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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It would seem the masters of the dark business arts have taken the town elders to their bed chambers. Alas, what has happened to the good old cry, “Burn the witches!” ? Instead all we get is “Bring out your dead…and be sure to mask up”.
CRE bubble was a global bubble. Provided the liquidity transport for the corporate debt bubble.
Thanks, Wolf. This excellent but scary article clearly demonstrates one more ‘unintended consequence’ of the madness of ZIRP on investment decisions across the West’s economies. As a self-funded retiree, I have a choice of investing in safe assets with no return, or risky assets with highly volatile returns. In short, I am screwed in either case. If interest rates do not soon return to a sensible level that restores the historical basis for prudent investing, western economies are sure to suffer a range of dire ‘unintended’ consequences that could and should have been avoided.
There is an in between where you construct a portfolio based on what kind of return you are targeting, and hedge the tail risks of it… but probably more complex than what most people want to do (but will probably be forced to do nonetheless because the complexity of the investing environment is likely to get more complex not less).
Btw, Nick wrote this not Wolf.
Do you know a way to construct a portfolio to give a return you target?
How would you do this for 4%? 6%? 10%?
If you cab do this, I would like to hire you.
well in OTC retail, there’s HY corp bonds you can buy that have yields up to ~1100 bps above the 10y UST when factoring +/- par value, so there’s that… and then their is option writing on OTC products but you have to compete with the dealers (but correlation cross products wont have to be done)…
but buying and holding outright is pretty risky (assuming each bond underlying could go into default at any time with some probability) so you would have to pare that with some kind of correlated OTC product (futures, options on bond etfs, options on futures) that could hedge downside exposure until you get the coupons on them (at least the notional bought + estimated %change in the hedging product relative to the bond(s) in par over the term held times that notional, weighted by some kind of default probability calculation).
then one could make daily or event driven adjustments depending on the statistics of the underlying bonds
then if you are buying and selling less than a year, there are the tax implications that need to be factored into est payout profits.
bigger funds have more options available directly with dealers with things like individual cds (but even those trades have like 1MM min size) or other bespoke things.
@ GotCollateral –
Thanks for the response, but am I wrong to assume it is just a gamble?
Pretty much nothing is collateralized in the IG or HY space on the retail level (like ~97% collateralized in IG when ~47% is BBB rated with ~11-12y avg maturity and 3.2% yield before taxes… lol, ~91% in HY) and hedging any of the downside risk is less gamble (while sacrificing some yield) than what most market participants are doing now with buying this trash (stocks/bonds) unhedged because jerome says he’ll save em… esp now.
A gamble… lol… most everyone else is gambling now! a gamble on the huge duration bubble!
Heck, if you tail risk hedge then notional and your HY port you construct with 9-15% of original par on the underlying paper, goes deep 6 completely, you’ll make way more on the hedge itself…
@ Got Collateral,
Thanks. I appreciate it. You’re beyond my pay grade. I need some education to have any chance at understanding and implementing what you are talking about. I will keep watching and thinking, and hope it clicks.
We are totally screwed. Fixed income doesn’t generate any income, let alone keep up with inflation. And returns on stocks are likely to be zero or negative over the next 10 years because all future returns have already been pulled forward by P/E expansion thanks to central bank manipulation.
There is really not much you can do, except hope that the imploding private debt helps to keep inflation in check. Japan (persistent low growth, low inflation) used to be the horror scenario but this may be the best outcome at this point.
Of course black swans can happen. If CPI (or expectations) significantly increase at some point, I would expect the long end of the curve to sell off (i.e. long interest rates could spike). Everybody now expects that the central bank simply steps in and suppress these rates, but that may not work in that case, because they would then be printing money to suppress inflation! It would be oil on the fire. The type of manipulation the central banks have done in the past decennium only works in absence of high inflation expectations. So far it seems nobody is really counting on that, so it could be a black swan for many people. And who will buy their stocks, bonds and RE then?
Nah. Cut consumption like there’s no tomorrow to make up for ZIRP. I was able to bring my savings rate up to 75% from just 35%.
Super proud of not letting the Fed turn me into a yield chaser! Avoiding consumption is also the right thing to do for the environment and future generations.
I’m cutting back on my business investment as well. Big plans out the window, just setup for no debt, low overheads and low personal expenditure. Will only invest off any surplus profit.
If I wanted to make money in this economy I’d start with nothing, get a boring corporate job, then take out massive leveraged loans on housing. If it all goes bad then I had nothing to start with anyway. When you’ve actually put in the sweat to build a real productive asset you just want out of the stupid bubble economy game that the fed has created.
Yeah I did: drop out of college, do somewhat interesting software/hardware jobs for years, and long tail risk on junk bonds… paid off well in feb/march… doing it again since things regarding debt/leverage haven’t been solved since…
If central bankers wanna play the bubble game, best to stay as debt free as possible and find the cheapest way to get the most exposure to the downside risk of others debts.
I agree. You can’t get a higher rate of return by choosing a riskier investment. A few win, most lose. All you can do is to save more.
Meanwhile, the money you are saving is losing purchasing power by the day. Put at least some of it into physical precious metals.
Oh yes this is way to do it. If you’re going to take away all the income that i used to receive from my savings then i’ll just stop spending to make up for it. The only purchases i make now are items that i can use to save money . For example, i used to take my car to the garage for repairs and now i do it myself. I’ve learnt some electronics to repair household items which also brings in a little money fixing other peoples items. I’ve also started doing some diy hair cuts but the wife has yet to let me lose on her barnet :D.
I realised twenty years ago that the financial markets would end up like this, and I am using my retirement funds to reduce my future expenditure. I bought a run-down rural property, gave up work also and am completely rebuilding it solo. My annual expediture is now down to under $8,000 a year for all basics, including taxes, utilities, vehicles, and food. I can further reduce that by 30% as my smallholding develops, and go completely off grid whenever I wish. And, more importantly, I have a relaxed life I enjoy in beautiful scenery. I can do every job myself from plumbing to roofing, and an engineering degree helps a lot with that, so it may not be an option for all. However, the only sensible approach to ZIRP and rising real inflation is expenditure now on items will will reduce future expenditure. Everyone could start with a new, high quality roof and extra insulation.
Agree with leanFire on this.
I remember when my family was young, and this was in the boom times. Every week the grocery store flyers would come out and we would shop accordingly, planning a weeks worth of menus (good & healthy family meals!!!), based on what was on sale, usually as loss leaders. Fast forward 25 years to a discussion with a co-worker who could not get out of debt. I explained this concept to him and asked how his family shopped? He admitted that most days, after work, he would dash up to the local and most expensive market in town and ‘pick something up for supper’, and maybe for lunches the next day if they bothered to pack one. Needs and wants? The concept flew right over his head.
We used the savings to pay off our house 10 years early and now we are long long since retired and can buy whatever we feel like. It was such a simple process. My father in law spelled it out one day when he was dealing with his son. “Norm”, he said, “you either don’t make enough money or you spend too much”. Pretty simple to understand, imho.
I live in a neighbourhood with many students. Students are supposed to be poor. However, I always see them shopping in an expensive local shop, while a pleasant half mile walk further down the road there is a supermarket selling exactly the same products at much lower prices. It really puzzles me!
“Annual income twenty pounds, annual expenditure nineteen nineteen and six , result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery”
David Copperfield, Charles Dickens
There’s a financial survival spectrum and the NWO wannabe rulers are pushing everyone down the rungs. First you work harder to make more, then you invest more carefully, then you cut spending, then you tap the government programs, then church charity, then you steal what you need.
I think that last part is a description of the modern incorporation, a new age religion where the bishops and cardinals come in suits. All hail the lords of funny finance. Alms for the poor, alms for the poor!
leanFIRE
You are right on. We talk on these sites about the impossibilities of chasing yield and inflation / deflation, but we have 100% control of consumption.
Forgot to mention: if you are going to consume more of anything, make that technology. Super deflationary, what’s not to like?
Bank of England is considering negative rates.
All asset prices will continue to climb.
Strategy of not wanting to sell by these councils may work out!
Once rates fell below 3% they were already negative.
Nick your article subject matter will be creating uncomfortable waves. There are hushed subjects only discussed in private. This may be one of them. Market competition is a fairytale. Laundering dirty money aims for British property precisely because the market is not open, fair, transparent and ‘managed’ by the few large land owners.
Some useful background perhaps: most of the big city councils in the U.K. (eg London) are labour (left wing). The central govt has been Tory (right wing) since 2010. It hates that councils essentially oppose many of their plans. So for the last decade they have cut central funding for them while constraining their ability to raise revenue. This has destroyed council finances and their ability to oppose govt plans to reshape things like the education and transport sectors.
This is all planned. Some council run schools can’t even afford hand sanitizer. The idea is to centralise power basically so if this debt scheme ends up with bankrupt councils there will be elements of govt that see that as a very good result.
Interestingly enough, though, if you read the original article, it turns out that in Spelthorne’s case “the self-styled “visionary” and driving force behind the investments” was a Tory.
UK local authorities and councils, have had their funding cut in real terms for a long time. It’s not just the Labour run ones. One problem is that central government controls most of the money they receive, l think it’s about 90%. Also the companies selling these “investments” are probably culpable, too. But this is gonna be really bad news further down the line…
The Tory is in the majority nationwide apart from the odd city ie London
Are citizens even considering their own real estate taxes being forced up by this BS? Im sure the municipality does not pay any taxes on that billion dollars worth of property. If they make it appear as if they do, its just a mirage. Truly, they need to bring back the tar and feathers.
UK does not have a functioning property taxation system. We have a weird ‘council tax’ thing for residential housing that is absurdly regressive – a studio flat in central London would pay about £1000 per year, Buckingham Palace literally pays about £1500 per year. For commercial properties the tax is called business rates and is levied on the occupier, not the landlord. Councils are constrained by central government in their ability to raise (or make fairer) council tax, but can set business rates, which is why the high street is full of empty shops.
Landlords are the foundation of British society. If they brought in a US style property rates system the Queen and her buddies would go bankrupt so it will never happen.
It matters not who pays the tax, its how they are able to pay it. In the case of gov paying taxes, its simply them taxing all the citizens at a higher property tax level so they can pay theirs. This happens all the time here in small town USA. Hardly any large, newer building that goes into bankruptcy is bought by private citizenry but rather by local gov. When that property goes off the tax rolls, rest assured you have to make up the difference so that gov income doesn’t fall.
Many commercial leases in the US are triple net:
The tenant pays the taxes
A triple net lease (triple-Net or NNN) is a lease agreement on a property whereby the tenant or lessee promises to pay all the expenses of the property including real estate taxes, building insurance, and maintenance. Aug 1, 2020
Investopedia
The Queen gets to live in some of the world’s most valuable real estate but she does not own them. https://en.wikipedia.org/wiki/List_of_British_royal_residences She doesn’t own the crown jewels either. I wonder how the Duke of Westminster’s family has managed to hold on to its vast real estate holdings in the past century, escaping confiscatory income taxes and death duties.
The Queen of course does not own the Crown Jewels, although her grand mother, Victoria, was personally given the big chips from cutting the Cullinan Diamond that went into the Crown Jewels (aka: grannies chips) that helped begin the began the rise of the family fortune from mere wealth to very wealthy.
She does personally own very large amounts of real estate in London’s most expensive areas: at least a billion pounds worth but I think it’s several billion. She also personally owns vast country estates.
A quirk: she personally owns the swans on the Thames, perhaps just a way of protecting them.
Clarification: apparently the really immense wealth is held by the family, about 100 billion US$ with Liz’s personal slice a mere 350 million. However at least de jure this is still private not public wealth.
With a flat in London costing more than a 10 bedroom 4 acre gardens house in a rural area of Scotland, then tax based on ‘price’ would be ludicrous too.
Tax should be flat on income for all.
Or in the case of council tax, it’s pretty flat for all with a moderate weighting based on an abstract idea of value of the property.
If you look around the UK, property values are distorted to heck and back.
Some areas have seen 8% rises year on year and others negative, some areas have seen sub £500k property rise like crazy, over £500k not move.
To tax based on “value” would be unfair as you’re just taxing people on the stupidity of others to pay too much or too little for things.
Consumer perception of value shouldn’t drive tax variations over time.
Even worse this year as resi property has become like toilet rolls in March/April.
Everyone must have it at any cost, even if they don’t need it.
Mania.
I was able to access my 2020-21 property taxes online this morning. My total bill went up by less than 1%. It remains very manageable, thanks to California’s Proposition 13, which has been in effect since 1978. On the other hand, if you live in one of the higher taxed counties around New York City, you may be forced to move to Vermont if you lose your highly paid job on Wall St.
“manageable” for some people means incredibly unfair as a whole. We need a wholesale reform of the property tax system in California.
The most troubling part is the UK treasury actually loaned them the money.
Not being a socialist, I see this as capitalism at work.
Ultimately, Treasury debts hang on the heads of taxpayers (ie those who can produce). When a people’s government just gives this to developers and RE speculators to satisfy their greed (ie those according to their needs) based in false profitability, you have just walked into the central concept behind communism. The public is holding a left-shoe factory with their right sole flopping open in the cold air. This one completely skips over socialism altogether. And there wasn’t a capitalist within a thousand miles of this game…nothing of real use comes of it to justify the investment level.
I see it as Government competing with private investors, which seems anathema to free markets or Capitalism. It becomes the taxpayer as a group competing with individual market participants.
When Civil Serpents control any form of money/debt it never ends well.
Especially those inept Central Bankers!
Nothing to see here. All according to plan. The only surprise to me is that the boroughs are not borrowing from the Chinese like the Africans. I guess the western bankers threatened violence if the Chinese poached on their turf. Although I see that as temporary as it’s racist.
But it will be a hoot to see who winds up owning the boroughs – the immigrants, the bankers, or the Chinese.
Debt will set you free. Or was that death?
This story first came to light a couple of years back. Spelthorne is a neighbouring council area. I knew it could only end badly. I’m only surprised at the speed it now appears to be unraveling at.
What you need for it to unravel are falling commercial real estate prices, rents not being paid, rising vacancies, and eventually lower rents to fill those vacancies. Suddenly the whole leverage bet is askew. But during a boom, nothing unravels. And they were counting on an endless boom.
A very bizarre situation and a good report. You have to wonder how many of these govt real estate magnates have ever risked their own money. Will they even be fired when it all falls apart or are they in some civil servant union?
The good part: Auditors are auditing now. In 2008 all the auditors were aiding and abetting the crimes.
The UK Government loans local authorities money to buy real estate that commercial companies wanted to sell. The authorities lose the money, the Government writes off money, state looted. What’s there not to like?
Spelthorne should have followed our local Council, Kingston.
Since the central government is matching, penny for penny, any income our council collects from property developers, Kingston has declared an open season on all and any mega property developments possible.
Especially very high rise ones, all of which are violating local planning laws and development plans as well as all English Heritage or Historic England guidelines.
Only big developers, leveraged to the hilt, need apply. The kind that may help tired councillors get some well deserved rest in their corporate Caribbean safe houses. Small people do not need to apply and any such impertinent dross is rigorously repelled by Council’s Planning department by the traditional tool of repeated discoveries of minute “imperfections” of their planning applications.
Next to grace our shores, a residential mega redevelopment of the grade 2 listed County Hall, accompanied with a 17 storey residential replacement of the old car park. All new accommodation is advertised as the ubiquitous “modern living”, prices a snap, starting at £750k. Tailored for first time buyers, of course.
Developers of course do not get to build new schools or hospitals to serve all the new residents. Their friends in Council Planning do not think this necessary.
This is no surprise of course as they see all this development malarkey as a nice tool to pay their wages and pensions. Our last or last but one mayor was a semi literate builder who finally got his pointy shoes.
Fek the current residents, they can squeeze to make room for more.
Well said.
Councils primarily exist to pay their own salaries and pensions now.
Serving their community is a secondary concern.
Central government and councils are just vying for the scraps of tax available from their increasingly poor tax payers.
It’s a slow motion crash. And before the end they’ll be coming for everything you have that they can easily take or tax you for, to keep themselves going.
Plan accordingly.
“For the last two years, KPMG has refused to sign off the accounts of Spelthorne borough council!
That’s where I live.
HELP!
It states that the Public Works Loan Board (PWLB), an arm of the UK treasury is supposed to offer relatively cheap loans to councils for building new schools and other civil projects.
You could argue that shops and offices are civil projects and will bring both rent and commercial council tax to the borough.
However, it appears that Spelthorne borough council has invested in property outside its borough which would be considered speculative and risky.
At least if it had invested in its own borough it could argue it was creating more jobs, getting more council tax in and if the commercial properties were empty would not have a liability to the council tax when empty because would be paid to itself in effect.
There appears to have been a lot of refurbishment and redevelopment by borough councils so suspect there is a lot of this going on.
I also recall some councils getting hit when they opened saving/deposit bank accounts with the BCCI bank i the 80’s because they could get 1% more interest from that bank as opposed to the UK banks at the time.
Rather fascinating that a local council which is a government organisation can venture way out of her charter and yet those responsible seeming condone or just close their eyes. Yes, commercial outfits, individuals and many countries are regularly into all these ventures without a thought of a mishap or an event like CV. And many have been successful through the years that to them a black swan event will not happen while they are in. And they are heroes many times over. So to hell with the bean counter. Continue to track the happenings of Evergrande holdings the largest property developer in China.
The last 8years were golden and with their connections all their business years of the future must be good. But then….now repaying their heavy borrowings of the past is a huge problem.
And CV has practically crippled all the airports of many countries. Several countries have very new airports. Runways, Arrival halls, Terminals, Malls, Gardens, etc etc. And billions and billions of borrowed money were used to welcome tourist traffic. Almost all asian countries over the last 10 years have constructed new airports. So we close them. And what about the A380 and other aircrafts? Any future use? If so when? Meanwhile millions needed to keep them in running order.
Knew a friend..a past hero . He made a cool $2miilion in the late period of 1990 transacting two private properties.
Retired in 2014 he moved to Sydney and in 2015 with his family they amassed 14 properties savings plus bank loans. Their main source of income for 6. For them hard to understand black swans before CV strikes.
I think some AB 380 are being scrapped.
Last word. The lack of responsibility and accountability now-a-days is mind boggling. Both from the elected officials violating their fiduciary and ethical duties and the voting citizens providing oversight.
I have a lot of sympathy for the citizens as it is very hard to provide oversight on someone that can call a cop had have you arrested on the spot for a trumped up charge. Even mass action can fail.
In a small town I once lived in, the town council wanted to build a big swimming pool at the high school for their kids on the swimming team.. We all flooded the meeting and voted it down. The next day with no one there the council reconsidered the motion and passed it.
Who said a democracy only exists until the voters realize they can vote themselves benefits? A more correct statement is that a legitimate government only exists until the officials realize they can vote themselves benefits, privileges, and immunity.
The stupid thing is that despite a housing crisis the councils are no longer allowed to invest in residential property. In fact property they owned had to be offered at large discounts to the renters,. That seemed like a good idea to Margaret Thatcher who thought people would take more pride in their own properties. What she didn’t anticipate, and was was excaberated by cheap Buy to Let loans to individuals was that when properties came onto the market again they were snapped up by private landlords (often one man and his dog, with the dog in in charge of maintenance). Now when the council has to rehouse a family made homeless (due for example redundancy ) they have to pay whatever said landlord decides to charge.
“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.”
Again…..
..”acquiring offices and struggling shopping malls nobody else wanted”..
Refocus….repeat….
..”nobody else wanted”…..
Let that statement sink in for a minute…… Apparently, there is no cure for stupid.