Corporate Report Format To the Chair and Members of the Cabinet Property Investment Fund Relevant Cabinet Member(s) Councillor Joe Blackham Wards Affected All Key Decision K1297 1. EXECUTIVE SUMMARY 1.1 As part of the 5.05m Asset Transformation savings, 450k has been identified as being from increased income generation. Whilst some income increase has been identified from the current leased portfolio the majority of this income will need to come from new property investment and a realignment of the current portfolio to create a commercial investment portfolio for long term income. These assets will provide a more sustainable, less management intensive income stream as well as investing in Doncaster s future with the people of Doncaster benefitting from the regeneration and increased value of property over the coming years. 1.2 The Cabinet are asked to consider the following proposals and agree to the setting up of a 4m fund with delegated decision making authority to the Property Investment Board: Proposal: This proposal outlines the basis for a 4m fund to be created through: Funding provided through reinvestment of capital receipts from disposals in the current portfolio ( 2m funding to be considered as part of this report). Capital Programme allocation ( 2m funding to be considered as part of budget setting 2016/17); The Fund: The fund will be based on core investment targets and risk management. This will include: Targeted Returns of 7% for the total portfolio (c. 280k revenue); Investment range between 5% & 12% (hurdle rate for consideration 5%);
Clear risk management through a balanced portfolio approach and link with the Investment Policy and strategy for the organisation as a whole; Policy for Asset Investment & Due Diligence process; Clear Governance in decision making (The Property Investment Board) & Reporting to the Executive Board (initially 6 monthly) see Annex 2 for membership details; 1.3 With properties in the investment market moving quickly it is requested that a fund be made available for drawdown to enable the team to take advantage of opportunities in the market. Each proposed acquisition will be reviewed via delegated authority to the Director of Finance and/or Property Officer (Director of Regeneration and Environment) within the Property Investments Board. 1.4 There are clear examples where Councils have been investing in property in their areas creating income to bring sustainable and self-generated income to the Council and less reliance on traditional funding. Good examples are backed by clear policy guidance on investment and management. 1.5 The proposal focusses on the income or yield produced from the investment. It should be noted that the properties invested in will also retain a value. Current projections suggest that over the long term these properties will increase in value providing an increase in the capital value of the investment as well as the investment return. It should be noted that there is a risk that the capital value could fall reducing the capital returned on disposal. 1.7 Further to legal advice the investment will use internal funds from the capital programme and Capital receipts from property disposals. QC advice was taken further to the planned use of the IMF fund with the advice outlining the need to set up a separate company when using borrowed funds. This paper outlined the first phase of investment. Once complete a further review will take place to consider if further investments should be made through a company setup (further consultation will take place at that stage) 1.6 The Board are asked to consider the outline principles in this paper and confirm support for the setting up of a fund and Policy to support Commercial Property Acquisition/ Investment for income generation.
EXEMPT REPORT 2.1 N/A 3. RECOMMENDATIONS 3.1 It is recommended that Cabinet agree the principles of the setting up of a fund for property investment with a total fund of 4m and allocate the first 2m to the project (with the second 2m to be considered as part of the 2016/17 budget setting process) 3.2 Agree for the Assets team to progress with a detailed process and policy to be signed off and agreed by the Director of Finance & Corporate Services and Property Investment Board. 3.3 Delegate authority to the Property Investment Board to make individual decisions on assets purchases. WHAT DOES THIS MEAN FOR THE CITIZENS OF DONCASTER? 4.1 For the Council to invest in property in Doncaster will show a commitment to improving economic conditions and regenerating the Borough. The Council will benefit financially from capital values and revenue returns improving which will in turn reduce pressure on budgets and services over the medium to long term. 4.2 The investment strategy will link directly to the regeneration plans for the Borough again ensuring that the Council and people of Doncaster benefit for the long term both socially and financially. BACKGROUND 5.1 As part of the 5.05m Asset Transformation savings, 450k has been identified as being from increased income generation. Whilst some income increase has been identified from the current leased portfolio the majority of this income will need to come from new property investment to create a commercial investment portfolio for long term income. Without investment back into commercial property this target of 450k will not be achieved. 5.2 5.3 An initial review of the market has shown that commercial investments are providing a yield of c.5.5% to >10%. The initial review has looked at an investment range of 200k - 1.4m covering retail, office and industrial investments on the open market. It should be noted that investments for the fund will be purely based in Investment returns and the criteria will not change to support strategic/ regeneration purchases, however, the strategic objectives of the Council will be considered as part of the selection criteria for investments. Any investments must meet the basic criteria for the fund.
5.4 Investment returns: There are two elements of investment return to consider: Rental Yield Capital return When weighing up an investment the rental yield will be used to ensure the hurdle rate is reached i.e. an investment property with a capital value of 1m should return at least 50k pa after costs to meet the criteria. This will take into account any costs of management of the portfolio property. Reporting will also outline the expected capital appreciation for the property and the overall IRR (Internal Rate of Return). The Portfolio yield target is 7% 5.4 Running Costs: Due diligence will be carried out on all potential properties. This will include: Full Survey and valuation of the buildings; Review of leases ensuring they are FRI (Full repair and insuring) and there is a clear service charge where needed covering 100% of all costs of maintenance; Review of tenant covenants including credit checks to ensure tenants are a low risk category and yields are appropriately set; Full book appraisal of service charge accounts to ensure these have been managed appropriately; Review of all contracts in place for the management of service charge contracts. No properties will be acquired where there is an excessive ongoing landlord responsibility for maintenance of the buildings that is not rechargeable through the service charge or other mechanism. Management of the portfolio will be carried out either through the existing assets team or outsourced. Any outsourcing of management will be considered on a cost benefit basis. Many leases contain an ability to recharge a percentage of the service charge budget as a management fee to the tenants and this will be considered and recharged on all transactions. 5.5 Examples of other Councils Investing in Commercial Portfolios: There are a number of cases where Councils have been investing in Commercial property for income generation. The LGA produced a case study of the work at Eastleigh BC who have an investment portfolio of c. 100m producing c. 4m PA (see Eastleigh case here). 5.6 Portfolio Diversification: The portfolio should be diversified both through asset type, sector and ultimately geographically i.e. within DMBC boundaries. Some diversification can take place through the use of indirect investment vehicles although this provides for lower (less risk) returns.
This proposal is considering direct commercial investments acquired from the market to obtain revenue returns quickly from longer term tenants. Portfolio risk will be managed through Finance with a review of indirect investments. OPTIONS CONSIDERED 6.1 The options considered are: Do nothing; Retain and look to create income from the current portfolio; Create a fund for the full 4m to create initial income stream to support the income generation target and create long term income; Create a fund for smaller amounts and Assets apply for funding on a case by case basis. 6.2 Do Nothing: By not investing in property then the 450k income generation target would not be achieved and the Council would lose the potential income from the future improvement in Doncaster s economy and regeneration. Should the target not be met then the income/ cost reductions will need to be found from elsewhere in the programme through the closure of buildings or from other parts of the organization, potentially affecting front line services. 6.3 Retain and look to create income from the current portfolio: A review of the current portfolio is taking place and from the work so far it is evident that we need to take a more commercial approach to the properties the Council rents for income (investment properties). Under this proposal properties that have an expected rental yield of less than 5% would not be held and would be sold for capital receipt and reinvestment. Properties will also need to meet the criteria on size, tenant type and maintenance responsibilities. The current portfolio also includes a number of smaller properties that require intensive management. This proposal will reduce the number of buildings held and hence management costs, through the purchase of larger units which are more relevant and appropriate for an organization of this size. 6.4 Create a fund for 4m: This will create an income stream to support the income generation target and create long term income for the Council as outlined in this paper. 2m will be allocated to the fund as part of this report with a further 2m to be considered at budget setting 2016/17. This fund will create c. 280k of income for the Council with the further 170k required to meet the target coming from reviews in retained investment properties and income achieved from indirect investment through treasury management.
6.5 Create a fund for a smaller amount: This is still a positive step however will either require higher yields (potentially higher risk assets) to meet the target or will meant that the 450k target will be unlikely to be achieved in the current portfolio. REASONS FOR RECOMMENDED OPTION 7.1 The key reason is to support the income requirement of the Assets Savings Programme delivering an extra 450k per annum to the Council. By not investing in property then the 450k income generation target would not be achieved and the Council would lose the potential income from the future improvement in Doncaster s economy and regeneration. IMPACT ON THE COUNCIL S KEY OUTCOMES 8. Outcomes All people in Doncaster benefit from a thriving and resilient economy. Mayoral Priority: Creating Jobs and Housing Mayoral Priority: Be a strong voice for our veterans Mayoral Priority: Protecting Doncaster s vital services People live safe, healthy, active and independent lives. Mayoral Priority: Safeguarding our Communities Mayoral Priority: Bringing down the cost of living People in Doncaster benefit from a high quality built and natural environment. Mayoral Priority: Creating Jobs and Housing Mayoral Priority: Safeguarding our Communities Mayoral Priority: Bringing down the cost of living All families thrive. Implications Investment in property in Doncaster will show a firm commitment to the economic growth and regeneration of the Borough. The returns from investments will help support and protect the vital services by creating a sustainable income that does not rely on traditional revenue funding. Through the generation of long term sustainable income this will help reduce pressure on budgets and therefore reduce the pressure for increase in areas such as Council Tax. Through the generation of long term sustainable income this will help reduce pressure on budgets and therefore reduce the pressure for increase in areas such as Council Tax. The returns from investments will
Mayoral Priority: Protecting Doncaster s vital services help support and protect the vital services for the longer term by creating a sustainable income that does not rely on traditional revenue funding. Council services are modern and value for money. Investment in property will show a proactive stance for the Council to generate income and create stability in the current and future environment. The returns will show good value for money and the management will be reviewed to ensure this is efficient and effective in delivery. Working with our partners we will provide strong leadership and governance. The investment in properties may provide better value and quality solutions for operational requirements. We will work with the Team Doncaster Partnership, Health Assets Partnership and the Sheffield City Regions Joint Assets Board to offer space through the portfolio (on an investment basis) where required. RISKS AND ASSUMPTIONS 9.1 There are clear risks in investing in property these are: Void Costs - Potential vacant units coming about either through lease end or break clauses being activated, or businesses becoming insolvent, reducing rent returns and increasing costs; Capital value goes down rather than up. On a commercial property this is fundamentally linked to the rental return achievable/ economic conditions. Strong landlord tenant relationships are required and there may be a conflict and potential reputational risk in implementing a strong commercial approach on tenants. Risks are to be managed under the Property Investment Procedure which will define clear Due Diligence processes to be followed and monitoring of market conditions. These investments would be seen as medium to long term investments which would reduce the risk to capital returns 9.2 Assumptions made are that: Only commercial property such as offices, industrial and retail will be invested in.
LEGAL IMPLICATIONS 10.1 Advice on the legal powers to undertake such a scheme has been sought from leading barrister Nigel Giffin, QC. Nigel has confirmed that the Council has the power to invest in commercial property by virtue of s 12 of the Local Government Act 2003. Provided that the Council already has the funds available for investment there is no need for such investment to be made through a company. 10.2 The advice has confirmed that investment may be made either within Doncaster or elsewhere and may be made for the sole purpose of making a profit. 10.3 Nigel Giffin has however confirmed that if the Council intends to borrow monies for the purpose of investment, that that proposal will require the establishment of a Company. Any plans to expand this scheme in that manner will require further legal and financial advice and must be the subject of further decision making. FINANCIAL IMPLICATIONS 11.1 The Asset Rationalisation Programme has a savings target of 5.05m over four years to 2017/18. As stated above, 450k of this target is planned to come from increased income. 11.2 In order to help meet this income stream the report recommends setting up a 4m property investment fund; financed from: - Funding provided through reinvestment of capital receipts from disposals in the current portfolio ( 2m funding to be considered as part of this report); Capital Programme allocation ( 2m funding to be considered as part of budget setting 2016/17). 11.3 The report outlines the financial criteria under which an investment will be made and a practical rate of return intended to provide the desired income stream, net of the costs of borrowing and management of the scheme. Individual property purchases will be appraised as part of the decision making process for investments. Detail of which is to be proposed by the Assets Team to be signed off and agreed by the Director of Finance & Corporate Services and Property Investment Board. 11.3 In this case, an investment of 2m delivering an average rate of return of 7%, after management and other costs have been met, will provide a net return of 140k. If the budget is extended to 4m a total return of 280k could be achieved. This is less than the target of 450k, with the remaining 170k intended to be met from income achieved from indirect investment through treasury management. 11.6 To ensure that all rental income can be treated as revenue income and contribute towards the savings target (rather than a mix of capital receipt
and revenue income) any lease needs to be classified as an operating lease rather than a finance lease. Operating leases are those where the risks and rewards of ownership are retained by the lessor (the Council) and must meet certain criteria. The main criteria being that the lease term should not be for the major part of the property s economic life and, at the start of the lease, the total value of minimum lease payments (rents) should not amount to a significant proportion of the value of the property. 11.7 Should the scheme expand or resources other than capital receipts are used, then further appraisal will be necessary to ascertain whether the Council would be acting for commercial purposes. Local authorities are required to undertake commercial activity through a company. The need for such a company would attract set up costs and the additional benefits of a wider scheme would be less in comparison due to potential tax implications. 11.8 Financial Procedure Rules (FPRs) require that where budget provision for an acquisition exists within the total Council budget, the Property Officer may approve a purchase of land or property. They also state that any project involving a capital commitment of 1m or more requires the completion of a report for approval by the relevant Director and CFO, in consultation with the Portfolio Holder (Finance & Corporate Services), before a formal commitment is entered into or a contract is signed. 11.9 This report recommends that the detailed process and policy are drawn up by the Assets Team and signed off by the Director of Finance & Corporate Services and the Property Investment Board. The process and policy need to ensure that the requirements of FPRs, as referred to above, are adhered to. Should the budget be approved, submission of a report by the relevant Director to the Property Investment Board will satisfy the requirements of FPR s. 11.10 It should be noted that this Cabinet report seeks to meet the key decision criteria of any investments made. HUMAN RESOURCES IMPLICATIONS 12. There are no HR implications associated with this report. TECHNOLOGY IMPLICATIONS 13. There are no technological implications associated with this report. EQUALITY IMPLICATIONS 14.1 The Equality Act 2010 has been given due regard and this proposal will not have an impact on Equality. When the Policy is written this will need to consider the type of properties the council invests in and elements such as accessibility.
CONSULTATION 15.1 There has been significant consultation around this programme and increasing income generation through investment or letting current vacant properties was outlined in the initial Cabinet paper in December 2013. 15.2 Consultation with the IMF Committee (Investment and Modernisation Fund) in January 2015 at which the principles were agreed. It has been decided not to use the IMF to take the proposal forward due to the legal requirement to set up a separate company when using borrowed funds to purchase. Once this initial investment has taken place the position will be reviewed and further consultation take place to decide whether to take the next step and set up a company. 15.2 Members have been made aware through discussions around the programme in ward meetings (October 2014) and Member Seminars (Jan/Feb 2015). BACKGROUND PAPERS 16. N/A REPORT AUTHOR & CONTRIBUTORS Oliver Judges Interim Projects Director Asset Transformation 01302 735900 oliver.judges@doncaster.gov.uk Peter Dale Director of Regeneration and Environment
ANNEX 1 Potential Questions The level of investment and not something that has been done before; A number of Councils have built successful portfolios in the past with the returns now supporting them in times of budget cuts. The investment is usually seen as a way to bring sustainable income to the Council to support it in times of uncertainty. Investments sought would be similar to a pension fund looking to support the longer term requirements of pension and annuity payments. Examples have been previously outlined in the previous paper. Why not just lease what the Council owns first? During the review of assets it has been recommended that the Council building an investment portfolio in order to provide a sustainable income into the future and as part of a wider investment programme. The current portfolio is made up from a large number of smaller buildings most of which require some form of refurbishment and upgrade in order to let. These buildings require intensive management with a large number of tenants and buildings to liaise with and rental payments to manage. It is recommended that the current investment portfolio is restructured to provide better, more sustainable returns and reduce the management requirement of the portfolio. This can be done by reviewing the current assets in line with the requirements set out in paper 1 and looking to invest in larger assets rather than a number of smaller units. For example if 1m was to be invested it would be more efficient from a management point of view to invest in 1 or 2 assets rather than manage 10-15 assets. The reason for investing in larger units is due to the following reasons: Overall there are less tenants and units to manage reducing costs (including processing costs of rent etc.); Larger units tend to attract larger firms with better covenant risk than smaller tenants; The downside is that the spread of risk maybe limited (fewer and larger investments meaning that a void in a property will have more overall effect due to the bigger unit size) and therefore this will need to be balanced off through good portfolio and investment management (i.e. investment in a unit fund). The investment properties identified in the current portfolio would be, in most cases, sold. Previous sales have shown that these properties are sold to local developers who then invest in them to bring them into use (residential/ Commercial). All properties are reviewed on a case by case basis.
Whether there were the skills required in the Assets team to manage an investment portfolio; The structure for holding the assets will be reviewed and a further review of the Assets team is due at the end of the current programme. It is proposed that investment assets will be managed and monitored separately to the Operational Assets with a key focus on investment returns and the landlord tenant relationship. External professional investment advice will be taken where required and the management of the properties and service charges will be reviewed and outsourced where required. For the purchase of investment properties external advice will be sought. Internally the current project team has the ability to weigh up the investments and make recommendations (not investment advice) with the backing of previous investment experience in the team along with qualifications in the area (Real Estate Investment qualifications). A full process for the management, review of investments and to ensure clear due diligence takes will be agreed prior to making the first investment purchase. Whether this would constitute a saving to the asset Transformation Programme The key to this proposal is that, no matter where the income sits within the Council, this proposal provides the ability to increase revenue income to the Council at better yields than are currently obtained through other investments. The previous paper outlined that the programme was looking to raise income by 450k during the programme and we need to ensure that best value is provided to the Council in doing so, however, this application is about the principles of investment to provide income to the Council. The question of allocation of those returns can be debated outside of this proposal. The current set up where there is no income benefit to the programme of disposing of buildings effectively incentivises the assets team to hold on to buildings and rent, many of which require intensive management and potentially lower returns. The key is to ensure the team do the right thing by getting best value to the Council and this fund will support that move. Further discussions around disposals will be taken forward outside of this request. With properties in the investment market moving quickly it is requested that a fund be made available for drawdown to enable the team to take advantage of opportunities in the market. Each proposed acquisition will be reviewed via delegated authority (s.151 officer) with the portfolio holder being updated on the position from an Assets point of view.
ANNEX 2 Governance The Property Investment Board The Property Investment Board will be set up outside of the Assets Board. The Board will consider proposed investments and it is proposed that the Board has delegated authority in order to make investments quickly and take advantage of the market through quick decision making. It is proposed that the Board Consists of: Mayor Assets Portfolio Holder Chief Executive S.151 Officer (Director of Finance & Corporate Services) Property Officer (Director of R&E) The Board will be supported by: Interim Projects Director Asset Transformation AD for Traded Services AD of Finance & Performance Agreement will not be required at the Assets Board for decisions on investment, however update report will be provided for information.