How your property strategy can help your beneficiaries in longer term

The time that you serve on a charity’s board of trustees or senior management team is limited relative to how long the charity has already been existence and is likely to continue to exist for. Therefore, what difference are you going to make during your tenure at a charity?

Considering how your property strategy can positively impact on your financial reserves, and therefore the support you can provide to future beneficiaries is one way of making a difference.

Cluttons’ National Head of Valuation, Jonathan Rhodes and RSM’s Head of Charities, Nick Sladden provide their ideas on how to implement such a strategy.

The importance of unrestricted funds

One of the fundamental principles of charity finance, which is underpinned by charity law, is the different funds a charity may hold on trust. A charity can only hold two types of fund: unrestricted and restricted.

1. Unrestricted funds are freely available to spend on any of the charity’s purposes.
2. Restricted funds (including endowment funds) can only be spent on a specific purpose(s), usually specified by a donor or funder.
   Detailed guidance on fund accounting can be found in Charities SORP (FRS102) for charities preparing their statutory accounts.

For those involved in running a charity, an appreciation of this fund accounting concept is vital, especially for trustees, to ensure the legal requirements are being followed when making decisions. Alongside this, there should also be a good understanding of the core income streams required to fund the costs of charitable activities being undertaken. This is important because knowing whether income and expenditure is coming from unrestricted or restricted funds is essential in understanding how to govern a charity. For example, a charity that is predominantly dependent on restricted funds for specific projects may have limited financial firepower to design and develop new projects in other or new areas that may help beneficiaries. Such a dependency on restricted income may result in reduced choice for trustees in developing new strategies and initiatives. Conversely, a charity that generates good surpluses from unrestricted funds is well-placed to pursue new initiatives or invest more in existing, or indeed new, programmes for beneficiaries.

Don’t forget the balance sheet

However, it’s not just the annual income and expenditure from a fund that is a measure of financial strength. Reserves, from the balance sheet, show the financial strength of your charity. Reserves is not just a simple measure of how much money you have in the bank. Instead, charity reserves are the unrestricted funds that are freely available to spend on your activities, after allowing for fixed assets and future spending plans. Having weathered the Covid19 pandemic, a robust and well-considered reserves strategy sends a clear message to funders and beneficiaries that your charity is well-led, well-managed and well-run.

Ultimately, it is up to trustees to work out how much your charity needs to keep in reserves. A good reserves strategy will establish a financial target, possibly a range, for the charity to achieve at a future date. More forward-thinking trustees will seek to consider a target level of reserves that will allow sufficient funding for future projects and services. Building up reserves for future investment in beneficiaries is a valid strategy although it’s not quite as simple as shaking the money tree to create the financial reserves required.

But how can trustees achieve a step-change increase in reserves for the good of beneficiaries?

One-off events, sale of property

To make a step-change improvement to reserves is likely to require a one-off event, such as a significant unexpected bequest or sale of a property. Rationalising a charity’s property portfolio or leveraging off its asset base is nothing new. However, with fundraising having become more difficult some charities may be faced with reducing reserves and / or other demands for monies, which require action of some sort or another.

As the pandemic has developed and with more people working from home either permanently, or on a hybrid basis, many charities have undertaken a review of their operational estate and considered, for example, whether they really need a head office, often in expensive city locations. As a result, some have sold; others have entered sale and leaseback arrangements.

When considering their property strategy, many charities seek professional guidance as not many will have the necessary expertise or knowledge as to what may be the options available. Any engagement with a property consultant may purely be on the basis that a charity has determined that they need less operational office space and as such have concluded that they could sell their existing premises.

The rationale for doing this may be driven purely by the amount of space the charity occupies and that as a consequence of the pandemic, this has reduced substantially. The cost of occupying this space – business rates, insurance, repair and maintenance, annual running costs, etc – is seen as a potential cost saving, where the charity can relocate into smaller premises.

The decision to therefore dispose of an asset is driven by the perception of a potential cost saving whilst also generating capital proceeds of an unrestricted nature. The property consultant is therefore asked to dispose of the property, but not to consider any other options.

The potential issue with this is that the proceeds of sale are likely to be expended over say a five to ten year period, whilst at the same time the asset base of the charity has diminished. Whilst the balance sheet may look stronger for a while, it is likely to become weaker as the proceeds are used up.

Property can generate unrestricted income. Therefore, rather than selling an asset outright, charities should consider how their assets could increase their income by considering other options. For example, a property could be sold on a long leasehold basis (125 years) but subject to a rent. Whilst this would reduce the capital proceeds, the freehold interest is still owned by the charity, but it would also provide an unrestricted income. This same structure could be used even if the property was more suitable for redevelopment.

Another option, depending on the nature of the property, could be to let part whilst still retaining the remainder for the charity’s own purposes, which again can generate an unrestricted income. It should be recognised however that there is a cost in achieving this.

What are your plans?

Property is likely to form a part of any charity’s organisation, albeit some may only have this for purely operational purposes. Even where this is the case, and as alluded to above, having a property strategy and determining how to optimise your property holdings should be an important consideration and subject to review on an annual basis.

Having property provides a charity with an asset base which can support its balance sheet. However, unless the way in which premises are used are subject to regular review then opportunities may be missed to do something different, which could benefit the charity. For example, surplus space could be rented to a third party; or, the property may benefit from redevelopment in whole or part; or, a rationalisation of the estate / looking to occupy less expensive premises could all be considerations.

Property, even where owned freehold, comes with liabilities. These include repair and maintenance, insurance and general running costs amongst other things. Having a planned preventative maintenance programme in place helps to keep costs in check but also avoids unforeseen large expenditure items which may not be budgeted for.

Over and above the existing asset base of a charity, and subject to the extent to which there is surplus capital, another consideration is to acquire a property as an investment from which unrestricted income can be obtained. The performance of an investment property may also wish to be considered alongside any existing other investment strategies, for example having equities or bond investments.

Having a diversified investment portfolio which support the charity’s financial requirements through unrestricted income should form the part of any strategy to ensure its financial stability in the long term. This can be achieved through some of the aspects discussed above, but a good starting point is having a property strategy which considers a wide range of options and assesses each in terms of the risks and opportunities each provides.

Furthermore, there is the opportunity to consider using existing property assets as security for a loan. This may help the charity to meet with larger capex projects, where there are existing budget constraints. However, whilst there will be an annual cost of servicing any loan, through interest payments, there should always be consideration and a strategy which determines how the loan will be re-paid, typically over five years but also for longer.

There are some banks which have a particular strategy to lend to charities, however there are many other banks which will also be prepared to lend. As such, there is a wider pool of potential lenders which may be prepared to offer terms which are better suited to the charity’s specific requirements. The amount of loan and the length of time this is required, coupled with the cost are all important aspects which will require consideration.

Engage early, seek advice

Agreeing these strategies is not a one-off exercise. As your charity’s circumstances and property requirements change, so too must your plan for financial reserves. The Charity Commission recommends that the reserves policy is reviewed by trustees at least annually. For fast-changing charities, or when outside influences occur such as the Covid19 pandemic, it is likely that the reserves strategy will need to be looked at more often. Likewise, the amount held in reserves should also be monitored throughout the year. This helps to align the reserves policy to your overall strategic plan.

In a period of building reserves for future investment, the policy will necessarily differ to that in a period of spending those reserves as the investment in beneficiaries is made. Aligning the property strategy to the financial reserves plan can assist in achieving the charity’s objectives and help to avoid any unforeseen circumstances, whilst seeking to optimise the opportunity to grow unrestricted income.

Your legacy

Some charities have been able to sustain success for centuries, what will be your legacy as a trustee or management team?

A joined-up consideration of your property and reserves strategies may provide some of the answers.

For more information please contact either Nick Sladden or Jonathan Rhodes.

Cluttons LLP is an International firm of chartered surveyors and property consultants based in Central London and operating throughout the UK. Established in 1765, Cluttons is one of the oldest established firms of Chartered Surveyors in the UK, and played an important role during the establishment of the Royal Institution of Chartered Surveyors.