardianpublic