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Highly Leveraged Commercial Real Estate Bets

Scorpio

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Highly Leveraged Commercial Real Estate Bets that UK Local Authorities Took to Meet Budget Shortfalls Begin to Unravel
by Nick Corbishley • Oct 13, 2020 • 58 Comments

With impeccable timing.

By Nick Corbishley, for WOLF STREET:
For the last two years, KPMG has refused to sign off the accounts of Spelthorne borough council, a tiny local authority on the outskirts of London that has taken on huge amounts of debt to buy more than £1 billion of commercial and residential property, it has been revealed. The council has an annual budget of just £22 million, yet it has amassed more commercial property than just about any other local authority in the UK, all of it debt financed.
Between 2016 and 2018 Spelthorne borrowed £1.17 billion from the Public Works Loan Board (PWLB), an arm of the UK treasury that is supposed to offer relatively cheap loans to councils for building new schools and other civil projects. But many councils have begun tapping the funds for speculative property investments instead, as a means of supplementing their income.
In correspondence seen by the London Times, KPMG raised “material concerns” about three purchases Spelthorne made in 2017-18 in which it allegedly ignored rules that forbid councils from borrowing purely to make a profit on subsequent investments. These investments significantly increased the council’s exposure to risks in the property market, though it insists it is not endangering funds, with this flawless argument:
The Council is not risking council taxpayers’ cash to buy commercial properties; the low cost government funding for this strategy comes from the financial markets.​

KPMG is not convinced and has said it may even take the council to court. Spelthorne recently replaced the big four firm as its auditor with BDO, which rents office space in a building that Spelthorne bought in September 2018 – a purchase that BDO was supposed to assess as part of the council’s 2018-19 audit. According to the auditor, auditing its landlord poses no conflict of interest.
Spelthorne’s investments include a research center in Sunbury it bought from BP for £385 million in 2018. It was the most expensive property investment ever made by a UK local authority. Its second most expensive asset is 12 Hammersmith Grove, an office building in West London that cost £170 million. The building’s tenants include WeWork, which recently persuaded Spelthorne to defer its rent for 18 months, resulting in a £4.5 million short-term loss to the council.
But that’s a drop in the ocean compared to the scale of the losses Spelthorne could face if KPMG were to take the “nuclear option” of taking the council to court. If the court were to rule in KPMG’s favor, Spelthorne would probably have to divest its properties. That could end up bankrupting the authority, a senior figure within the council told the Bureau of Investigative Journalism:
“Supposing the council has to sell the properties and repay the Public Works Loan Board. The cost of [early] repayment is massive – someone told me it’s as much as 30% on top of what we borrowed. And then you’re trying to sell properties into a Covid-related commercial market. It would bankrupt the council. There’s no doubt about it.”​
A ruling against Spelthorne would not only put at risk the council’s entire £1 billion investment portfolio but could also have serious knock-on effects for dozens of other local authorities across the UK that have also borrowed heavily to fund property purchases, as well as other speculative investments.
Many of these cash-strapped councils invested in the commercial property market in order to offset recent spending cuts forced upon them by the central government. In 2018-19 alone, councils across England and Wales spent £6.6 billion acquiring offices and struggling shopping malls nobody else wanted – more than ten times the amount spent in the previous three years.
A recent inquiry by the Public Accounts Committee into local authority property acquisitions accused the government of turning a blind eye while councils ignored the rules and borrowed heavily to fund property binges. The Treasury said it would put an end to such practices, but has yet to deliver on the threat, reports the Bureau of Investigative Journalism.
Many other councils now face the prospect of big losses on their property bets. The Office for Budget Responsibility (OBR) has warned that the price of offices and commercial buildings across the country will fall by nearly 14% this year.
In Reading, one of London’s largest satellite cities, the city council has invested £61 million in office buildings. But it appears to be unfazed about the prospect of its investments losing value.
“We’re not concerned about the capital value of the property because we’re not looking to sell it,” said councillor Ross Mackinnon, executive member for finance. “In a sense, it doesn’t matter what the overall value of the building is in the interim if you’re not planning on selling it… As long as the rental income keeps coming in, then they are fulfilling their purpose.”
But less rental income is coming in today, as commercial tenants seek deferrals and rent holidays. Between April and June, all of the council’s tenants paid their rent in full. But between July and August, the council collected 83% of the rent owed.
Spelthorne has a similar investment ethos: “We aim to have tenants signed up on leases for around 10 years. We are investing on a long-term basis and we fully expect to hold these assets through a number of economic cycles.”
In order to weather the low points of those cycles, such as now, the council says it is “building up sinking funds, to ensure the money is there when we need it.” It currently has £11 million set aside and by April 2023 this will rise to £35 million. By Nick Corbishley, for WOLF STREET.
What does it mean when Wall Street mega-landlords that bought the impaired assets after the last crash are trying to unload during the worst economic crisis on record? Read…
Private-Equity Firm Blackstone, Spain’s Largest Landlord, Tries to Unload its Properties
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https://wolfstreet.com/2020/10/13/u...commercial-real-estate-bets-begin-to-unravel/
 

keef

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Its time to throw all those crooked bankers into the Tower of London.

Bring it up with Lord Cromwell.
 

Scorpio

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Carrion Crow

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#4
“We’re not concerned about the capital value of the property because we’re not looking to sell it,” said councillor Ross Mackinnon, executive member for finance. “In a sense, it doesn’t matter what the overall value of the building is in the interim if you’re not planning on selling it… As long as the rental income keeps coming in, then they are fulfilling their purpose.”

Post CCP-virus, good luck with commercial renters coming in and paying top dollar.
 

Voodoo

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“We’re not concerned about the capital value of the property because we’re not looking to sell it,” said councillor Ross Mackinnon, executive member for finance. “In a sense, it doesn’t matter what the overall value of the building is in the interim if you’re not planning on selling it… As long as the rental income keeps coming in, then they are fulfilling their purpose.”

Post CCP-virus, good luck with commercial renters coming in and paying top dollar.
Well exactly. This is just nonsense to try and keep hope going. Commercial Real Estate value is all about the income. So if the values decrease then it means the potential income stream is declining. Even if they have good current renters under contract the next time it comes up they'll likely take a big hit.