Local authority investment in commercial property has called the soundness of the prudential borrowing framework into question and raised concerns about how far the Government can rely on it to support value-for-money decisions.
That view has come from spending watchdog the National Audit Office (NAO) in a report Local Authority Investment in Commercial Property.
It said that in response to funding cuts councils had sought income from commercial property and had invested £6.6bn in it between 2016-17 and 2018-19.
Just 49 councils out of 352 accounted for 80% of this, with a strong bias to those in the South East.
The NAO said: “Buying commercial property can deliver benefits for local authorities including both the generation of income and local regeneration.”
But it warned that income from commercial property would be uncertain over the long term posing a risk to debt costs and services that had become dependent on property income.
While councils have long held some property investments there had been “a step-change in scale” during 2016-17 to 2018-19, with £6.6bn spent on commercial property, a 14.4 times increase on the preceding three-year period.
Auditors said while the bulk of acquisitions had been made by only 49 local authorities, some 105 had spent at least £10m on commercial property.
District councils were “disproportionately active relative to their size” and councils in the South East accounted for 52.9% of acquisitions by value.
Some 47.9% of all acquisitions by value in 2018-19 had been outside the boundary of the council concerned.
The NAO said it could not quantify the exact extent of borrowing by councils to buy commercial property but estimated that up to £6bn - equivalent to 91.2% of the total - might have been borrowed, and that at least £2.5bn had been.
External auditors whom the NAO contacted “considered there are clear areas for improvement in some authorities’ governance and risk management arrangements for their commercial property acquisitions”.
The NAO said the government needed better data on new trends such as buying out-of-area properties and the contribution of commercial income to service expenditure.
Auditors warned: “Recent trends and practices in commercial property investment raise questions about aspects of the prudential framework and its oversight in the current context.
“Affordability, a key duty underpinning the borrowing arrangements at the heart of the prudential framework, is no longer effective in constraining each authority’s overall borrowing by keeping it linked to their ability to fund borrowing costs from government grant or local tax.”
The borrowing framework’s permissive nature “is now being tested…some authorities, perhaps inadvertently, will test the limits of compliance”.
Auditors said that Whitehall had not responded in a timely way to such changes and “should strengthen oversight of prudential borrowing”.
Richard Watts, chair of the Local Government Association’s resources board, said: “Councils have faced a choice of either accepting funding reductions and cutting services or making investments to try and protect them.
“When making investments, councils follow the strict rules and assessments to ensure they invest wisely and manage the risk of their investments appropriately.”
Sharon Taylor, finance spokesperson for the District Councils’ Network, said: “Unless districts secure alternative sources of revenue, essential services that our local communities rely on face being cut back or stopped altogether.
An MHCLG spokesperson said: “Councils are responsible for managing their finances and must properly consider the risks and opportunities when they make commercial decisions.
“We will carefully consider this report in our work as stewards of the local government finance system.”