The hunt for cash

Your pension fund could be coming to a council estate near you as property investors and local authorities begin eyeing one another up. The backdrop for the increasing interest in private-public deals is next year’s comprehensive spending review, which looks set to be the toughest for many years.

With the high level of health spending politically sacrosanct and chancellor Gordon Brown’s audacious promise in March’s Budget to bring state school spending per pupil into line with the fee-paying sector, all other government departments face severe cutbacks. Ministers’ lack of leeway is illustrated by the scale of June’s £7.2bn public sector deficit – the biggest on record.

Perry Lloyd, director of Pinnacle Regeneration, says the message that the good times are over has reached town hall housing and regeneration bosses. “I’ve noticed a significant change in the last six to nine months, partly driven by the current spending review. It’s becoming obvious that there’s not going to be the money to do the things that people want to do.” Julie Cowans, policy consultant at the Joseph Rowntree Foundation, agrees:

“The 2007 spending review is going to be tight. There’s unlikely to be sufficient public spending for housing and regeneration for anything other than firefighting.”

Private sector cavalry to the rescue

But while the public sector is facing a squeeze, the chancellor’s minions have noticed that many of the rest of us have been benefiting from the biggest and most sustained property boom in British history. Now the Treasury wants a slice of the action. As well as hoping to net a bigger share of development profits via the planning gain supplement, the Treasury has been exploring how the private sector can cross-subsidise the regeneration of failed housing estates through its mixed communities initiative.

John Callcutt, the recently appointed chief executive of English Partnerships, is keen to see the agency become more financially self-sustaining by recouping a bigger share of the long-term rises in value from the schemes it undertakes. He will have his eye on how the government implements its plan to offload 10% of its property assets by 2010, which should net about £30bn for the exchequer.

Councils are coming under pressure to follow suit and become more self-sustaining. Chris Brown, managing director of pension fund Morley’s Igloo regeneration fund, says: “The government is putting a lot of pressure on councils to get rid of assets and release capital receipts.” However, recently introduced and as yet little used changes to the way councils can dispose of their assets means authorities no longer have to settle for fat, immediate receipts.

Some councils, emboldened by ministerial warm words about upcoming moves to hand more responsibility to local government, are looking at using their assets to establish joint ventures with the private sector. And they hope such tie-ups will deliver not only a financial but also a social dividend.

Credit: Jonathan Edwards

Joint ventures develop regeneration sites

The first such joint venture is being set up in Dudley. The Black Country council, with the help of property agency King Sturge, is setting up a partnership to develop nine strategic sites that have been identified for regeneration in the borough’s main town centres. Another council is close to signing a similar deal. The eight core city authorities are all taking a close look at setting up similar joint ventures. Cowans says this approach is the shape of things to come: “If any public body wants to do anything other than firefighting or something proactive, they are going to have to find different ways to raise cash and that involves private sector investment. The only option is to look at existing assets and how you can use them to lever in investment.”

The land and the loot

King Sturge housing associate Jim Briscoe says: “Many authorities are recognising that they are the most important land holders and the most important strategic players in their area and they are starting to find ways to release value.” Many councils remain significant landowners. King Sturge has carried out an audit of local authority property holdings.

Partner Chris Pratt says: “If you look at the top 100-150 councils, they have got assets that in the private sector would make them medium-sized property companies. But they don’t have the cash or the ability to borrow against their revenue budget. The private sector on the other hand has more cash than it knows what to do with.”

Most councils own significant portfolios in the form of housing, industrial estates and shops. The Blueprint fund, developed by Igloo and the East Midlands Development Agency, has sparked significant interest in town halls. The idea underpinning the fund is that the public sector body transfers its property portfolio into the ownership of the joint venture, which then uses the asset as collateral to borrow cash.

Igloo’s Brown argues that it makes better financial sense, in the long and short term, for public bodies to set up joint ventures than to opt for more straightforward asset disposals.

In the long term, the public sector gets the opportunity to secure a share of the long-term growth in capital values that development can deliver. “If you sell an asset, you get at most current value, whereas if you sell a share of that asset, you are getting a share of a much larger future value,” says Brown.

In the short term, he estimates that authorities can generate up to 40% more in rent from their assets. He adds that co-ownership of the joint venture means councils can ensure that the venture meets their objectives.

Institutions are on the trail

At the same time, pension funds and other investors are waking up to the potential of housing and regeneration as an opportunity. Not so long ago, anything but shopping malls and city-centre office blocks were anathema to the average pension fund property manager. But the oft-cited “wall of money” that has washed into property since the stock market downturn of 2002 means that such investment opportunities have become harder to find and more expensive. The institutions control the biggest slice of that cash. “They [the funds] are much more interested in residential than they ever have been,” says Pinnacle’s Lloyd, who points for a parallel to the increased interest from the likes of Macquarie in companies that own infrastructure projects. Like airports and bridges, regeneration schemes offer the potential for a long-term revenue stream.

They also offer the prospect of an appreciating capital asset.

Credit: Jonathan Edwards

Going for the long-term pay-off

Cowans believes institutional investors are potentially better partners for the public sector than housebuilders, which are wedded to the need to generate short-term cash. “Institutional investors are long-term players who are prepared to ride out temporary blips in the market and local authorities are likely to be interested in the large amounts of money that pension funds have,” she says.

She adds: “Investors in commercial activity are becoming more exposed to residential with the increase in mixed use. And there’s increasing evidence that … over a long period returns from residential are a lot higher than commercial.” Partnerships between local councils and institutions are commonly used in Holland to fund housing projects, points out Cowans.

Lloyd adds: “Within the institutional investment market, there will be unit trusts and investment companies that will be happy to take a lower rate of return. Fund managers have to find stable, secure homes for their money; they don’t look for the sort of returns that a private housebuilder will be looking for. The perception of the private sector is that the money is there and available if the right structures can be put in place.”

But establishing the right structures can be a problem and Igloo’s Brown believes that such partnerships are only likely to interest the biggest councils with the largest and most valuable land holdings. The costs of putting together a £50m and a £2m deal are not substantially different. “I'm not sure how much further it will go than the big cities,” he says.

The unreliable partner

Many developers are understandably wary about getting too closely involved with councils, given the chequered history of relations between the two sectors. Local government has often proved an unreliable partner. St Modwen became the latest private developer to learn this lesson when its deal with Great Yarmouth council foundered.

King Sturge’s Chris Pratt admits that dealing with the public sector can be painstaking. “It’s a political process. There’s often a long lead-in time from introduction to instruction.” The process is often complicated because few councils are awash with top-quality property development expertise. Lloyd says: “There are certain local authorities that we would not do a PFI contract with because we can’t be convinced that they can deliver.”

One way to get round the problem is to buy in expertise. But securing the services of the likes of PricewaterhouseCoopers is not cheap. “Projects like PFI and joint ventures require hundreds of thousands of pounds of spending on consultants just to put together. Have they got the money to buy that capability?” wonders Briscoe. Another problem is that local government remains essentially risk-averse, anxious about the bad headlines that can be generated from any whiff of scandal about how public assets are used.

Igloo’s Brown wonders whether many public sector estates managers hide fears about their jobs behind such concerns. “It’s sometimes difficult to unravel political agendas from judgments about risk. As an individual, if you don’t want something to happen, you will portray it as very risky.”

But despite the recent property boom, it is always important to remember that markets can go down as well as up. Should the prospects for England’s most run-down areas depend on our historically fickle property market?