Strategic Investment Case Local Housing Delivery Company

Strategic Investment Case

Local Housing Delivery Company October 2018

GVA Real Estate Finance

Appendix 1

Client: Stratford upon Avon District Council Report Title: Commercial Case

Date: October 2018

Contents 1. Background ................................................................................................................................................................................ 1

2. Council Objectives .................................................................................................................................................................... 3

3. Company Structure Overview ................................................................................................................................................. 5

4. Financial Considerations - including Initial Funding/Working Capital Facility/ Financial Relationship with the Company .................................................................................................................................................................................. 13

5. Council Land Transactions ..................................................................................................................................................... 21

6. Proposed Council Report Recommendations .................................................................................................................... 23

7. Next steps .................................................................................................................................................................................. 26

Prepared By: James Dair/ Ishdeep Bawa/ Nicolas Dent Status: Final Draft Date: October 2018

For and on behalf of GVA Financial Consulting Limited

Client: Stratford District Council Report Title: Strategic Business Case

Date: October 2018 Page: 1

1. Background

1.1 Stratford upon Avon District Council approved the strategic business case in April 2018 to establish a

housing delivery company. The strategic case established the key parameters and objectives of the Council

in establishing the company.

1.2 GVA have been commissioned to provide professional support and advice to Stratford upon Avon District

Council to help establish a housing delivery company, building on the advice already provided.

1.3 Our commission covers the following key areas of activity:-

a) Agree the final form of the company structure, building on advice already provided.

b) Propose a budget and indicative funding proposals for the working capital facility provided

by the Council to the housing company.

c) Provide a framework for the acquisition activity of the Company.

d) Provide a financial options analysis and structure to enable the transaction of the Council

land held as part of the proposed Canal Quarter development.

e) Propose a land disposals mechanism of Council owned land to the company to ensure the

Council achieves best consideration.

f) Advise on the corporate governance arrangements from the Councils perspective.

g) Provide a comprehensive risk management strategy for the Council in managing its interest

in the Company

1.4 GVA has worked alongside KPMG who have provided high level tax advice and Trowers Hamlin who have

provided legal advice to the Council. The previous advice is contained in the Strategic case report that was

considered by Cabinet in April 2018 and Full Council in July 2018. Our advice builds on the previous report.

1.5 The main purpose of this report is to set out sufficient detail to enable the Council to progress with

establishing the Local Housing Company. This report provides background information to the Cabinet report

which provides the constitutional mechanism for a decision to be made. Based on the workshop held in

September we have set out recommendations to the council in order to establish the Company.

1.6 The proposed recommendations that this report supports are as follows:-

a) Authorise the establishment of a limited company by using its “general power of

competence” under section 1 of the Localism Act 2011.

b) Approve a working capital budget up to £10m to facilitate the activity of the company.

c) Approve the arrangement by which LHC will draw down working capital.



d) To appoint Directors to the company Board, yet to be determined

e) Delegate Authority to the S151 Officer and Monitoring Officer to undertake the following

activity:-

Produce the Memorandum and Articles of Association and Shareholder

Agreement

Register the Company

Apply for a company bank account

Appoint company auditors, legal advisors, commercial property advisors

Set up the financial systems

1.7 The contents of our report follows the activities set out in paragraph 1.3 above.



2. Council Objectives

2.1 Housing represents one of the most significant challenges facing local authorities up and down the country,

this linked with continued levels of reductions in public funding and specifically ever reducing revenue

budgets is leading Council’s to consider alternative options to generate much needed revenue resources.

2.2 With the backdrop of significant regional demand and undersupply of housing of all different tenures, linked

with continued levels of public funding austerity and a broad agenda to become self-sustainable, Stratford-

upon-Avon District Council (SDC) has embarked on a key project to help address some of these challenges.

2.2.1 SDC has set a number of targets with regards to house building in its district. Pressure has been put on local

councils from central government to maximise housing delivery to try and compensate for the current

nationwide housing shortage the UK finds itself in.

2.2.2 The figure of how many houses to be built is stated in the Core Strategy 2011 – 2031, which was adopted in

July 2016, states that “at least an additional 14,600 homes (an average of 730 per annum) will have been

built across the district.” Within this figure the council seeks to ensure that “affordable housing will comprise

35% of the homes, unless credible site specific evidence of viability indicates otherwise”. The target area for

these houses is varied with 3,500 in Stratford, 3,800 in main rural areas and a total of 4,400 in new settlements

at Lighthorne Heath and Long Marston Airfield.

2.3 Over recent years house prices have grown in Stratford upon Avon, making home ownership for many an

unachievable goal. Although the Local Housing Company will be established with a commercial purpose, it

will in part seek to make a positive impact on both the quality and availability of affordable housing

products.

2.4 The main purpose for the Council to set up a Local Housing company is to help deliver the following strategic

objectives.

a) Maximise the Councils financial return from the disposal of its land and property assets, with

a preference to generate a secure revenue income stream(s) which positively contributes

towards the Councils medium/long term financial strategy

b) Secure local economic growth

c) Better utilise the Councils assets to drive socio economic change to secure a sustainable

future for the benefit of the community.

d) Ensure the Council is not exposed to undue financial risk

e) Improve the environment

f) Increase housing supply and in particular the level of affordable housing offered within the

Councils geographical boundary, either through self-delivery or acquisition (affordable

provision is likely to be cross subsidised through other commercial activity)



g) Contribute to ensuring that businesses are encouraged to invest in Stratford.

2.5 The above strategic objectives have been considered at a Cabinet workshop held on 3rd September 2018,

and build on the objectives agreed in the Cabinet report of April 2018.

2.6 To positively contribute towards delivery of the above objectives the Council has decided to establish a

wholly owned company (WOC). Following the company being set up it will develop its own business plan

which will set out how it is going to achieve the objectives set by the Council.

2.7 WOC’s are relatively straight forward to establish. This structure should provide the Council with flexibility to

meet its objectives over the coming years. If necessary the WOC is capable of establishing subsidiary

vehicles, this could also include joint ventures with potential investor/developer partners.

2.8 The Strategic business case approved by Cabinet in March 2018 reviewed a range of alternative options

available to the Council to support delivery of its objectives set out above. This report builds upon previous

advice and provides appropriate analysis and explanation to support the next stage of the Council decision

making process.



3. Company Structure Overview

3.1 It is recommended that four Directors should be appointed, with the potential for a number of Non-

executive Directors.

3.2 We have set out below what we believe are the key issues that the Council should be considering when

identifying the Directors of the Local Housing Company.

Governance

3.3 The Local Housing Company is a separate legal entity distinct from the Council and any other

owners/partners. The Council will need to consider a range of governance related issues, including:

a) the division of responsibilities between shareholders/members (as owners) and directors, and

matters reserved to the shareholders/members;

b) directors and company secretaries, their duties and potential liabilities (where the vehicle is

structured as a company);

c) board composition;

d) managing conflicts of interest, for both Council officers and elected members; and

e) the requirements of Part V of the Local Government and Housing Act 1989 and the Local Authority

Companies Order, where relevant to the particular company.

3.4 It is proposed that the Local Housing Company is a company limited by shares; the owners are its

shareholders. Shareholders ultimately control the company through the ability to appoint and remove

directors on the company's board and certain statutory rights to make decisions in the form of special and

ordinary resolutions. In addition, shareholders may exercise control in accordance with the rights given to

them either in the articles of association or a shareholders' agreement.

3.5 For local authority wholly owned companies, it would be normal for a shareholders' agreement to be put in

place to provide the Council with strategic control over the operation of the company through the right to

approve a business plan and certain "reserved matters". A sample list of reserved matters can be supplied,

but they reflect the decisions which are often important enough to the owners of a separate vehicle to

warrant the owners' specific approval. The type of decisions usually included in lists of reserved matters

include:

a) entering transactions of a significant scale;

b) changing the type of business undertaken;

c) buying or selling a significant part of the JV undertaking unless envisaged by the agreed

business plan;



d) admitting new shareholders to the company;

e) changing the constitution of the company; and

f) winding up the company.

3.6 The reserved matters would need to be modified to suit the particular governance requirements of individual

vehicles and may require negotiation where third parties are involved in the vehicle as this is a key control

mechanism which the council can exercise over the vehicle. A balance needs to be struck between

maintaining appropriate control but also to recognise that the vehicle is operating with public money and

giving the vehicle sufficient freedom and flexibility to operate commercially.

3.7 The Council will need to decide who it wishes to exercise its shareholder function. Given the function is

about the strategic control over the company's activities, it would be usual for this function to be exercised

by the Council's members. Depending on the level of control retained under the shareholders' agreement,

this could be:

a) through all shareholder decisions going to Cabinet;

b) a committee of the Cabinet being established to undertake some or all decisions;

c) certain decisions being delegated to certain member(s) (e.g. a portfolio holder) and/or senior

officers.

3.8 If a matter is not by law or through the vehicles governing documents reserved to its owners, then it is

effectively delegated to those persons charged with management responsibility within the vehicle. In a

company, this group is the board of directors.

Directors and board composition

3.9 Directors owe a number of duties under the Companies Act 2006 and common law generally, a summary of

the principal duties and liabilities of directors is set out below. Additionally, it is commonplace, though not

essential, for a private company to appoint a secretary. Directors will be in control of the operation and

management of the company, subject to the control which the owner(s) have under the articles of

association and any shareholders' agreement.

3.10 There is no set template for the size or composition of the board of a company. There are however a

number of issues to be considered when deciding on the make-up of the board:

a) the appropriate size for a board;

b) the appropriate mix of skills and experience needed to lead a successful enterprise;

c) the need to demonstrate sufficient control; and

d) the potential for conflicts which could hinder the effective operation of the board (or indeed

the Councils).



3.11 Although the company will be a body which is owned in whole or in part by the Council, it must be allowed

to operate as a separate enterprise. The company's board therefore needs to be of a sufficient size to

ensure an appropriate spread of skills and experience but not so large so as to inhibit fast and flexible

decision making, sometimes to tight commercial timescales. We would usually consider that a board of

between 4 to 7 individuals (with the ability of directors who cannot attend any meeting to send agreed

alternates/substitutes) to be a workable size.

3.12 The Council will need to consider ideally what skills and experience are needed from individual directors to

drive the company forward and make it successful. Council members and officers, who may not have a

commercial background, will need to be supported by a commercially astute company board.

3.13 In terms of the different "types" of people who may be considered for board membership, these can be

identified as follows:

a) elected members of the Council (non-executive directors);

b) officers of the Council (also called non-executive directors), i.e. officers who are not

transferring to the company but are staying in their Council roles;

c) senior managers/employees of the company itself (executive directors), i.e. officers who have

either transferred/been seconded from the Council to the company or have been directly

recruited by the company. It would usually only be the Chief Executive who would be

considered for a director role as well as their employee roles; or

d) independent people selected (ideally through open recruitment to adhere to good

governance principles) because they bring specific skills and experience (often referred to as

independent non-executive directors).

3.14 The question of whether elected members should be on the company board is considered further below

from a conflicts perspective. If a view is taken that elected members should be on the company board, it is

still relevant to consider what personal skills and experience they are required to bring.

Summary of Directors Duties

3.15 To act within powers – a director must act in accordance with the company's constitution and only exercise

powers for the purposes for which they are conferred;

3.16 To promote the success of the company – a director must act in a way s/he considers, in good faith and

would be most likely to promote the success of the company for the benefit of its members as a whole. In

doing so, s/he must have regard to (amongst other things) the following factors:

a) the likely consequences of any decision in the long-term;

b) the interests of the company's employees;

c) the need to foster the company's business relationships with suppliers, customers and others;

d) the impact of the company's operations on the community and the environment;



e) the desirability of the company maintaining a reputation for high standards of business

conduct; and

f) the need to act fairly as between members of the company

g) to exercise independent judgement – this duty is not infringed by acting (i) in accordance

with an agreement duly entered into by the company that restricts the future exercise of

discretion by the directors or (ii) in a way authorised by the company's constitution.

h) to exercise reasonable care, skill and diligence – this means the care, skill and diligence that

would be exercised by a reasonably diligent person with (i) the general knowledge, skill and

experience that may reasonably be expected of a person carrying out the functions carried

out by the director in relation to the company and (ii) the general knowledge, skill and

experience that the director has.

i) to avoid conflicts of interest - a director must avoid a situation in which s/he has, or can have,

a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the

company. This applies in particular to the exploitation of any property, information or

opportunity (and it is immaterial whether the company could take advantage of the

property, information or opportunity).

j) not to accept benefits from third parties - a director must not accept a benefit from a third

party conferred by reason of (i) being a director, or (ii) doing (or not doing) anything as

director.

k) to declare interests - if a director is in any way, directly or indirectly, interested in a proposed

transaction or arrangement with the company, s/he must declare the nature and extent of

that interest to the other directors.

3.17 Where more than one duty applies in a given case, the directors must comply with each applicable duty.

The general duties also do not require or authorise a director to breach any other law.

3.18 The general duties apply to all the directors of a company. "Director" is defined in the Act to include any

person occupying the position of director, by whatever name called (and can include so called shadow

directors being a person in accordance with whose instructions a Director is accustomed to act). The Act

makes no distinction between executive and non-executive directors.

3.19 The general duties are owed to the company. Two broad implications follow from this:

a) Directors must act in the interests of the company, even where they are appointed to the

board by a third party, such as the Council. The nominated directors will need not only to

avoid conflicts of interest but to avoid the perception of any conflict.

b) Only the company will be able to enforce the general duties, although in certain

circumstances individual members may be able to bring an action on the company's behalf

(often referred to as a derivative action) and creditors may be able to do so where the

company is (or may become) insolvent.



3.20 It is important to note that the Companies Act 2006 did not codify all common duties and law rules or

equitable principles which directors need to consider when exercising their functions as directors. Directors

will continue to owe certain equitable and common law duties to the company, such as:

a) the duty of confidentiality (this can be particularly problematic where directors are appointed

by a third party with potentially overlapping interests); and

b) the duty to consider or act in the interests of creditors when the company is insolvent, with a

view to minimising losses to them.

3.21 Liability for breach or threatened breach of the general duties is personal to the directors concerned and

unlimited in scale. Accordingly, it is not possible to quantify the potential exposure of a director. There may

be a need to consider insurance and/or indemnity for directors.

Conflicts of interest

3.22 In relation to conflicts, there are a number of issues to consider which can impact on the composition of the

board and in particular, what role should elected councillors and/or council officers play in relation to the

board.

Council officers as directors

3.23 Our advice is for councils to appoint officers to a board of a corporate entity which it owns. This is because

it is easier to manage the conflicts for an “officer director" than for an elected member - the Council

can agree to the officer continuing to act as an officer despite potential conflicts; agree not to take

action against him/her where s/he is required to act contrary to the interests of the Council due to his/her

role as a director; and agree to his/her remuneration as a director (or that the person will not receive any

additional remuneration from the Council).

3.24 There are three caveats to the recommendation of appointing officer directors which may affect who is

identified to undertake this role:

3.25 We would advise against statutory officers (the Monitoring Officer and s.151 Chief Finance Officer in

particular) being appointed as company directors as they may be required to undertake their statutory roles

in relation to the company at some point which would raise difficult conflicts;

3.26 There needs to be consideration of the "retained client" role i.e. if all officers who know anything about the

services being delivered are either transferred to the company to run them and/or on the company board

as a director, who is left to provide the expert, impartial advice to the Council to make decisions about

service performance by the company and about decisions in relation to the company in their capacity as

owners;

3.27 If officers, who are also company directors, are making decisions (at Council level) about the company,

those decisions will potentially be open to challenge because the decision is influenced by bias or the

perception of bias (because of their role at the company) and/or by pre-determination (that they have

made their minds up because of the company role and are not making the decision objectively and fairly).


Date: October2018 Page: 10

3.28 It is a criminal offence for officers, under the cover of their office, to accept anything other than their proper

remuneration. Accordingly, where officers are appointed as directors by reason of their post within the

Council, they may not accept any payment from the company for their services as a director, unless the

Council agrees that the additional payment shall form part of the proper remuneration for that role. It is

therefore recommended that any officer director should be formally appointed and should formally notify

the Council of their interest, and their declaration should be kept on the officer declaration file.

Elected members

3.29 Although it is completely lawful for elected members to be directors of Council companies, there are some

intrinsic conflicts which need to be carefully addressed. These relate both to the Code of Conduct for

Members but also to the risk of decisions made by a councillor where s/he is also a director of the company

being challenged on the basis of bias or predetermination. It is not possible for the Council to avoid

accusations of bias or predetermination, especially if the member is senior. Directorships can therefore

constrain elected members' "Council side" activities and inhibit members carrying out their elected strategic

policy direction and scrutinising roles.

3.30 In the light of this, local authorities often decide only to involve officers in director roles, ensuring that elected

members are free to decide key issues about the organisation (i.e. the reserved matters) on behalf of the

Council in its strategic role as sole or part owner.

3.31 Directors' remuneration (if any) with the company will be governed by the provisions of the Local Authorities

(Companies) Order 1995, which restricts the amount of remuneration that a member can receive. This

means that they cannot receive any additional remuneration from the company for acting as a director

which is beyond the special responsibility allowance they would have received had the activities of the

company been discharged by the Council. Any remuneration they receive will be deducted from the

special responsibility allowance that they receive within the Council and they may only claim mileage and

subsistence at the rates that apply to members. Remuneration would also potentially amount to a

Disclosable Pecuniary Interest.

Practical points

3.32 If members or officers are appointed as directors of the company, there will be a number of

arrangements/processes to be put in place to ensure that conflicts are properly addressed and managed

as follows:

3.33 The constitution of the company should address "inherent situational conflicts" of the Council-appointed

directors on the board given that these conflicts can be foreseen because of the links between the councils

and the company – this helps to ensure openness of decisions making and probity at the company end of

activities;

a) appropriate conflicts and interests should be declared and recorded at all relevant

company meetings;

b) at the Council end, any officer serving as a director on a company must declare interests

(and be given the necessary consents to act);



c) under s.117 of the Local Government Act 1972;

d) under his/her contract of employment; and

e) under any relevant code of conduct for officers;

f) any elected member serving as a director of a company must declare an interest under

the Councillors' Code of Conduct) and comply with other rules about members on

companies (including a restriction on any remuneration); and

g) there must be arrangements at the Council end to ensure that decisions can be made in

relation to the company which are robust. Although all the necessary conflicts and

interests can be declared, if decisions are made by the Council by members or officers

who have an interest in that decision from a company perspective, there will always be a

risk of an allegation of bias or pre-determination being made to challenge that decision.

3.34 Although the detail around which Directors are likely to be appointed has not been agreed, it is still

appropriate to set out the company structure that will need to be in place. This section of the report provides

an overview of the basic company structure requirements.

3.35 It should be noted that all key decisions taken by the company will be undertaken in accordance with the

governance documents, which include the Memorandum of Understanding and Articles of Association.

3.36 Although the structure will evolve over the initial period of activity, it will need to provide oversight for certain

elements of the business even initially. The diagram bellow illustrates the overview of responsibilities needed

during the initial period. We have assumed that for each area a Director will be appointed and this is

intended to be the basis for the Company Board.

3.37 We would suggest that a number of Non-Executive Directors are appointed to support the Board, however

we would recommend forming the Board first and allowing it to become established before introducing the

Non-Executive Directors.

3.38 Initially the Board will need to be resourced either from interim external advisors or from staff seconded

across from the Council. Longer term we would anticipate the Company properly recruiting staff to support

the company.

Approach to risk management



3.39 Risk will be managed through two alternative mechanisms, as set out below:-

a) Council led risk management Business plan and land transaction mechanism – the

company is required to submit a business plan to support each site drawdown, this will be

independently assessed by the Council to establish whether the Council is achieving best

consideration at the point of disposal. In addition to each site being reviewed the

Council will also need to approve the annual business plan for the company. Both

mechanisms provide a way of controlling and managing the Council’s reputational and

financial risk exposure. The detail associated with these mechanisms is provided

elsewhere in this report.

b) Company Board led risk management – as part of the annual business planning and

monitoring process the Board will need to establish and review the companies risk

register, and take appropriate action where appropriate.

3.40 The company Board will be required to identify two types of key risks. Firstly risks that impact on the delivery of

the business plan and risks that impact on the shareholder.

3.41 The business plan for the company will need to set out the key elements of the risk register as well as

identifying how risks are to be managed and mitigated.

3.42 The Company will have to arrange Professional Indemnity Insurance and Personal Liability Insurance.



4. Financial Considerations - including Initial

Funding/Working Capital Facility/ Financial

Relationship with the Company

Funding of the Company

4.1 As set out in the Strategic Business case, the Council as sole shareholder of the company will need to provide

initial working capital for the Company’s operations along with the seed capital to make investments in the

residential market place. In this section of the report we set out the market analysis conducted to shape the

quantitative analysis for the company including the investment and return of the company as well as the

Council.

4.2 Our analysis is set in the context that the Council wishes to ensure that the Company is active in the market

as soon as possible and that it is able to reach a scale that allows it to start making a genuine impact in the

local housing market. As part of the quantitative analysis we have set out an initial investment of £10m which

would enable the Council over a 3 year period reach a reasonable scale, however this will be heavily

dependent on the on the market conditions along with the quantity and quality of stock available to

purchase. The £10m should not be seen as either a minimum or cap on investment and the analysis should

be seen as what could be achieved within that envelope of funding. At this time the Council will be

agreeing in principle to provide the Company with up to £10m to acquire properties; however the funding

will be drawn down based on a business plan which will be set out by the Company and individual business

cases going forward for each acquisition.

4.3 The Council as shareholder and approver of the Company business plan will be able to increase that limit in

the future, however at this stage the approval of £10m would enable the Company to be established,

operate and acquire properties over a 3 year phased period.

4.4 The Council will provide funding to the company and it is likely to be in the form of debt and equity. Until the

final business plan of the company has been agreed it is not possible to determine the optimum balance

between the two. In structuring the working capital as a combination of shareholder equity and debt

funding, the structure must avoid “thin capitalisation” in that the company should have sufficient equity

funding to meet any debt and interest obligations to the Council and run in a financially solvent manner.

4.5 The Council will be the sole shareholder in the subsidiary and will own 100% of the share capital. The Council

could provide all the funding to the company by way of share capital. However, this would result in any

benefits of the funding to the Council being paid by way of dividends after tax and hence would not

represent an efficient use of the Council’s funding.

4.6 The Council can provide debt funding to the company by way of loans or loan notes (shareholder loans)

with an interest charge to the company. The interest would be tax deductible and would result in the

Council receiving interest on the loan before tax, the Council would also receive dividends on its

shareholding after tax.



4.7 Utilising our presence in the funding markets and experience of residential investments we have

benchmarked the debt/equity split for the housing company at 70%/30% based on loan to cost ratios. This

has been the basis of our financial evaluation for the Company’s operations.

4.8 It is recommended that the Council’s intention in lending to the company should be based on market rates

to avoid any Transfer Pricing issues as well as to ensure state aid compliance. It is assumed that the Council

and the company are connected parties for tax purposes; as such transfer pricing rules will apply. Transfer

pricing rules are the cost of supplies, goods and services (revenue not capital, including loans) between

connected parties. These prices need to be market related. This issue becomes significant where the Council

charges higher than market prices for supplies, goods, services and interest, as this would result in a lower tax

liability (i.e. lower than market) to the company and provide the Council with an advantage.

4.9 Where the Council charges more than market value, transfer pricing rules would apply to the company,

adjusting the tax to be paid by the company.

4.10 The company will initially be funded by the Council committing funds for the set-up and establishment of the

vehicle; operational expenditure and project development costs. Given the differences in the tax status of

the Council and the company it is recommended that these funds will be provided by the way of a loan

(loan note) to the company, this loan will carry an interest rate to be State Aid compliant.

4.11 The Council would provide funding or assets (land) to the SPV by way of existing resources, Public Works

Board Loans (PWLB) or the transfer of property. Where property is transferred this would also be provided on

a loan (loan note) basis. For the purposes of our analysis we have assumed that the Council will be

borrowing in order to on-lend to the Company, however we understand that an element of internal

borrowing is possibly dependent on the overall scale of investment agreed as part of the business plan

process.

4.12 The loans provided by the Council to the company will be at a higher interest rate than the PWLB loan rate

to ensure the Council receives a margin (profit) for the risk of providing a loan to the company and to ensure

compliance with State Aid regulations. Where the Council is internally borrowing, the margin received will be

greater due to the PWLB borrowing costs being replaced by the opportunity cost of cash investments, which

is significantly lower.

4.13 The company’s initial business plan is likely to evolve around the acquisition of properties on the open market

and therefore the company will borrow on the basis of investment loans. The loan terms could be either an

annuity payment which pays back an element of interest and principal or an interest only facility with a

bullet payment for the principal at the end of the loan term. The exact loan structure will again be

determined once the business plan has been put in place, but it will be important for the loan structure to be

sustainable and enable the company to operate on a sound financial footing. This will inevitably require a

balance between the desired returns of the Council as both lender and shareholder and the requirement for

a financial sustainable business.

Operational Budget

4.14 The Company will need a working capital to operate. The types of costs that the Company will occur over

time will include:



Salaries

Back office functions (Finance, Audit, HR, I.T)

Professional Fees (External Advisors – corporate finance, business planning, due diligence)

4.15 Upfront costs will need to be incurred prior to the Company acquiring assets such as incorporation of the

legal entity, memorandum of understanding and articles of association alongside the development of a

business plan. Costs will increase over time as the Company scales up with respect to its operations but in the

early years, the Company will not want to be burdened with significant costs especially before it is

generating income through its activities. Indeed some of the items above will not necessarily be cash items

but will be resources that the Council will provide to the Company through service level agreements. While

the exact level of working capital facility will be determined by the exact governance structure and business

plan agreed, for the purposes of this report we have set out an indicative budget of £300k over the first 3

years.

4.16 The diagram below sets out what the expected flows of cash will be from the Council to the Company and

vice versa

4.17 The Council is also considering the disposal of land to the Company for the canal quarter (this option is

considered in more detail later in the report). Any Council land that is disposed of to the Company will need

to transfer at a value that achieves best consideration. The transfer of the land can be either before or after

planning has been achieved but should be based on an independent valuation to demonstrate that value

for money has been achieved. Land transferred to the Company after planning has been achieved will

maximise the capital receipt that the Council receive whereas pre planning disposal to the Company will

see a financial benefit accrue to the Company and enable proceeds to be recycled by the Company.



4.18 One of the options being considered for the Canal Quarter includes the Company receiving residential units

in lieu of a capital receipt. In these circumstances, the Company will not have a cash receipt to pay the

Council for land. The Council would therefore need to structure the sale of the land as either a loan note

which would accrue interest and be repaid as and when surplus cash is available in the company or

potentially structure an arrangement whereby the company pays the Council a ground rent over a period

where the value of the lease is equivalent to the best value consideration required on any disposal.

Market Analysis

4.19 In order to develop a financial model to assess the company’s forecast performance and subsequent

Council returns; we have undertaken local market analysis to understand the types of properties currently on

the market, the acquisition costs that the Company may incur and the resulting residential rental values that

could be achieved. We understand that the Council wishes the Company to acquire a greater percentage

of smaller units sizes and therefore we have assumed that the acquisition portfolio will be split as follows:

50% - 1 Bedroom Properties



4.20 We have taken the assumed portfolio split and the market data to calculate a weighted average cost for

both acquisition costs and rental income received per annum. The table below summarises this analysis.

No Beds Average Rent

(pcm) (£)

Average Rent

(Pa) (£)

Average house

Price £

Yield % in

Portfolio*

1 Bed 674 8,088 171,000 4.73% 50%

2 Bed 876 10,509 206,588 5.09% 30%

3 Bed 1,238 14,850 362,717 4.09% 20%

Weighted Average 846 10,362 220,020 4.71% 100%

*The actual portfolio split will be determined through the business planning process

4.21 The table shows that across the portfolio split, the average rental per property that could be achieved is

£846 per calendar month (pcm) which equates to £10.4k per annum (pa). Based on a weighted average

acquisition price of £220k, this would give the Company a gross yield of 4.7%.

4.22 We have assumed that the Company will deploy capital equally over a 3 year period and this will need to

be refined during the business planning process. As set out above, we have set this analysis in the context of

available funding of £10m over the 3 year period. Assuming that there will be a need to put aside c£100k for

the on-going operations, this leaves £9.7m for acquisitions. Accounting for transactions costs (professional

fees and stamp duty), this would leave a net of c£9.1m to bid for and acquire properties in the market. This

would enable the Company to acquire around 14 properties annually over the first 3 years which would



result in a portfolio of 41 units. The actual drawdown of funds by the company and therefore the size of the

portfolio will be based on company business plans.

Financial Implications

4.23 We have looked at the financial implications from both the Company and Council perspective. The analysis

in the table below are an indicative representation covering a 30 year period including the 3 year phased

acquisition programme as set out above. Key assumptions for the modelling are set out below:

3 year acquisition programme for 41 units

Interest only loan from the Council at 4.5% (including a 1.5% Margin over and above PWLB)

Disposal of portfolio at year 30 to enable loan principal repayment

All surpluses available for distribution to the Council

Working capital facility for the first 3 years (£300k) injected as equity – this however may be in the

form of resources as opposed as pure cash.

Rental increase of 2.5%

Housing Price Inflation 4.5% - utilised to calculate vacant possession value at year 30 (Historical average going back 20 years has been 6% for Stratford)

4.24 The table below shows the key financial metrics for the Company

Company Financial Position

£ Acquisition Costs 9,700,000

Funded By:

Equity 2,910,000 Debt 6,790,000 Total Investment Funding 9,700,000

Working Capital Facility 300,000

Total Funding Received 10,000,000

Income: 30 Year Period

Net Rental Income 13,216,599 Portfolio Disposal @ Yr 30 16,271,916 Tax Liability (740,478) Total Income 28,748,038



Debt Interest Repayments 8,860,950 Debt Principal Repayment 6,790,000 Surplus available as Dividends (after tax) 13,097,088 28,748,038

4.25 The Company’s rental income shown in the table is the net position after accounting for gross to net

efficiency of 30%. This means that 30% of the gross rents have been allocated for items such as, voids,

management and maintenance, bad debts etc. The surplus shown above is a post-tax position and

applies the current know rates of tax as set out by the government, with the rate being 19% in 2019 and

reducing to 17% in 2020. The tax liability is calculated on the profit and loss the company makes and while this

can differ from the net cash surplus generated by the company we have taken this as a proxy for the profit

that could be liable to tax.

4.26 In many ways the Council’s financial position will mirror that of the Company’s given the shareholder and

lender relationship between the two. While we understand that the Council would potentially be able to

utilise internal borrowing for initial cash injection into the Company we have taken the approach of the

Council borrowing and on-lending the full amount. This will be a treasury management decision as and when

the Company draw down on the approved funds and to be conservative we have assumed that the

Council will need to borrow.

4.27 The table below shows the Councils returns as both shareholder and lender.

£ PWLB Borrowing 10,000,000

Invested as:

Equity 2,910,000 Debt 6,790,000 Total Investment Funding 9,700,000

Working Capital Facility 300,000

Total Funding Provided 10,000,000

Surplus received as Dividends (after tax) 13,097,088 Interest Payments Received from Company 8,860,950 PWLB Interest Payments (8,700,000) MRP Provision (5,800,000) Net Revenue Surplus/(Expenditure) 7,458,038



4.28 As set out in the assumptions the financial analysis is based on an acquisition programme of 3 years. In

practice the Company will have a rolling business plan which will be updated annually and over time the

Council and Company will be able to agree to upscale the investment proposition (or indeed scale back if

market conditions are not favourable). We have also assumed that the entire surpluses generated by the

Company are available for distribution; however those surpluses could be reinvested by the Company.

4.29 Should the Council choose to prudentially borrow then considerations will need to be given to minimum

revenue provision (MRP). MRP is the minimum amount which a Council must charge to its revenue budget

each year, to set aside a provision for repaying unsupported external borrowing (loans). The Council will

need to agree its MRP policy as part of its wider treasury management policy and whether there will be a

charge in relation to Company loans.

4.30 For the purposes of modeling GVA has been provided with assumptions by the Council and utilised a 2%

straight line annual MRP charge. On this basis the stabilised annual MRP provision that the Council would put

aside is £200k. This is a significant provision in the context of the annual cashflows that the Council would be

receiving from the company and will result in a net budgetary pressure for the Council until rental growth is

sufficient to cover the MRP charge. Based on the assumptions made this would peak at £179k reducing

annually.

4.31 The net budget position for the Council will therefore be dependent on the decisions made around MRP and

therefore the analysis should be seen in this representative context and not the actual returns that the

Council will receive once the local housing company has been established.

Tax Considerations

4.32 As we have set out above, this report does not look to quantify the tax implications of the activities of the

Company in any detail but utilising representative figures. Below we have included a summary of the

high level tax implications that will need to be considered during the business planning process. While

this was covered in the strategic business case along with a more detailed opinion by KPMG, it is

important to reiterate the potential tax issues that the Council and Company will need to consider.

4.33 A limited company is treated as being opaque for tax purposes (i.e. as a separate taxable entity from that of

the owners and directors).

4.34 Trading profits - a company will pay corporation tax on its trading profit. Corporation tax is charged at 19%

regardless of the level of profits distributed by the company.

4.35 Trading losses - a company can off-set losses of its trade generated in any given accounting period against:

other income and gains of that company generated in the same or previous accounting period (e.g.

Capital Surplus 2,590,000

Total Surplus 10,048,038

Consolidated IRR 3.24% Consolidated NPV (293,679)



income from other trades or capital gains) (current year and carry back relief); and profits generated in the

same trade in that company in future accounting periods (carry forward relief).

4.36 A company can also off-set trading losses generated in the last 12 months of a trade that permanently

ceases, against other income and gains of the company in the same accounting period and the three

previous accounting periods (terminal loss relief).

4.37 Stamp duty land tax will need to be paid on acquisitions of properties. The stamp duty cost will be

dependent on the bands that the properties acquire will sit in. Should future activities include land transfer

from the Council to the Company (e.g. Canal Quarter) then group relief would be available and there

would not be a stamp duty liability that will need to be paid for those transactions.

4.38 Capital gains - a company pays corporation tax on its chargeable gains (other than gains on properties that

have been subject to the annual tax on enveloped dwellings, which will be instead be subject to capital

gains tax at 28%).

4.39 A company is entitled to indexation allowance when calculating its capital gains, which effectively allows

for inflation over the period of ownership of the asset.

4.40 A company may also be able to take advantage of roll-over relief on disposal of an asset.

4.41 Capital allowances - a company may claim capital allowances on eligible assets which it uses in its business.

The allowances are the tax equivalent to the depreciation of capital assets and, if claimed, reduce the

trading profits generated by the company and therefore the amount of corporation tax payable.

4.42 VAT - VAT registration is mandatory once the value of VATable supplies made by the company in the year

exceeds the registration threshold. A company may only have one VAT registration regardless of how many

trades it carries on.

4.43 NICs - NICs are only payable by a company when it pays remuneration to an employee.

4.44 When a company pays an employee:

4.45 The employee is required to pay (usually by deduction from salary by the employer) primary class 1 NICs of

12% of earnings between the primary threshold and the upper earnings limit (£157 and £866 earnings per

week, for the 2017/18 tax year) and 2% of earnings above that upper earnings limit; and the company, as

employer, is required to pay secondary class 1 NICs of 13.8% of earnings above the secondary threshold

(£157 earnings per week for the 2017/18 tax year).

4.46 From 6 April 2016, a company that pays secondary class 1 contributions is entitled to an "employment

allowance" of £3,000 broadly to be set off against class 1 secondary NICs (albeit, from 6 April 2016, a

company where the only employee is also a director of the company cannot qualify for this allowance).

4.47 Dividends - a company may distribute taxed profits to its shareholders by means of a dividend. Dividend

income, in the hands of the recipient, will be taxed in accordance with the tax status of the recipient.



5. Council Land Transactions

5.1 Alongside the investment acquisitions that the company will be making over the next few years, the Council

needs to determine how it should invest land and potentially property into the Local Housing Company and

importantly have a clear process for considering the disposals on a site by site basis. This section of the

report identifies the preliminary issues to be considered as well as various risks and challenges that are likely

to be faced and provide some suggestions for tackling or minimising them.

5.2 The Council in due course will prepare a list of sites that may be transferred to the company. This is separate

from the Council's ongoing disposals programme and ad-hoc disposals to other developers or other

collaborations.

5.3 The Council needs to ensure that it obtains best consideration for any land and property that it agrees to

transfer to the company (and this will be tested through independent valuation). Sites will generally be

transferred on a freehold basis. The drawdown of sites from the list will be as agreed between the council

and the company, through the preparation of business plans for each site. The drawdown of sites will be

subject to the decision of the Council (and the discretion of the Council may not be fettered in this regard).

5.4 Probably the most important element is finding the most appropriate power under which to dispose of land

for development. Local authorities have very wide powers to acquire, sell, appropriate and develop land,

as set out below;

a) S.120-123 Local Government Act 1972 (LGA 72);

b) Ss.227 and 233 Town and Country Planning Act 1990 (TCPA 90);

c) Housing Act 1985;

d) Local Government Act 1988; and

e) Local Authorities (Land) Act 1963.

5.5 A combination of these specific powers would usually be sufficient for the Council to undertake any property

related project, both within its area and potentially outside its area where the motivation is connected with

the benefit or improvement of the area.

5.6 Because there are a number of options, the Council needs to be clear as to its primary purposes for

undertaking any land and property investment and development. We would normally advise that "powers

follow purposes". Powers must also be exercised properly, taking into account all relevant considerations.

5.7 Clearly the Council's audit trail needs to back up what are its stated objectives as part of taking any decision

to authorise a project.



Best consideration

5.8 The Council has a fiduciary duty to tax payers to manage its commercial estate effectively and to generate

a commercial return. On the sale of any land and property under s.123 LGA 72, s.32 Housing Act 1985 and

s.233 TCPA 90, local authorities are required to get "the best consideration that can reasonably be obtained"

(otherwise the Secretary of State's consent is required for disposals longer than seven years at an

undervalue). Sales at an undervalue may also constitute state aid.

5.9 The Council needs to obtain best consideration, even where it transfers land to a company in which it has an

involvement, for example a wholly owned separate legal entity. Failure to dispose at best consideration

could result in claims of unlawful state aid and/or there may be a breach of section 123 LGA 72 (or similar).

5.10 The Council should obtain professional valuation advice on whether best consideration is being achieved.

Whilst such advice may be provided by in-house valuers, it may be more appropriate to obtain independent

advice since the Council will be making a disposal to a connected body and this could raise questions over

how the valuation was made. Where the Council considers it may be challenged as to any valuation it may

therefore wish to seek external valuation advice; also in circumstances where there is any question of being

unable to agree upon best consideration, then a second professional opinion may be sought (consistent

with the state aid guidelines issued by the EU). The rules are now set out in the "Commission Notice on the

notion of State aid as referred to in Article 107(1) TFEU" published in May 2016 and require, in the case of sales

of land, "an independent expert evaluation prior to the sale negotiations to establish the market value on

the basis of generally accepted market indicators and valuation standards".

5.11 Best consideration may only be assessed close to disposal – it would not be possible now to give a binding

valuation of all of the indicative sites that could form part of the initial phase of development of the

company as values will fluctuate over a number of years. The drawdown process will require appropriate

valuation at the time (or just before) the sites are transferred. Best consideration may include overage or

whatever may be usual for the nature of the site and type of development. Where consideration is deferred

it will be important for the Council to consider what security may be available in relation to the land (eg. a

restriction on title).

5.12 It will be the responsibility of the company to determine the timing of any sites to be acquired from the

Council. We would expect the company to develop a business case for each site it wishes to acquire the

business case will set out the following information:

a) Production of a development appraisal for the site, including the residual land value for

the site.

b) How the land purchase price and construction costs are to be funded, including the

implications on the working capital facility.

c) Forecast profit/long term income arising from the completed development.

d) We would envisage that a combination land price, interest rate margin on the working

capital facility and profit share will form the basis of the Councils assessment of best

consideration for the purposes of satisfying the legal requirements.



6. Proposed Council Report Recommendations

6.1 Following Cabinet approval to progress with a local housing company in March 2018, the Council has taken

the opportunity to review and refine the proposition. The process of refinement has included reviewing what

is required for the company to be established. Our advice to the Council has set out a two stage process to

achieve this objective.

6.2 Initially the Council must form an appropriate corporate vehicle and agree the legal framework used to

establish the vehicle. Alongside forming the corporate vehicle and importantly the Council needs to provide

an envelope of funding that can be made available to the company. The envelope of funding is generally

referred to as “working capital” and the company will call down the facility from time to time to enable the

company to deliver its objectives.

6.3 As part of the workshop held in September with Cabinet, we identified what we believe should form the

basis of a set the recommendations that will need approval from Cabinet to enable the establishment of the

company to process.

6.4 The recommendations are as follows:-

a) Authorise the establishment of a limited company by using its “general power of

competence” under section 1 of the Localism Act 2011.

b) Approve an initial working capital budget up to £10m to facilitate the activity of the

company.

c) Approve the arrangement by which LHC will draw down working capital.

d) To appoint Directors to the company Board

e) Delegate Authority to the S151 Officer and Monitoring Officer to undertake the following

activity:-

e.1. Produce the Memorandum and Articles of Association and Shareholder

Agreement

e.2. Register the Company

e.3. Apply for a company bank account

e.4. Appointment company auditors, legal advisors, commercial property advisors

e.5. Set up the financial systems

6.5 Following receipt of legal advice from Trowers Hamlin, the Council has now been able to satisfy itself of the

legal route to enable the company to be established. In this case the legal powers are the Localism Act

2011, which identifies the general powers of competence as a way forward.



6.6 The form of the corporate vehicle is to be a company limited by shares, and the shareholder in the first

instance will be the Council. Obviously this structure does not prohibit changes in the future and the

potential for subsidiaries to be established with alternative shareholding, if the circumstance arises. One

circumstance we have envisaged which could arise is if the Council were to transact the land referred to as

the Canal Quarter into the local Housing company, and then establish a joint venture with a potential

developer of the site across the Canal. If this is pursued it might be appropriate to from a new vehicle which

would sit beneath the Local Housing Company, however is likely to have a different share structure and

could be a 50:50 ownership structure.

6.7 In this option the local housing company enters a joint venture with a development Partner for the delivery of

the canal quarter development, in most examples, the public sector party transfers its land into an external

vehicle, the value of which represents its equity investment in the vehicle. In this case the Council will transfer

its land to the local housing company which will then transact the land with the Joint venture.

6.8 This value is matched by cash from a development partner. The land is then used as collateral to source

debt, which coupled with equity funds are used to develop the scheme. Returns are then used to repay

equity investments and pay returns to the two Partners. This is another development option which could be

considered for the Canal Quarter.

6.9 The diagram below illustrates the way a normal joint venture operates.

6.10 We have identified a minimum working capital facility of £10m, the justification and rationale for this sum is

set out in section 4 of this report. It is important to note however that if the Council wishes to increase the

level of working capital, for a range of potential reasons this will be subject to a new Cabinet authority. We

have assumed that this sum is sufficient to fund the operational requirements of the company and also for

the company to make some initial acquisitions.

6.11 The arrangements associated with drawing down the working capital facility are set out in section 4 of this

report. It is important to note that although the local housing company will have its own Board and



governance arrangements it will be required to agree periodically with the Council the bases by which it will

drawdown the working capital facility. The company will be required to establish how it will repay the

Council for use of the facility.

6.12 As stated the Council will need to identify suitably qualified Directors to the company. We have provided

advice which we would encourage the Council to review prior to confirming the appointment of its

Directors. Our advice is set out in Section 3 of this report.

6.13 The final recommendation identified above relates primarily to some of the practical issues associated with

establishing a company. Rather than burden the Cabinet approval process with some of the practical

decisions associated with the company we have recommended that these points are delegated to the

S151 officers and the Monitoring officer of the Council to progress.



7. Next steps

7.1 Following Cabinet approval of the recommendations set out in section 7 of this report, the company will

need to be formed and properly constituted.

7.2 The council must also consider and agree an appropriate name for the company; this will be required prior

to forming the company, unless a temporary name is adopted in the short term.

7.3 Its first task will be to start to develop the business plan for the initial three year period. We anticipate that the

company business plan will cover the following areas:

7.4 Background -

a) providing strategic and market context,

b) outlining any perceived delivery issues

c) Its regulatory structure

d) Basis of access to finance and funding, this will include the working capital facility.

7.5 Objectives – What it intends to achieve over the plan period

7.6 Investment Strategy – how it intends to achieve its objectives and the basis for acquisitions, such as types of

homes and quantum of homes etc.

7.7 Delivery Plan – including long term aspirations as well as the projected delivery plan over the business plan

period

7.8 Financial Plan – including the initial budget 2019/20 and 2020/21

7.9 Governance and operations –

a) Human Resources and Executive support

b) Policy, strategies and corporate board

c) Professional and financial registrations

d) Procurement strategy

e) Legal and contractual agreements

7.10 Key performance indicators – these can be monitored by the operation and Shareholder Boards going

forward.

7.11 Risk management strategy – A clear risk register including mitigation measures.



7.12 We would anticipate the business plan for the company being completed over the next few months

alongside some of the delegated actions from this Cabinet report.

7.13 We would recommend that the business plan document is refreshed annually and presented to the

company Board in the first instance for approval. It would be normal practice for the business plan to be

presented to the Board no later than three months before the start of the new financial year.

7.14 Although not set in stone, we envisage that following the Board approval the business plan will be presented

to Cabinet to approve on behalf of the shareholder.

Contact Details

Enquiries James Dair 0121 609 8297 [email protected]

Visit us online gva.co.uk

GVA Real Estate Finance 3 Brindleyplace, Birmingham B1 2JB GVA Financial Consulting Limited, trading as GVA Real Estate Finance is a wholly owned subsidiary of GVA Grimley Limited

© 2018 GVA Financial Consulting Limited

Strategic Investment Case Local Housing Delivery Company

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