In February 2019, Network Rail sold a portfolio of 5,261 commercial rental spaces, around 70% of which were railway arches, on a 150-year leasehold basis to a consortium of private investors for £1.46 billion. However, Network Rail and the Department for Transport (the Department) failed to consider the interests of tenants until far too late in the sale process, despite them being those most affected by the sale. The new owner – The Arch Company, backed by Blackstone and Telereal Trillium – has committed to work with tenants to establish a “tenants’ charter”, and is expected to invest in the properties. But the commitments that have been made are not legally-binding and there is no certainty that future owners would have the same intentions should any properties be sold on. Furthermore, future tenants’ rights will be weakened as Network Rail has required that all new tenants’ leases must be contracted out of the Landlord and Tenant Act 1954.
The sale was professionally managed, generated competitive tension and achieved a fair price for the portfolio when valued as a business. But Network Rail has been a public sector body since 2014, and yet the sale was conducted without considering how it could complement wider government interests, such as the industrial strategy, support for small and medium-sized businesses and tenant protection. In the long-run, uncertainty remains about the value of the sale, as Network Rail may need to buy-back properties for future railway development purposes, but it does not know yet know how many or how much this might cost. Network Rail has also foregone around £80 million a year in rental income. Ultimately, government took a short-term decision to sell a profitable asset to plug a funding gap. We remain unconvinced that the sale represents the best value for the public and the public sector finances in the long term.
“The government took a short-term decision to sell a profitable asset to plug a funding gap in Network Rail’s budget. We remain unconvinced that the sale represents the best value for the public and the public sector finances in the long term.
“The Department for Transport failed to consider the interests of tenants until far too late in the sale process, despite them being those most affected by the sale.
“New tenants will have less legal protection than existing tenants who themselves will be put in the position of being unable to renew leases on reasonable terms unless they agree to be contracted out of the Act of Parliament that protects them.
“This is another case of government failing to see the big picture. It did not recognise the potential of the arches to further its industrial strategy and support small and medium-sized enterprises.”
Conclusions and recommendations
Network Rail and the Department did not engage with tenants early enough, and only obtained non-binding commitments to protect tenants' interests. Government’s engagement with tenants in the early stages of the process was limited. Network Rail and the Department did not seek the views of tenants prior to launching the sale and did not keep them sufficiently informed during the sale process. Government also only considered further options to protect the interests of tenants following a campaign by some tenants. Network Rail and the Department accept that they could have done more to give tenants more certainty and ease their concerns. It is disappointing that Network Rail and the Department did not appreciate sooner that SMEs need clarity and certainty over changes that might affect their livelihoods. Following a request during the final stages of the sale, the new owners have provided non-binding commitments, including working with tenants to create a “tenants’ charter”, supporting SMEs and long-term tenants facing financial hardship. However, these commitments are not legally binding and future owners of the portfolio may not make the same commitment.
Government should learn lessons from this experience for future sales and interactions with those most affected by its decisions. It should ensure that in future asset sales, those stakeholders most impacted by the transaction are given consideration early on and throughout the process.
Network Rail should write to us in twelve months’ time with an update on how the new owners have performed against its non-binding commitments, including how the tenants’ charter put in place by the new owners is supporting existing tenants being treated fairly.
Future tenants will have fewer rights than most current tenants. Network Rail has stipulated in the agreement with the new owners that all new tenants’ leases must be contracted out of the Landlord and Tenant Act 1954 (the Act). It claims that the Act hinders its access to the properties that may be required for it to carry out urgent repairs to the railway. However, these protections effectively give the tenants the option to extend their lease at the end of its current term, so tenants are also losing that right and we see no safety reason which justifies all tenants being made to forego these protections. Furthermore, with only 18% of leases currently contracted out of the Act, and Network Rail itself acknowledging that instances of being refused access for urgent work have been ‘very rare’, there is very little evidence to support the need to contract out for safety reasons and justify bypassing protections enshrined in the Act. As things stand, by 2022 more than half of existing releases will have expired, and new tenants will not be protected by the Act. We are also very surprised to hear that the Department seems to have been content not to get involved and simply to have unquestioningly allowed Network Rail to bypass an Act of Parliament. The Department argues that the process of contracting out of the Act was not introduced as part of the sale process, and so was not drawn to the attention of Ministers. But we question the need to contract outside of the Act to achieve Network Rail’s safety objectives, and remain concerned not just that new tenants will have fewer rights than existing ones, but also that existing tenants will be put in the position of being unable to renew leases on reasonable terms unless they agree to being contracted out of the Act.
HM Treasury should write to us within one month, setting out its policy in relation to departments, and bodies within their control, actively promoting measures to get around Acts of Parliament.
The Department and Network Rail should write to us within one month setting out what it can and will do to ensure that, when leases are due for renewal, existing tenants are able to do so on reasonable terms without being essentially forced into contracting out of the Landlord and Tenant Act unless they pay disproportionately higher rents. If they have left themselves in a position where no such reassurances can be offered to existing tenants, then they should at least be open about acknowledging that.
Government failed to recognise the potential of the arches to further its industrial strategy and support for SMEs. The sale of 5,261 rental spaces has made the new owners the biggest landlord to SMEs, and with a presence in local communities across urban centres of England and Wales. Given this, we are surprised that neither Network Rail, the Department nor HM Treasury thought to consult with other departments on how the portfolio or the sale might be used to support government’s wider aims. HM Treasury’s Green Book guidance requires that wider policy goals, such as the industrial strategy or support for SMEs and local communities, should be considered as part of asset sales. Network Rail and the Department believe that the new owners are economically incentivised to invest in the properties, which in turn would benefit local areas. However, the Department did not consult widely enough with other departments in preparing for the sale. HM Treasury says that the government has a different set of policies for supporting SMEs, and that this wasn’t an objective of this sale. This only further underlines our concerns about departments working in silos, on which we have reported before.
HM Treasury should monitor departments’ compliance with its Green Book and Business Case guidance, and develop more specific guidance for assets sales. It needs to ensure that departments, rather than working in silos, take account of wider government interests and objectives when overseeing or conducting asset sales.
In its Treasury Minute response to this report HM Treasury should explain more fully why the pursuit of government’s policies should not be considered in asset sales, in particular when these have a visible impact on local communities.
To plug a funding gap, Government took a short-term decision to sell a profitable asset. The property sale was part of Network Rail’s response to a shortfall in funding required to deliver its investment programme for the period 2014 to 2019. Network Rail and the Department sold a profitable asset, which generated £83 million of rental income in 2017-18, for £1.46 billion. In exchange for the sale proceeds government has foregone future income and the opportunity to increase this income through investment. Network Rail’s ability to maximise the return of the portfolio was hampered by its inability to invest in the properties owing to borrowing restrictions imposed since it was reclassified as a public body. Network Rail estimates that, with investment, its income could have risen to £160 million a year by 2027-28. Its investments offered a rate of return which even exceeded the return government would expect for its investments using the Social Time Preference Rate. However, as there was no policy reason to hold it, government decided to sell the portfolio rather than invest in it, and to help Network Rail fill a short-term funding gap.
Recommendation: As a part of its balance sheet review, HM Treasury should consider whether to invest in profitable assets now, irrespective of the government’s policy to sell assets where there is no policy reason for continued public ownership, in order to exploit opportunities and maximise the value of public assets in the long run.
Network Rail is unable to say how many arches it might need to take back over the next 150 years, and how much this could cost. Network Rail has the right to take back the properties for safety or rail development reasons but will need to compensate future owners. It excluded from the sale around 800 railway arches that it expects to access for known rail projects over the next five to ten years. However, the long-term value for money of the sale is uncertain as Network Rail is unable to say how many arches it may need to buy back in the longer term (either temporarily or permanently) and how much that might cost. These costs will add to Network Rail’s future railway investment programme if the value of the properties increase by more than expected. Network Rail still has an obligation to protect the railway and maintain the safety and security of passengers, and it will now also have to manage the relationship with the new and future owners over the whole length of the lease. It has a newly created team to manage this relationship, the costs of which will be incurred for the next 150 years.
Recommendation: For each future control period, Network Rail should disclose: a) the expected cost of, and number of employees in, its interface team, and b) the expected number and cost of taking back properties, and whether they are taken back permanently or temporarily.