PENSIONS REFORM AND PROPERTY Local Government Pension Service reform and what it means for real estate

Iain Mulvey

Iain Mulvey is an experienced regeneration and business development professional. He spent the first six years of his career working with the Regional Development Agencies, and the next 20 years working in private practice with GVA/Avison Young and Carter Jonas. During that time, he has worked with many local authorities across the country, advising on a range of issues across investment, development and regeneration, as well as with central government departments, corporate occupiers, pension funds and overseas investors.

ACES’ supporter of many years, Iain has written this article which is relevant to recipients of local government pensions. It considers the potential implications of pension funds being directed to real estate projects. “However, even at £360bn, use of the LGPS is certainly not the silver bullet to solve the UK’s infrastructure funding problems when you consider the overall costs involved.” 

What is being proposed? 

Rachel Reeves announced an ambitious plan in mid-November 2024 at the annual Mansion House speech to merge local government pension schemes (LGPS) which currently have a combined asset value of £360bn. 

This is not the first time that it has been considered, and was previously raised by George Osborne in 2013, which gave rise to eight pooled vehicles formed from 86 authorities. Since then, the pooling process has seen over 70% of LGPS’ assets moved into pooled vehicles. 

The ever-reducing amount of ‘fiscal headroom’ means that it seems that a more radical and structured approach is required to stimulate growth, to prevent the economy flatlining and ensure that investment in critical projects is made. Logically, the sentiment behind merging LGPS schemes is that larger funds can make larger commitments and help drive much needed economic growth in the UK by investing in infrastructure, housing and other major projects of national interest. 

This is largely based on the effective use of similar funds to achieve those objectives in countries such as Australia, and in particular, Canada. We have seen the ability of those funds to commit significant spend to real estate projects in the UK such as the Ontario Teachers’ Pension Fund, which has over £15bn invested in property alone on a global basis. Both Canada and Australia have significantly smaller populations than the UK, which means that investment is constrained by the size of the domestic market and their needs to internationalise, to spread risk and diversify income. However, if it can work effectively there, why not here? 

What does this mean for real estate? 

Local authority pension funds have historically been major investors in real estate, both in terms of direct and indirect holdings. Overall, the LGPS is valued at £360bn across all asset classes. This of course does not include the direct investments made by local authorities into property such as those made by Spelthorne, Portsmouth and Surrey, which have been the subject of much debate elsewhere and sit outside the LGPS schemes. Real Estate currently has an overall weighting of 8% across all LGPS assets, according to the latest figures shown in the chart. 

LGPS Assets

Even at 8%, £28.0bn of real estate assets is highly significant in the context of the overall market. In order to compare this to the size of the wider market, most agents reported that the total universe of real estate investment in the 2024 calendar year was c£40.0bn, albeit this is significantly lower than previous years, where over £60.0bn has been achieved. Major investment into institutional grade commercial property has been made over a significant period of time by the likes of Teesside Pension Fund, West Midlands Metropolitan Pension Fund, Strathclyde Pension Fund, Greater Manchester Pension Fund, and others, and the assets allocated to real estate which form those mandates are managed by external Financial Conduct Authority accredited advisors. 

In the past, some other smaller local authority pension funds have often been forced to target smaller lot sizes due to the overall size of the individual funds and the need to diversity that capital across different sectors. In some cases, this led to geographically dispersed portfolios of management intensive stock. As a result, some authorities divested of their direct property holdings as they took up a disproportionate amount of management time for limited returns, in comparison with other asset classes and the capital received was distributed elsewhere or put into indirect property vehicles. 

Logically, having larger merged allocations for real estate would allow investment into projects of a national interest that may assist in driving economic growth. However, it doesn’t necessarily follow that the returns will exceed or even match those currently received from activity undertaken to date. The majority of LGPS assets are made up of institutional grade core and core plus assets that have often performed strongly against established benchmarks. Targeting that investment capital at supporting economic growth may serve a purpose for UK PLC but not necessarily members of the scheme. 

The difficulty with direct real estate investment is the lack of liquidity. The ‘pooling’ will therefore be far harder to achieve for direct property holdings than other asset classes in terms of managing the transition, where it relies on transactions taking place or combining contracts placed with external advisors. Fund managers will see an opportunity to align with large discretionary mandates, although for those with existing contracts it may represent something of a threat. I suspect this may only be achieved over a two-term Labour government for the same reasons that this has now already been on the table for 12 years. 

According to the most recently published figures, there is already investment in ‘Infrastructure’ by LGPS Funds which accounts for around 6%/£22.7bn of the total. It would be logical to assume that the vast majority of this is held in equities or other asset classes more liquid than property and could be more readily redirected. Again for context, the latest estimates suggest that the HS2 line from London to Birmingham might cost over £80bn in total, the upgrade to the TransPennine Express at over £11bn, Crossrail 2 at £30bn and the London Underground Bakerloo Line extension between £5.2-£8.7bn. It has also even been estimated that £16.3bn would be required to fix all the UK’s potholes, according to the local authority road maintenance and repair survey. Therefore, despite its current size, a material reshaping of the LGPS would be needed to contribute a significant proportion impact to projects of that nature. 

Another potential complication is the how to factor in ESG considerations. This is likely to make the picture more confusing if the funding can only be provided to ‘sustainable’ projects, which may limit its effectiveness and of course returns for members. Rather like local authorities buying property assets directly, once the lines become blurred between investment and regeneration considerations, it appears that both objectives can never be achieved in tandem. 

Conclusion 

Overall, the logic appears sound – the UK needs increased funding to drive future economic growth and pay for larger infrastructure projects. That won’t all come from the private sector or overseas investors, especially as investors have become distrustful of following cost overruns, delivery times not being met, and of course the cancellation of HS2 Phase 2. However, even at £360bn, use of the LGPS is certainly not the silver bullet to solve the UK’s infrastructure funding problems when you consider the overall costs involved. 

The other key question is the practicality of making it happen. Is there really any guarantee that returns will be better for the 6.5m members of the LGPS and how will challenges to making it happen be overcome, especially for the real estate element as it is so illiquid. It will be fascinating to see the results of the most recent consultation, but expect significant resistance from a number of stakeholders. 

Therefore I am not entirely confidant we will see much change over the term of the next parliament, however much it may be needed.