Question

Page 65 of the Medium Term Financial plan approved in February shows new income generation of £150,000 in 2019/20, £850,000 in 2020/21 and £1,350,000 in 2021/22 arising from the purchase of commercial assets.  The Council set up a property investment fund of £100 million, and page 80 of the Medium Term Financial Plan shows that it is planned to invest £55 million in such property in 2019/20, which coupled with the money already spent indicates that the whole £100 million is planned to be spent by the end of the next financial year. 

When I do the maths, this new income on new spending is a return of 0.2% in the first year, 1.1% in the second year, rising to a maximum of 1.8% in the third year.  The current inflation rate is 2.5% so, even at its best, the return is less than inflation, leading to the conclusion that this is a bad investment. 

It is possible for ordinary people to get a more-or-less risk-free rate from banks of around 1.5%.  However, commercial property investing is not risk free so one would expect a much higher return for the risk of the venture.  This evidence, too, points toward this being a bad investment.

How can the Council justify investing in risky commercial property with such a poor return, at a time when all the advice seems to be that the high street retail is very risky?

Page 65 of the Medium Term Financial plan approved in February shows new income generation of £150,000 in 2019/20, £850,000 in 2020/21 and £1,350,000 in 2021/22 arising from the purchase of commercial assets.  The Council set up a property investment fund of £100 million, and page 80 of the Medium Term Financial Plan shows that it is planned to invest £55 million in such property in 2019/20, which coupled with the money already spent indicates that the whole £100 million is planned to be spent by the end of the next financial year. 

When I do the maths, this new income on new spending is a return of 0.2% in the first year, 1.1% in the second year, rising to a maximum of 1.8% in the third year.  The current inflation rate is 2.5% so, even at its best, the return is less than inflation, leading to the conclusion that this is a bad investment. 

It is possible for ordinary people to get a more-or-less risk-free rate from banks of around 1.5%.  However, commercial property investing is not risk free so one would expect a much higher return for the risk of the venture.  This evidence, too, points toward this being a bad investment.

How can the Council justify investing in risky commercial property with such a poor return, at a time when all the advice seems to be that the high street retail is very risky?

Answer

You refer to the Medium Term Financial Plan which estimates on a deliberately very cautious set of assumptions around investment income achieved during the plan period.  The very nature of the property investment market, being opportunistic and unpredictable, does not lend itself to precise planning of property acquisitions and income profiles.  Therefore it is to be expected that any interpretation of these cautious income assumptions would lead the questioner to arrive at a very low rate of return – way below the rate that has actually been achieved on property acquisitions to date and indeed below the rate of return on pure cash investments.  The investment principle therefore is to make a net return over and above the cost of capital.  This net return or surplus is then available to fund the escalating cost pressures, such as inflation, faced by the Council.

The Council’s Investment Policy requires a positive margin of at least 2% over Public Works Loan Board debt cost at the point of allocating funds.  This provides a prudent risk and Minimum Revenue Provision margin. So far all our purchases have shown a significantly wider margin; our current running yield on total acquisition costs is just over 6.5%.  Plans are in hand to balance this risk profile by allocating a portion of the funds to lower yielding assets, just above the margin threshold to increase diversity and security.  The other point I would make is that we are not necessarily investing in high street assets and therefore the issues of risk that you refer to around that are actually not relevant to this portfolio.

Supplementary Question:

Who is advising you on these investments?

Supplementary Answer:

I think the answer to that is a range of professionals.  We have an in house professional who is extremely skilled in this sort of investment, having being involved in both the commercial sector and working for Wokingham Borough Council for probably the last 30 to 40 years.  He is extremely professional and extremely capable and I have complete confidence that he will not lead us astray.