Why private finance deals make sense in the short term but not in the long run

I read this morning that the Ministry of Defence is looking to buy back 38,000 homes that it sold in 1996 and has since been renting from the private equity firm that now owns them. The National Audit Office has calculated that this arrangement has left the taxpayer between £2.2 and £4.2 billion worse off. Like many private finance deals, this deal probably made sense in the short term, but its long-term financial impact has been a disaster.

The homes in question are lived in by military service personnel and their families. The Guardian reports that 57,400 properties were sold under Conservative defence secretary Michael Portillo to Annington Homes, which according to its website appears to exist primarily to own these homes and to lease them back to the MoD. Annington was acquired in 2012 by the private equity firm Terra Firma Capital Partners.

Under this ‘sale-and-leaseback’ arrangement, the MoD sold the homes to Annington for £1.7 billion and leased them back for a 200 year period. Somewhat unusually, the MoD is also responsible for their maintenance and refurbishment. The Guardian estimates that the MoD is paying about £180 million a year in rent and a further £140 million each year for repairs and upgrades.

When properties are no longer required by the MoD, they are released from the arrangement and Annington is free to sell or to rent them to private individuals. The MoD has terminated its lease on more than 17,000 properties, meaning that just over 38,000 remain within the agreement between Annington and the MoD.

Like the housing market in general, the value of these properties has risen substantially over the years since their sale. According to the Guardian’s report, which is backed up by Annington’s own financial statements, the portfolio has been valued at £7.6 billion. Or around £10 billion under vacant possession, i.e. if they weren’t leased to the MoD.

The UK government has now announced, though, that it wants to reverse the deal and to take the homes still subject to the sale-and-leaseback agreement back into its own ownership. Essentially, having privatised them, it now wants to nationalise them again.

The defence procurement minister says that the MoD has a statutory right to buy out Annington’s interest in the properties. Terra Firma, which according to the Guardian is looking to sell Annington, disputes this right and says that it will fight to maintain its ownership position.

As a chartered public finance accountant and a former auditor in the public sector practice of a ‘big four’ audit firm, I’ve come across numerous deals like this. As well as other approaches to the private financing of assets used to deliver public services, such as public-private partnerships and the construction of assets under the private finance initiative. And I’ve not been a fan of any of them.

Before we go any further, though, let’s be clear. Sale-and-leaseback arrangements like this are perfectly legitimate. They’re pretty common and they feature in the syllabus of all accounting qualifications. And from what I’ve read in the news reports and from my own research, nobody involved in this particular sale-and-leaseback arrangement appears to have done anything underhand or skulduggerous in any way.

The fact is, however, that arrangements like this tend all too frequently to represent atrocious value for money for the public purse. They may be a great deal for the private sector investors (otherwise they’d hardly be likely to invest in them), but they represent an “appalling” deal (the National Audit Office’s word, not mine) for the taxpayer.

In this case, it appears that the MoD negotiated a 25-year discount on rent, which presumably led it to believe that it would save money in the longer term. But it then, for whatever reason, took on responsibility for repairs and maintenance. And there is, as far as I can tell from the media reports, no provision for the MoD to share in any increase in the value of the properties included within the deal.

I’m not an asset finance specialist and I have no inside knowledge of this particular deal, but I can’t see how any public sector finance professional could think it makes good financial sense for the public purse.

And, as we now know, it doesn’t. I mentioned above that the National Audit Office has calculated that this arrangement has left the taxpayer between £2.2 and £4.2 billion worse off than if it had just kept hold of the properties. That’s after just 21 years. (The NAO reported on it in 2018.) The deal, don’t forget, runs for 200 years.

So how do deals like this end up getting signed at all? In my experience, there are two main reasons. The first is an ideological conviction among some politicians and political parties that the public sector should not run things if the private sector can do it instead. A deep-seated belief – verging on a dogma – that privatisation is a noble end itself, rather than a means to something more profound.

The second reason is cash. Government departments get through a lot of it. And there’s never enough of it to go around. Furthermore, government bodies face restrictions on financial borrowing, even for building things like schools and hospitals, because this would appear on the Government’s balance sheet and so drive up the public debt.

And so, when departments see that they have billions of pounds tied up in houses and other assets, it’s understandable that they might give consideration to freeing up this value – through deals such as the one between the MoD and Annington – for investment elsewhere. This may well help to improve the delivery of public services in the short term, by allowing public bodies to fund things that they wouldn’t otherwise be able to fund, but in the long run it has a tendency to be – financially, at least – a less-than-spectacular success.

Arrangements within the UK public sector for the funding of capital assets have improved a little since 1996. And the private finance initiative and arrangements of a similar ilk are, thankfully, no longer seen as the ‘only game in town’. But there’s still a substantial reluctance to invest public funds in the creation of large-scale capital schemes and a heavy reliance on the private sector to fill the gap.

Until this changes, the Annington arrangement won’t be the last public sector financing deal to hit the headlines.

2 thoughts on “Why private finance deals make sense in the short term but not in the long run

  1. The problem appears to be the short term power of politicians to muck about with assets for their short term gains. As you say there is no legal issue, but even Portillo must have known that property in the UK increases in value and that proper maintenance of the property was required, and should be the owner’s responsibility. I wonder what our Civil Servants thought and why they allowed this.


    • Agreed. It’s quite distressing, really, how frequently politically-driven ideology trumps what might be seen by many as common sense. But I guess that’s intrinsic to democracy. And I know from experience that it’s easy enough to put together a reasonable-looking financial model that will prove whatever you want it to prove. I also worry, though, that public sector professionals, while extremely dedicated to what they do, sometimes lack the skills and expertise to engage effectively with their private sector counterparts, especially on complex deals like this one.


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