report to cabinet 29th april 2014 - basingstoke
TRANSCRIPT
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Report to Cabinet
Portfolio Holder Presenting: Portfolio Holder
for Property, Finance & Commissioning
29th
April 2014
Subject: Property and Alternative Investment Strategy
Status: Open
Report Ref:
Ward(s): All
Key Decision: Yes
Key Decision Ref:
Report of: Head of Resources
Contact:
Kevin Jaquest-Head of Resources [email protected]
01256 845513
Mike Bovis-Property Manager
01256 845360
Nicholas Collins –Asset Manager
01256 845350
Appendices:
Appendix 1 – DTZ Review of the Commercial Portfolio
Appendix 2 – Example of De-Levering a Gearing (To follow)
Appendix 3 – PAI Panel Terms of Reference (to follow)
Appendix 4 – EPP OSCOM’s comments – to be submitted after EPP on 23 April 2014
Papers relied on to produce this report
None
SUMMARY
1 This Report
1.1 This report outlines a framework and governance approach for a future property and alternative investment strategy, which includes setting out an approach to enhance property asset management.
2 Recommendation
It is recommended that Cabinet:
2.1 Recommends to council the Property and Alternative Investment Strategy as outlined within this report.
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2.2 Recommends to council the earmarking of £25m of currently invested capital receipts for the ‘property and alternative “invest to grow” investment fund’.
2.3 Agrees the principle of establishing the Member/officer Property and Alternative Investment Panel to evaluate acquisition and investment proposals and to make recommendations to Cabinet.
2.4 Agrees the budget allocation of £250,000 for the appointment of specialist advisors to work with the officer team.
2.5 Notes EPP OSCOM’s comments.
PRIORITIES, IMPACTS AND RISKS
Contribution to Council Priorities
This report accords with the Council’s Budget and Policy Framework, Asset Management Plan and supports the Council Plan priority of improving economic vitality.
GLOSSARY OF TERMS
Term Definition
AMP Asset Management Plan
Ground Lease Property forming the land and which is owned by the council and being the subject of a long lease to a tenant who owns the building on the land.
Gearing This refers to a proportion of an asset’s rent which a ground lease owner is entitled to. e.g 5% gearing would be 5% rent share.
MI Management Information system holding all property and financial records.
De-lever Reduce the level of gearing.
PAIP Property and Alternative Investment Panel
The Commercial Green deal A mechanism introduced by the government whereby energy efficiency investments in buildings can be recovered by payments made over the electricity bill , paid by those who have benefited from the lower bills.
MAIN CONSIDERATIONS
3 Background
3.1 The Medium Term Financial Strategy identifies that the council faces future financial pressures arising from increasing costs, reducing government grant and flat or declining rent and interest income.
3.2 The budget strategy includes objectives to improve financial resilience by increasing future income to support services and council plan priorities and to secure, maintain and develop the council’s capital assets.
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3.3 The Council also has an Economic Master Plan for Basingstoke which outlines how the council will plan for future prosperity, secure investment and ensure that residents benefit from economic growth with improved employment opportunities and enhanced infrastructure.
3.4 The review of the council’s Treasury management strategy identified that up to £25m could be reallocated from cash investment to alternative ‘invest to grow’ opportunities subject to the appropriate business case, risk assessment and to income returns exceeding a minimum investment level.
3.5 The Council has a large commercial property portfolio valued at £227m which generates £15.6m in rental income (73% from ground leases) which supports the base budget of the council. The portfolio is ageing and shows signs of obsolescence. This is most evident at Basing View but affects many other properties within the portfolio. The outlook for future revenue growth on the portfolio is poor, with downside risk in the medium term resulting from:
Investors of a poor/ limited financial standing who hold historic long leasehold interests
Continued ageing of stock impacting demand from tenants. Again, an
example is on Basing View where the office stock is dated and occupational demand for such has been very limited and in some examples non-existent. This has a poor effect on the town’s ability to attract inward investment.
3.6 As outlined further within this report, the view of the market research undertaken by the council’s consultants is that the portfolio requires rebalancing in favour of property which produces direct income as opposed to ground lease income. It is considered that this will improve prospects for rental growth and for investment into the ageing building stock that is prevalent in the borough
3.7 Through improved rental growth and other new income streams, this strategy could enhance the overall delivery of council priorities, either directly or through producing additional funding, which can then be utilised to deliver those priorities. Therefore, the Property and Alternative Investment Strategy and ‘invest to grow’ framework will support the financial and strategic objectives of the council.
4 Property and Alternative Investment Strategy
4.1 The proposed Property and Alternative Investment Strategy has four key strands:
4.1.1 Enhanced Asset management of the existing property portfolio
4.1.2 New commercial property acquisition
4.1.3 New Housing and regeneration alternative investment
4.1.4 New Renewable (green) alternative investment
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4.2 The work undertaken by the commercial investment agents DTZ (attached in Appendix 1) identified that the council should be looking to pro-actively manage its commercial property portfolio.
4.3 They advise that there are inherent risks attached to holding the current number of ground leases in their current form. The high gearing in some ground leases, the growing obsolescence in the portfolio and the current state of the property market mean that many ground leases are a threat to BDBC preserving and growing its current level of rental income.
4.4 Very little turnover has occurred in the portfolio and as a result, much of the stock is of a similar age, needing investment to upgrade to modern standards. The ground leases are moving towards a time when head lessees will become more inclined to seek renegotiation given reducing lengths of term and are unattractive to the investment market. The historic gearing arrangements can be seen as a barrier to new investment in some of the properties and will need to be addressed to meet current market conditions as situations arise.
4.5 The Property and Alternative Investment Strategy proposes the following strands of future enhanced asset management activity:
4.5.1 Look to rebalance the council’s exposure to ground lease income over time. This will enhance potential for medium and long term revenue growth and give the council greater control of its investments and improve perception of Basingstoke with other real estate investors.
4.5.2 De-lever selected ground lease investments so that BDBC high gearing does not stifle future investment e.g. Basing View and Viables. An example of how de levering works is illustrated within Appendix 2. This could reduce risk, encourage investment and will also improve perception of Basingstoke with other real estate investors. It is acknowledged that this will take considerable time and will need to be done in a planned risk assessed way given the council’s reliance on the ground lease income. Progress on this will depend on the success of the move towards investing in more directly managed property and having financial policies and reserves in place to manage the revenue implications.
4.5.3 Reduce exposure to low value and low income properties, only retaining those where there is a genuine requirement for the council to retain ownership for social, economic and/or policy reasons.
4.5.4 ‘Invest in the Core’ of the town where possible, invest funds to provide more cohesion between the town centre, the railway station and Basing View and to improve the vitality of the town.
4.5.5 Invest in directly managed income producing industrial properties to provide medium term income and potential for capital growth. Where possible, make investments that are consistent with site assembly objectives of ground lease re-structuring.
4.5.6 Co-ordinate the implementation of the above initiatives to protect short term income.
4.5.7 Analysis of the existing property portfolio into the following broad categories;
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Investment Property where the prime objective is to provide income to the council. An example of this would be a ground lease in Houndmills or Malls shops. For investment the council will always seek to let at full market value, behaving as a responsible, long term, commercial landlord
Operational properties held for the delivery of services. An example would be the council offices and depots
Legacy investment property where the holding of such provides a socio economic service. An example of this would be Attwood Close mobile home park
Land for development and regeneration. Examples would be Manydown, Basing View and the Leisure Park, all of which have land to be developed
Strategic property (as opposed to vacant land) held for regeneration purposes. An example of this would again be Basing View.
4.5.8 The property portfolio will then be segmented into sub-sets that will drive asset management activity on the following indicative basis;
Hold – no action. This is for properties generating a good income yield relative to their risk profile or for properties in a strategic location where there is limited opportunity to improve income returns.
Hold – asset management opportunity. This is for properties where proactive management intervention, possibly including some capital investment, will result in an improvement in income and/or capital value or could result in a reduction of risk.
Hold – address ownership structure. Will mainly relate to ground lease properties and the need to either sell the freehold interest, de-lever the ground lease income or acquire the long lease interest.
Divest – active disposal. Properties identified for disposal but where an asset management or other initiative prior to disposal will result in an uplift in proceeds realised.
Divest – disposal. Straightforward disposals where properties should simply be divested through the most appropriate channel.
4.5.9 Improve operational management of the property portfolio. This will involve the formalising of the commercial estate strategy in a written document, establishing appropriate governance arrangements to improve the efficiency of decision making and the implementation of a robust and reliable management information system that will deliver relevant and timely outputs.
4.6 A key element of the property and alternative investment strategy is to invest in new assets. The purpose of new acquisitions is mainly to generate income to support council services and priorities and/ or, for the improvement and development of the Borough, however in some cases investment may also offer the potential to unlock future development or regeneration opportunities.
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4.7 The council has already taken a pro-active approach to using property assets to drive economic regeneration and has previously invested in The Mall’s acquisition and refurbishment; the provision of a new doctor’s surgery in South Ham; new facilities at the Leisure Park and investing in the regeneration of Basing View.
4.8 The following criteria will be used to inform decisions as to whether property should be acquired, based upon both financial and strategic reasons and the potential acquisition will be considered against:
a) The financial return generated and which must achieve a positive net return and as a minimum would provide a greater return than that achievable by cash investment over the medium term.
b) The potential of the purchase to contribute to strengthening the Borough’s
economy.
c) The potential to consolidate the Council’s existing land holdings portfolio to facilitate larger developments.
d) The potential to modernise the Borough business infrastructure and/or will
encourage inward investment, relocation and business start-up within the Borough, promoting both skills and the local economy.
e) The support provided to the council’s plan and its key priorities. f) Contribution towards the council’s Economic Master plan – “2033-A Master
Plan for Success” g) Acquisition will not increase the council’s long term ongoing revenue costs h) Each investment will need to be looked at on its own merit and will be
subject to appropriate business case assessment, risk assessment and due diligence.
4.9 A tool kit has been developed in conjunction with DTZ to assess the merits of a purchase taking into account such parameters. It is acknowledged that a potential acquisition may not meet all of the above criteria. The rate of return required would be considered on a case by case basis having regard to both the inherent risks of the opportunity and the objectives that would potentially be achieved by the council’s intervention.
4.10 To date consultants have only been appointed to look at the commercial
property portfolio and hence the detail above. A similar approach will be required for alternative Housing and renewable investments.
5 New Housing and Regeneration Investment
5.1 This strand of the proposed strategy would enable the council to consider appropriate investment options in support of the provision of housing in the borough.
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5.2 Types of initiative that are being developed by other councils include;
Establishing a council owned company to acquire a portfolio of homes to provide rented accommodation to ease homelessness pressures.
Establishing a council owned company or joint venture to deliver private and affordable rent properties on council owned land.
5.3 Further detailed research and assessment will need to be undertaken to identify appropriate potential options that could be available to the council.
5.4 The following approach could be used to initially assess proposals:
a) Each proposal will need to be considered on their own merit and would be subject to appropriate risk and business case assessment and due diligence.
b) Proposals would need to deliver a positive net return and as a minimum provide a greater return than that achievable by cash investment over the medium term.
c) Support delivery of the Council Plan housing priorities
d) Support delivery of the council’s Housing Strategy
e) Further criteria need to be established following research and analysis
6 New Renewable (green) alternative investment
6.1 This strand of the proposed strategy would enable the council to consider appropriate investment options in renewable initiatives.
6.2 Renewable energy products could provide opportunities for future investment, meeting both economic and social objectives. The scope of investment “products” would need to be carefully investigated and the work via the GreenFit project in Basing View during 2014 will help provide a better understanding of the opportunities via the feasibility work on energy production.
6.3 The scope for investment in renewables could include for example;
Combined heat and power on a district or part district basis – A feasibility study is being undertaken for Basing View via the GreenFit project. Manydown could also, with the scale of the development, be appropriate for investment in renewables
Solar energy generation
Commercial “green deal” investment
Retro-fit/low carbon investment - the installation of energy efficient measures in existing buildings (eg plant upgrades, monitoring and control systems, Solar photovoltaics etc)
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Energy performance contracts – the use of a third party to assess council buildings, then design, install and maintain agreed energy efficient measures based on a contract and guaranteed energy savings, which could repay the project investment. This could include investing the council’s own capital to fund projects and receive the savings as an investment return
Consideration of a more structured “energy” fund approach harnessing broader investment in non-domestic energy efficiency and renewable energy products
6.4 The criteria for assessing investment would consider the payback and meeting the minimum investment return requirement. Further work is required to evaluate the opportunities which will help devise the necessary detailed investment criteria.
7 External Advice
7.1 Implementation of the Property and Alternative Investment Strategy will require addition external expert and professional support.
7.2 In particular, it will be necessary to appoint external agents to support the council with market intelligence and the identification of suitable commercial property acquisition opportunities.
7.3 Property investment advisors, legal and financial specialists, including taxation advice will also be required.
7.4 Significant further work will be required for the council to understand the options for potential Housing and Renewable alternative investment opportunities and to produce initial business case and return analysis. This will require external support yet to be scoped. The external technical advice will support the officer team and assist in the delivery of robust projects that could generate significant future income streams for the council.
7.5 Therefore it is also proposed that additional expert temporary programme/project management support is identified to work with the officer team so that these alternative investment areas can be taken forward in a planned and timely way.
8 Governance
8.1 All investment proposals will need to meet the agreed investment criteria and be within the legal powers of the council.
8.2 To ensure an appropriate and responsive decision making process it is proposed that a cross party Member Property and Alternative Investment Panel (PAIP) is established to consider significant (those outside existing delegation levels) property acquisitions and alternative investment proposals from the officer strategic property group and provide advice to the Portfolio Holder and Cabinet on investment proposals. Terms of reference for PAIP are attached as Appendix 3.
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8.3 The officer team, with consultant advice as necessary, will undertake the appropriate option appraisal and business case assessment and make recommendations to the PAIP.
8.4 It is proposed that following the briefing and due consideration of such by the PAIP for a property acquisition, officers are given delegated authority to express an interest/negotiate subject to formal approve and sign off by Portfolio Holder/Cabinet. This will enable a timely response to be provided, in often limited periods of opportunity.
8.5 The PAIP will meet as required and this may be at short notice given the limited timescales often afforded by the property market to be made aware of potential opportunities, evaluate and provide its feedback as part of the process in reporting to Portfolio Holder/ Cabinet. Given the time constraints, as outlined, it is recognised that the Council may have to make use of its emergency decision making process in some instances.
8.6 For alternative investments, a similar approach will be followed utilising the PAIP but it is less likely that urgent decisions may be required given the nature of the assets and investment.
8.7 It is proposed that half yearly Cabinet reports on portfolio/project financial performance will be produced.
8.8 A flow chart of the proposed decision making process is set out overleaf;
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9 Financial Implications
9.1 The primary objective of the strategy is to use the council’s financial resources to invest in income generating assets to support the council’s long term financial planning, contribute to a balanced and sustainable medium term budget and contribute to improving or developing the economy/area of the borough.
9.2 All investments will require a robust business case to ensure that the investment is affordable, sustainable and provides value for money. Risk will need to be appropriately managed and mitigated where possible through a thorough governance process.
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9.3 Cabinet will need to ensure that full due and proper consideration is given to the balance achieved between risk and reward and the underlying security of the investments proposed to ensure that the financial standing of the council is protected.
9.4 It is proposed that Cabinet request Council to earmark £25m of currently invested capital receipts, as identified in the Treasury Management strategy review, to establish the Property and Alternative investment fund.
9.5 All investments will need to demonstrate a positive risk based financial return in excess of the medium term cash investment return as currently invested capital receipts (the interest on which is supporting the base budget) will be used to fund the schemes approved under the strategy.
9.6 The Council will need to consider changes to its current financial policies to identify and earmark revenue resources to enable future lease restructures to occur in a planned way. This will need to be considered as part of the 2015/16 budget process.
9.7 It is recommended that up to £250,000 is released from the ‘invest to grow’ revenue reserve to enable the appointment of Property advisors, professional support and recruitment of a temporary project/programme manager.
10 Legal Implications
10.1 Section 120 of the Local Government Act 1972 gives councils the power to acquire property by agreement for the purpose of any of its functions or for the benefit, improvement or development of the area.
10.2 S.1 of the Localism Act 2011 enables a local authority to do anything that an individual generally may do(subject to prohibitions, restrictions and limitations in existing statute), known as the general power of competence.
10.3 The council also has the power to invest for purpose of the prudent management of its financial affairs under Local Government Act 2003
10.4 If the Council was to undertake commercial trading activity it would be required do so through a company formed under the Companies Act 2006 or a society formed under the Co-operative and Community Benefit Societies and Credit Unions Act 1965. A company may be required if it is the most suitable or required method of delivery for a particular project for example: a) Joint venture company with a partner eg for delivery/purchase of housing b) The council must establish a limited company to trade commercially eg some forms of private sector housing, energy trading
10.5 Each proposal coming forward under the strategy would need to be assessed to ensure that it is within the legal powers of the council before funding was made available.
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11 Risks identified
11.1 Each individual opportunity will require a full risk assessment that will be considered by the Property and Alternative Investment Panel.
11.2 In respect of property transactions an assessment of risk will include the following inter alia:
a) Acquisition Risk – there is always the potential for a downturn in the
property market at some point in the future with less institutional activity, but there may be signs of increased competitive activity from smaller property companies. This could result in the Council being one of several bidders for any good quality assets available in the Borough. It is likely that the Council will be an unsuccessful bidder on a number of occasions. The Council, both Members and officers need to be aware of this possible outcome.
b) Timing – decisions may need to be taken quickly in order to put offers
forward. Offers can be subject to conditions and will be subject to due diligence being undertaken before proceeding to acquire.
c) Cost Risk – abortive costs, including legal costs, survey fees, and officer
time all may be incurred in abortive transactions including costs for initial feasibility investigations but are inevitable if commercial acquisitions are considered important for the ongoing financial stability for the Council.
d) Lack of suitable sites - The local property market is restricted in its size
geographically. There may therefore be a shortage of suitable stock in the Borough ultimately despite DTZ’s view to the contrary.
e) Property Market risk - property is an inherently riskier asset than other
asset classes because of its physical characteristics, which need to be managed and maintained. This is ideally compensated by increased returns. However, the property market is not a certain market and the Council may not achieve target returns if market conditions significantly worsen. Ground leases have historically been seen as low risk investments when compared to directly owned property investments. Greater exposure to directly managed property will therefore raise the council’s exposure to risk, albeit with an enhanced level of return/ income.
f) Void Risk - close management of the asset portfolio is critical to the
success in delivering additional income to the Council. The existing arrangements will be extended to cover these assets and marketing of the assets in a timely and efficient manner is crucial.
g) Market Information - Many investment transactions happen prior to
even coming to the market. Information is vital and getting to know about properties for sale is important. This can be done through contacting property owners and agents in the Borough proactively and market knowledge is crucial. Appointing agents will help to mitigate this risk.
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11.3 Appropriate risk assessments will be required for the alternative investments and this is an area which will need to be developed using external advisors as appropriate.
12 HR issues
12.1 There may be a requirement to appoint temporary project/programme management staff.
13 Equalities
13.1 As this stage no equality impact assessment has been carried out.
14 Consultation
18.1 The findings of the DTZ and officer study have been presented to members at group meetings and were the subject of a Member workshop on December 5, 2013. The paper has been reported to EPP OSCOM on 23rd April 2014 and that committee’s comments are attached within Appendix 4.
15 Conclusion
19.1 The council has been pro-active in recent years in identifying investment opportunities and enhancing its property income profile through the “Invest to Grow” scheme. The proposed Property and Alternative Investment Strategy is intended to both further this work in identifying additional investment opportunities, whilst addressing the asset management issues identified by DTZ review.