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NAO sounds alarm on local authority investments in commercial property

19 February 2020: The National Audit Office (NAO) last week reported on the 1,340% increase in local authority spending on commercial authority acquisitions in the three years to March 2019 compared with the previous three years, highlighting the risks these investments could pose to the public finances.

The NAO is the independent audit body responsible for scrutinising public spending on behalf of Parliament. Although most English local authorities are audited by commercial audit firms, the NAO also has the power to look into local government finances, in addition to considering how the local authority prudential financial framework overseen by the Ministry of Housing, Communities & Local Government is operating.

The NAO reports that district and unitary authorities have invested £6.6bn in commercial property over the three years to 31 March 2019, of which £2.5bn (38%) was invested outside of their local areas.

Borrowing at very low interest rates to invest in higher yielding assets can benefit residents by providing an income stream to fund local public services. But, as the NAO report concludes, this comes with significant risk, in particular a substantial and growing exposure to the struggling retail sector.

The NAO commented on weaknesses in the monitoring and understanding of these risks by both central government and by elected representatives of some of the councils involved. It also reported auditors’ concerns over transparency and reporting of commercial property transactions, limited internal challenge to decision making, and limited capacity and skills at officer level.

Alison Ring, Director, Public Sector at ICAEW, commented: “It is important that the NAO has shone a light on the significant increase in balance sheet risk being taken on by a small but growing number of local authorities. Unfortunately, the NAO report did not address the structural issues that are driving local authorities to establish debt-financed ‘mini sovereign wealth funds’ that predominately invest in one particular asset class, rather than spreading risk across multiple types of investment.”

ICAEW agrees with the NAO that the Government needs to improve its monitoring of the overall exposure of the public sector balance sheet to the commercial property market. However, in updating the devolved financial framework it should consider how local authorities can be encouraged to invest in infrastructure and other productive assets that will support economic growth and benefit local taxpayers in the long-term, in addition to managing financial investment risks effectively.