Final Results - Part 1

Land Securities Group Plc 17 May 2006 17 May 2006 Land Securities Group PLC ('Land Securities' / 'Group') Preliminary results for the year ended 31 March 2006 Highlights â€¢ Basic net assets per share increased 23.5% to 1597p (2005: 1293p); adjusted diluted net asset value per share up 28.5% to 1912p (2005: 1488p) â€¢ The combined portfolio valuation increased by 15.3% over the reporting period to Â£12.9bn (2005: Â£9.4bn) with valuation uplift from retail warehouses of 14.1%, shopping centres of 12.0% and London offices of 19.7% â€¢ Pre-tax profit rose 80.4% to Â£2,359.2m (2005: Â£1,307.5m), including revaluation surpluses and an exceptional profit of Â£293.0m on the sale of the Group's share in Telereal â€¢ Revenue profit increased by 8.2% to Â£391.3m (2005: Â£361.8m) â€¢ Basic earnings per share were 357.95p, an increase of 57.5% (2005: 227.32p); adjusted diluted earnings per share up 5.4% to 70.47p (2005: 66.87p) â€¢ Total dividend for the year of 46.70p, an increase of 8.0% compared to last year (2005: 43.25p); lower final dividend of 28.55p (2005: 32.85p) more than offset by the increased interim dividend, reflecting the board's decision in 2005 to pay a greater proportion of the dividend at the interim stage â€¢ Major business development achievements included the successful acquisition of Tops Estates PLC and the LxB portfolio. â€¢ Good progress within the Group's retail portfolio, which now comprises 30 shopping centres, 30 retail parks and 11 supermarkets, and a retail led development pipeline totalling 364,000 sq m. Whitefriars, our major new retail scheme in Canterbury, was completed during the year and has won several notable industry awards â€¢ Strong progress in London offices with a 19.7% increase in value, the acquisition of 15 properties at a total cost of Â£643.4m and notable advances in the 301,000 sq m development pipeline. We reached practical completion at Cardinal Place our retail and office development, where we are making good progress with letting. We started on site at New Street Square and One Wood Street, which we let just after the year end â€¢ Significant strategic changes during the year for Land Securities Trillium, with the sale of Telereal. Capital released to be invested into further development of its offer, including new sectors such as Defence and Education. Commenting on the results, Peter Birch, Chairman of Land Securities, said: 'We have made considerable progress on all fronts this year and, in particular have positioned our London Portfolio business to benefit from the strong growth that the London office market is enjoying and which, we believe, it will continue to enjoy. Our Retail business now has a scale and quality of assets positioning it to generate ongoing income growth in a more challenging retail environment, and Land Securities Trillium is now pursuing a wider range of new business opportunities than at any time in the past. 'We now also have the prospect of a thriving REIT sector in the UK and we are enthusiastic about the opportunities this will present to us. Our preliminary assessment is that the regulations being introduced with REITs will not adversely inhibit flexibility and we believe that our existing strategy and mix of business can be accommodated within them. While we will not announce any final decision on REITs in advance of legislation, our view at present is that we are ideally positioned to benefit from this status. I would hope to announce our intentions and the implications for shareholders in the coming months and, subject to any unforeseen obstacles, am of the view that it will be in shareholders' interests to convert as soon as is practical after 1 January 2007. 'Land Securities has enjoyed a year of strong growth helped by continuing low interest rates. The outlook is positive for the business with a strong development pipeline, a high quality investment portfolio and an outsourcing business which has growth potential. I would like to congratulate everyone who has made this possible, most especially our people.' For further information, please contact: Land Securities Financial Dynamics Francis Salway/Emma Denne Stephanie Highett/Dido Laurimore Tel: 020 7413 9000 Tel: 020 7831 3113 Preliminary results for the year ended 31 March 2006 Financial Highlights 31/03/06 31/03/05 % change Â£m Â£m Gross property income (including joint ventures) Retail portfolio 371.8 298.1 24.7% London portfolio 514.0 358.1 43.5% Other 88.8 165.2 -46.2% Property outsourcing 1,013.6 1,054.8 -3.9% ----------- ----------- Total 1,988.2 1,876.2 6.0% Operating profit 2,443.4 1,404.8 73.9% Pre-tax profit 2,359.2 1,307.5 80.4% Revenue profit (pre-tax) 391.3 361.8 8.2% pence pence Earnings per share 357.95 227.32 57.5% Adjusted diluted earnings per share 70.47 66.87 5.4% Dividends per share 46.70 43.25 8.0% Diluted net assets per share 1590 1289 23.4% Adjusted diluted net assets per share 1912 1488 28.5% Â£m Â£m Combined portfolio valuation 12,892.9 9,365.8 37.7% Net borrowings 3,685.9 2,438.1 51.2% Equity shareholders' funds 7,493.9 6,050.3 23.9% % % Gearing (net) 49.2 40.3 Preliminary Results for the year to 31 March 2006 Chairman's Statement The outstanding performance of Land Securities over the past 12 months can be summed up by the 28.5% growth in adjusted diluted net assets per share, driven largely by the 15.3% valuation surplus on our investment portfolio and the Â£293.0m profit on the sale of Telereal. Growth in net assets is one of the leading financial measures against which we are benchmarked and I am delighted with this result in a year which was exceptional for both Land Securities and the property industry. Under International Reporting Financial Standards (' IFRS') our pre-tax profit was Â£2,359.2m and now includes revaluation surpluses as well as exceptional items, providing a simple measure of the value we have created for shareholders. Revenue profit, our measure of underlying pre-tax income, was up 8.2% to Â£391.3m and we are recommending a final dividend of 28.55p per share. Over the year we have made a total business return of 32.4%. Benchmarking We have reported against key benchmarks for three years now, allowing you to evaluate our performance against our major competitors and the underlying commercial property market. Once again this year the Group outperformed all its key benchmarks and given the important role benchmarks play, I hope you will not mind if I expand a little on these here. â€¢ Total shareholder return Total shareholder return is the most widely recognised way to compare returns from one publicly quoted company against another. As a constituent of the FTSE100 we compare our performance against both this and the FTSE Real Estate Index, over the 12 month period under review and since 1 April 2000 when we embarked upon the reinvigoration of the business. This year we produced a total shareholder return of 54.3% compared to 25.5% for the FTSE100 and 48.6% for FTSE Real Estate Index. The returns over the six years since 1 April 2000 are even more impressive recording 224.4% for Land Securities compared to 9.8% for the FTSE100 and 210.9% for FTSE Real Estate. â€¢ Investment Property Databank The next benchmark we employ is an external commercial property benchmark, known as the Investment Property Databank ('IPD'). By participating in this benchmark, which is the industry standard, we are able to compare the performance of our underlying property portfolios against the commercial property industry average. It also enables us to set key performance indicators for our Retail Property and London Portfolio business units. Our ungeared total investment portfolio return was 23.3% as compared to 20.6% for the IPD quarterly benchmark. â€¢ Weighted average cost of capital We also compare our return on average capital employed against our weighted average cost of capital ('WACC') which reflects the cost of the company's equity and debt capital. As well as providing a minimum hurdle rate for our investment decisions this also provides a sharp focus on the returns we make from our property investment, development and outsourcing activities. This is essential in a capital intensive industry. Over the past year our pre-tax WACC moved to 7%, which is half a percent lower than it was a year ago as a result of a lower cost of debt. This compared to a return on average capital employed of 26.4% and a return on average equity of 35.5%. Performance highlights In a year of high activity, I find it extremely hard to pick key highlights to demonstrate to you why I believe that this business is truly different to the organisation I joined when I became Chairman some eight years ago. I have, therefore, chosen three examples which not only demonstrate links to our sources of competitive advantage of scale, financial strength and skills but also ones which link clearly to our values. The first is our acquisition of Tops Estates PLC which was the first corporate acquisition made by us for over 35 years. The fact that we could purchase a business for over Â£0.5bn (including debt) and finance this out of existing resources is testament to our financial strength, particularly as we also invested a further Â£1.8bn across our business in the same year. We now own 30 shopping centres, which receive some 300 million visits per annum and provide some 5.8% of the retail accommodation across our core markets. This represents scale in a fragmented industry and can only be of benefit to our customers, the retailers. However, the reason that this acquisition so manifestly fulfils our values criteria is because the founder Chairman and majority shareholder of Tops Estates, Everard Goodman, had sufficient confidence in our company values that he recommended the sale to us of a business that he had spent a lifetime creating. Second on my list is the completion of two of our substantial developments, namely the mixed-use development at Cardinal Place, London SW1 and Whitefriars retail scheme in Canterbury. To date, we have invested a total of Â£369.8m in developing these two schemes and our development and project management teams delivered 46,580 sq m of retail space and 51,130 sq m of office space. The return on our investment, including acquisition costs, was 46.3%. Cardinal and Canterbury are now in the top ten properties in our Â£12.9bn investment portfolio. These schemes created 2,400 retail jobs and, at Cardinal Place, we will provide new accommodation for some 4,000 office workers. The link here with our values? Our values underpin our approach to development enabling us, in complex and difficult circumstances, to create attractive and economically thriving environments. The third example is the sale of Telereal, which generated Â£293.0m of profit for shareholders. And while it is always difficult to sell-out of successful ventures, we made this decision in anticipation of future reinvestment opportunities. The profit generated speaks volumes about the value Land Securities Trillium has created for the Group, leaving it poised for further growth from new business, the winning of which is supported by the excellent reputation for customer service that this business has developed. The Board We are fortunate to identify and recruit individuals to the Board with wide-ranging and complementary skills, who provide clear strategic direction, strong guidance and leadership to the Group. It is our primary responsibility to support and challenge executive management as they pursue our strategic objective of creating long-term sustainable returns for shareholders as well as ensuring the governance of the business on your behalf. I would like to welcome our new finance director, Martin Greenslade (41) who joined the Board earlier this year from BAE Systems and has supported the organisation through the transition IFRS. Strategic direction Six years ago we set out a new strategic direction and embarked upon a series of business initiatives aimed at the transformation of the Land Securities Group. The ambition was to create a modern, dynamic property business with a strategic focus on the customer and on income as well as asset value growth. We have been very successful in our ambitions. We have re-invigorated the investment property business, through an active sales and acquisitions programme, creating two highly-focused business units which, through scale, are now meaningful providers of accommodation to retail and London-based office occupiers. We have also invested in our property outsourcing business, Land Securities Trillium, creating the market-leading property solutions provider. This represents real innovation in an industry which can be slow to accept change. We have also become a more demanding employer, focusing our people with stretching performance based reward schemes and challenging many to adopt new ways of working and new skills. Regulatory We were very pleased with the Government's proposed legislation for the introduction of UK-REITs which it published in April 2006. This is likely to be enacted in the Finance Act in July 2006 allowing REITs to be formed from 1 January 2007. UK-REITs will be publicly listed, limited liability companies resulting in no change in the corporate status for quoted property companies like us. Conversion to a REIT will involve a change in tax status, and is the means by which the Government intends to create a level playing field in terms of taxation between owning shares in a quoted property company and direct ownership of property. In return for paying a conversion charge equal to 2% of the gross value of qualifying property assets, REITs will then be exempt from both corporation and capital gains tax on their qualifying property activities although dividends paid by REITs will be subject to withholding tax. We are waiting for final legislation to be enacted following which we will announce whether the Board believes conversion to a REIT will be in the interest of our shareholders. At present, we consider it likely to be so. Should the Board decide to make a positive recommendation we will need to alter our Memorandum and Articles of Association which will need the approval of our shareholders at an Extraordinary General Meeting. Outlook We have made considerable progress on all fronts this year and, in particular have positioned our London Portfolio business to benefit from the strong growth that the London office market is enjoying and which, we believe, it will continue to enjoy. Our Retail business now has a scale and quality of assets positioning it to generate ongoing income growth in a more challenging retail environment, and Land Securities Trillium is now pursuing a wider range of new business opportunities than at any time in the past. However, over the next 12 months we expect certain aspects of our environment to be more challenging. The Department for Work and Pensions, the largest of our property outsourcing customers, has started to use its flexible accommodation allowance, so, as expected, income from that contract will decrease over the next few years. We also do not believe that the unprecedented levels of growth in property values will continue at the same rate or necessarily be sustainable across all property types, particularly more secondary buildings. This growth occurred against a background of low interest rates which have increased recently in both Europe and America and it is for this reason that I sound a note of caution. At this time in the cycle we need to be particularly astute when purchasing standing investments and also take the opportunity to capture value through selective sales. However, if growth should slow or stall, we are in a strong financial position to be acquisitive once more while at the same time continuing to use our skills to create value from within our portfolio. We can also invest more in development and property outsourcing, which rely more heavily on our skills to deliver value to shareholders rather than the forces of investment markets. We now also have the prospect of a thriving REIT sector in the UK and we are enthusiastic about the opportunities this will present to us. Our preliminary assessment is that the regulations being introduced with REITs will not adversely inhibit flexibility and we believe that our existing strategy and mix of business can be accommodated within them. While we will not announce any final decision on REITs in advance of legislation, our view at present is that we are ideally positioned to benefit from this status. I would hope to announce our intentions and the implications for shareholders in the coming months and, subject to any unforeseen obstacles, am of the view that it will be in shareholders' interests to convert as soon as is practical after 1 January 2007. Land Securities has enjoyed a year of strong growth helped by continuing low interest rates. The outlook is positive for the business with a strong development pipeline, a high quality investment portfolio and an outsourcing business which has growth potential. I would like to congratulate everyone who has made this possible, most especially our people. Operating and Financial Review Headline results Profit before tax increased by 80.4% to Â£2,359.2m as compared to Â£1,307.5m for 2005. Revenue profit, our measure of underlying profit before tax, increased by 8.2% from Â£361.8m to Â£391.3m. Earnings per share were 357.95p, up 57.5% (2005: 227.32p) with adjusted, diluted earnings per share at 70.47p showing a 5.4% increase on the prior year (2005: 66.87p). The combined portfolio rose in value from Â£9.4bn to Â£12.9bn, which included a valuation surplus of Â£1,683.1m or 15.3%. More detail of this performance is contained in the Investment Property Business review. Net assets per share rose by 23.5% to 1597p from 1293p, with adjusted diluted net assets per share rising by 28.5% to 1912p (2005: 1488p). Profit before tax Under IFRS, profit before tax effectively represents the total pre-tax return to shareholders for the year, including both realised and unrealised gains and losses on the value of our investment properties. Previously, unrealised gains and losses were taken directly to reserves without being recognised in the income statement. In 2006, profit before tax increased by 80.4% to Â£2,359.2m, representing a pre-tax return of 39.0% on shareholders' equity at the beginning of the year. The principal drivers behind the increase in profit before tax are detailed in Table A. Profit Revenue Table A - before tax profit Principal changes in profit before tax and revenue profit Â£m Â£m Year ended 31 March 2005 1,307.5 361.8 Valuation surplus (A) 787.6 - Profit on disposal of Telereal (B) 293.0 - Distributions received from Telereal (C) (53.7) - Impact of Telereal sale 30 September 2005 - (17.4) Profit on disposal of fixed asset properties (35.8) - Profit on sale of trading properties 7.2 - Debt restructuring interest saving (D) 14.7 14.7 Increase in capitalised interest (E) 9.4 9.4 Amortisation of bond de-recognition (F) (16.9) - Long-term contract profits (G) 10.3 - Goodwill impairment (H) (51.8) - Property outsourcing profit (I) 2.8 2.8 Net rental income (J) 50.7 50.7 Exceptional costs relating to debt restructuring (K) 64.6 - Interest on increased debt (30.7) (30.7) Other 0.3 - ------------ ------------ Year ended 31 March 2006 2,359.2 391.3 ======= ======= (A) The valuation surplus was Â£787.6m higher than last year as described in the Investment Property Business review. (B) The disposal of our interest in the Telereal joint venture was completed on 30 September 2005. (C) Distributions from Telereal were significantly higher in 2005, reflecting a full year and higher levels of property sales. (D) This represents a full year's reduction in interest charges compared to a part year in the prior period resulting from the debt restructuring in November 2004. (E) Capitalised interest is higher than last year due to greater levels of investment in developments, principally at Cardinal Place and Bankside 2 and 3. (F) The debt instruments issued as part of the refinancing in November 2004 do not meet the requirements of IAS 39 as they are not deemed to be substantially different from the debt they replaced. As a result, the book value of the new instruments is reduced to the book value of the debt it replaced and the difference is amortised over the life of the new instruments. This year's charge was for the full year compared to five months in the prior period. (G) Higher levels of activity, primarily the recognition of profits from the development contract to build Bankside 1 for IPC. (H) Goodwill arising on the acquisition of Tops Estates PLC in June 2005, against which full provision has been made, is principally attributable to deferred tax on the revaluation of its investment properties. (I) Better performance on DWP contract, largely offset by the lower unitary charge from the BBC contract. (J) Largely driven by acquisitions and developments coming on stream. (K) Costs incurred last year related to the debt refinancing and not repeated in the current year. Revenue profit Revenue profit is our measure of the underlying pre-tax income of the Group. It is a financial measure we use internally to report our results and includes the pre-tax results of our joint ventures but excludes capital and other one-off items such as the valuation surplus and gains on disposals. For this year end, we have amended our definition of revenue profit to exclude trading profits and long-term contract income as both of these are considered more capital in nature than revenue. Furthermore, unlike the majority of our revenue profit, trading profits and long-term contract income will remain taxable even if we convert to REIT status. Revenue profit for the year grew by 8.2% from Â£361.8m to Â£391.3m. The main reasons for this increase are detailed in Table A. Under our old definition, revenue profit including trading profits and long-term contract income increased by 8.4 % from Â£401.3m to Â£434.9m. A reconciliation between profit before tax and revenue profit is shown in Table B. Table B - Reconciliation of profit before tax to 2006 2005 revenue profit Â£m Â£m Profit before tax 2,359.2 1,307.5 Revaluation surpluses - Group (1,579.5) (827.9) - joint ventures (105.5) (69.5) Fixed asset property disposals (75.3) (122.5) Goodwill impairment 64.5 12.7 Exceptional costs of debt restructuring - 64.6 Mark-to-market adjustment on interest rate swaps 2.2 2.7 Eliminate effect of bond exchange de-recognition 28.1 11.2 Credit arising from change in pension scheme benefits (8.3) - Profit on disposal of Telereal joint venture (293.0) - Adjustment to restate the Group's share of Telereal earnings from a distribution basis to an equity basis 5.0 (23.2) Joint venture tax adjustment 37.5 45.7 ----------- ----------- Revenue profit (old definition) 434.9 401.3 Profit on sale of trading properties (21.7) (27.9) Long-term development contract income (21.9) (11.6) ----------- ----------- Revenue profit (new definition) 391.3 361.8 ======= ======= Earnings per share Basic earnings per share grew by 57.5% to 357.95p (2005: 227.32p), the increase being mainly attributable to the same reasons as set out for profit before tax in Table A. The growth in earnings per share, however, has also been impacted by a rise in the tax rate. Reasons for the change in tax rate are set out in the section on taxation. In the same way that we adjust profit before tax to remove capital and one-off items to give revenue profit, we also report an adjusted earnings per share figure, although this includes some additional adjustments to revenue profit. The adjustments to earnings per share are set out in Note 7 and are based on the guidance given by the EPRA (European Public Real Estate Association) with a limited number of further adjustments to reflect better our underlying earnings. Adjusted diluted earnings per share rose from 66.87p per share in 2005 to 70.47p per share in 2006, a 5.4% increase. The growth in adjusted diluted earnings per share is largely due to the items in Table A related to changes in revenue profit as well as the lower profits on sale of trading properties and higher long-term contract income. Adjusted diluted earnings per share has not grown as strongly as revenue profit because of the higher current tax rate discussed below. Dividend We are recommending a final dividend of 28.55p per share this year, compared to 32.85p in 2005. Taken together with the interim dividend of 18.15p (2005: 10.40p), the total dividend of 46.70p represents an increase of 8% over last year's total of 43.25p. The lower proposed final dividend is more than offset by this year's higher interim dividend, which reflected our move to pay approximately 40% of our total dividend at the interim stage. The total dividend for 2006 is covered 1.5 times by adjusted earnings (2005: 1.6 times). Subject to approval by shareholders at the Annual General Meeting to be held on 19 July 2006, the final dividend will be paid on 24 July 2006 to shareholders on the register on 23 June 2006. The decision to increase our dividend by 8% is both a reflection of the growth in revenue profit and our view that the introduction of REITs will increase the focus of listed property companies on dividend payout ratios, irrespective of whether or not they convert to REIT status. Our aim will continue to be to deliver steady dividend growth, although we recognise the quantum of future dividends will be influenced by whether or not we choose to become a REIT. Net assets At the financial year end, net asset value per share was 1597p, an increase of 304p. In common with other property companies, we also calculate an adjusted measure of net assets, which we believe reflects better the underlying net assets attributable to shareholders. IFRS has increased the number and value of these adjustments, the largest of which is to reverse out the requirement under IFRS to provide deferred tax on valuation surpluses. The adjustments required to arrive at our adjusted diluted net assets per share are listed in Table C. The adjusted diluted net assets per share were 1912p at 31 March 2006, an increase of 424p or 28.5% over the previous year end. Year ended Year ended Table C - Net assets 31/03/06 31/03/05 Â£m Â£m Net assets at beginning of year 6,050.3 5,152.2 Profit after tax 1,675.9 1,060.9 Dividends paid (238.9) (175.5) Other 6.6 12.7 -------------- -------------- Net assets at end of year 7,493.9 6,050.3 Deferred tax on investment properties 145.0 145.0 Deferred tax on net revaluation surpluses 1,739.7 1,180.7 Mark-to-market on interest rate hedges 8.6 3.6 Debt adjusted to nominal value (375.3) (395.0) -------------- -------------- Adjusted net assets at end of year 9,011.9 6,984.6 ========== ========== Cash flow and net debt During the year cash receipts totalled Â£972.6m from property disposals (including the disposal of our 50% share in the Telereal joint venture). In total we invested Â£2,353.4m in our properties including Â£1,429.2m on direct acquisitions and Â£579.1m on corporate acquisitions. From our joint ventures, we received a net Â£133.8m, largely as a result of new financing that was put in place during the year. At 31 March 2006, the Group's net debt was Â£3,685.9m, some Â£1,247.8m higher than 2005 (Â£2,438.1m). The factors contributing to this increase in net debt are shown in table D. Year ended Year ended 31/03/06 31/03/05 Table D - Cash flow and net debt Â£m Â£m Â£m Â£m Operating cash inflow after interest and tax 375.9 216.6 Dividends paid (238.9) (175.5) Property acquisitions (including Tops Estates) 2,008.3 315.2 Development and refurbishment capital expenditure 345.1 378.4 ---------- ---------- Investment in properties 2,353.4 693.6 Other capital expenditure 26.9 19.3 ---------- ---------- Total capital expenditure (2,380.3) (712.9) Disposals (including Telereal) 972.6 690.4 Joint ventures 133.8 157.0 Other movements (110.9) (125.0) -------------- -------------- (Increase)/decrease in net debt (1,247.8) 50.6 Opening net debt (2,438.1) (2,488.7) -------------- -------------- Closing net debt (3,685.9) (2,438.1) ======== ======== Although we have continued to invest substantially during the year, increasing net debt by over 50%, gearing levels have only increased modestly. The main reason for this is that the large valuation uplift has resulted in increased net assets which have largely offset the growth in net debt. Details of the Group's gearing are set out in Table E, which includes the effects of our share of joint venture debt, although the lenders to our joint ventures have no recourse to the wider Group for repayment. At At Table E - Gearing 31/03/06 31/03/05 % % Gearing - on book value of balance sheet debt 49.2 40.3 Adjusted gearing (1) 46.9 43.0 Adjusted gearing (1) - as above plus notional share of joint venture debt (excluding Telereal) 51.1 44.2 ---------- ---------- (1) Book value of balance sheet debt increased to recognise nominal value of debt on refinancing in 2004 divided by adjusted net asset value. Financing strategy and financial structure Our finance strategy is to maintain an appropriate net debt to equity ratio (gearing) to ensure that asset-level performance is translated into good returns for shareholders as well as optimising our cost of capital. It has been our stated intention over the last 12 months to increase gearing through investment in our development programme and suitable investment properties. As noted above, we have successfully invested in the business but strong growth in the valuation of our portfolio has limited the increase in gearing. It is important, however, to put our gearing ratio into context. The gearing ratio only reflects our year end net debt position and not the average net debt during the period, which was Â£3.1bn (2005: Â£2.7bn). Furthermore, the increase in value of our properties is largely driven by yield shift as opposed to increased rental income. The gearing ratio is not the key measure of our ability to service the increase in debt. The more appropriate measure is interest cover. Despite the increase in our year end net debt, our interest cover ratio, excluding our share of joint ventures, has improved from 2.39 times in 2005 to 2.65 times in 2006. This reflects our higher earnings, a full year of lower interest costs due to our debt refinancing and a smaller difference in the average net debt between 2005 and 2006 than the respective year end positions might suggest. While, Land Securities may have lower financial gearing than some other listed property companies, it has significant operational gearing through its exposure to a large development pipeline. Developments tend to provide a greater percentage valuation change than conventional investment properties, with this being magnified by any change in yields or in occupier demand. Developments also carry a higher risk around timing, cost to completion and subsequent letting. On the basis of our interest cover ratio and the significant amount of funds available to us we would be prepared to see our financial gearing rise modestly from its current position. However, given the recent strong rise in property valuations and our caution about future growth prospects from investment properties, it may prove difficult for us to find suitable investment properties to acquire at this stage in the cycle. It is also becoming increasing difficult to acquire investment properties with good medium term prospects which yield above the marginal cost of our debt although we continue to invest heavily in development and outsourcing activities. As well as having the right level of debt in the business, we also need to ensure that we have a financing structure that is both flexible and cost effective. Both of these issues were addressed in the last financial year with the introduction of a new funding structure. Operational flexibility is provided through provisions which allow us to buy and sell assets easily as well as maintain our development programme. A committed revolving credit facility as part of the funding structure provides us with the financial flexibility to draw and repay loans at will, and react swiftly to investment opportunities. The cost effectiveness of the structure is achieved by providing lenders with security over a large proportion of our investment properties, resulting in lower interest margins than an unsecured structure. During the course of the year, we issued our first two new sterling bonds within the secured structure through our Â£4bn Note programme. The first was an issue of Â£400m with a fixed coupon of 4.875% and an expected maturity of 2017. The second was a Â£300m 4.625% fixed rate bond with an expected maturity of 2011. To illustrate the efficiency and flexibility of our funding structure, the more recent of the two bond issues took four working days from Board approval to pricing at an effective spread to a prevailing LIBOR of 9 basis points. As at 31 March 2006 Land Securities total borrowing amounted to Â£3,701.5m, of which Â£750.0m was drawn under our Â£2.0bn secured bank facility, and Â£74.6m related to finance leases. Committed but undrawn facilities amounted to Â£1,252.0m. The Group also has Â£123.5m of uncommitted facilities. Hedging We use derivative products to manage our interest rate exposure and have a hedging policy which requires at least 80% of our existing debt plus our net committed capital expenditure to be at fixed interest rates for the coming five years. Specific hedges are also used in geared joint ventures to fix the interest exposure on limited recourse debt. At the year end we had Â£858.2m of hedges in place, and our debt was 92% fixed. Consequently, based on year end debt levels, a 1% rise in interest rates would increase full year interest charges by only Â£3.2m. Future funding The Group's modest gearing levels and interest cover provide significant debt capacity to meet its projected capital requirements. Market capacity remains in Sterling and the Group has the flexibility if necessary to tap other markets such as the Euro. With Â£1.25bn of committed but undrawn facilities, the Group is confident that it will be able to finance its planned capital commitments. Taxation The tax charge for the year is Â£683.3m, giving an effective rate of 29.0% (2005: 18.9%). The lower tax rate in 2005 was primarily due to higher prior year adjustments and a lower effective rate of tax on property disposals. The tax rate on profit before exceptional items is lower at 27.8% (2005: 19.2%). The tax rate on exceptional items is higher than the standard rate largely due to the impact of the Tops Estates' goodwill impairment, which cannot be offset against taxable profits. Table F - Taxation Effective tax rate Ordinary Exceptional Total Profit before tax 2,130.7 228.5 2,359.2 Tax charge 593.3 90.0 683.3 Effective tax rate 27.8% 39.4% 29.0% ----------- ----------- ----------- IFRS requires that full provision is made for the deferred tax liability associated with the revaluation of investment properties. Accordingly, the tax charge includes deferred tax of Â£473.9m on revaluation gains arising in the period (2005: Â£248.3m). The current or 'cash' tax charge for the year, before tax on exceptional items and property disposals, is Â£76.9m. If we adjust this for tax related to prior years and the IFRS bond amortisation which is not tax deductible, we have an effective rate of 23.2%. This rate reflects the benefits of approximately Â£80m of gross capital allowances on developments as well as tax deductions available for capitalised interest. The equivalent rate for 2005 is not comparable due to the losses generated by the Group refinancing in the period. Pension schemes The Group operates a number of defined benefit pension schemes which are closed to new members. At 31 March 2006 the schemes had a combined deficit, net of deferred tax of Â£4.5m (2005: Â£7.6m). During the year we made a further special contribution of Â£1.5m (2005: Â£11.5m) to the principal defined benefit pension scheme and we are maintaining our enhanced contribution rate to address the relatively small deficit. During the year we introduced amendments to the main scheme which were adopted by the Trustees for active members who have given their consent. As a result, active members will have their accrued entitlement at 31 March 2006 linked to inflation, with future benefits according to annual earnings. The effect of this has been a reduction of approximately Â£8.3m in the Group's pension liability associated with funding future anticipated salary increases. Investment property business The performance of our Â£12.9bn combined investment portfolio is the responsibility of our Retail and London Portfolio businesses, with property management and project management skills being provided to them by the professional services departments headed up by our Group Chief Operating Officer. The day-to-day responsibility for the performance of the London retail properties, with the exception of Â£234.5m of retail and Â£14.5m of office assets held in the Metro Shopping Fund, is with the London Portfolio business. However, to assist comparison with our performance against the Investment Property Databank ('IPD'), we include the performance of our London retail properties under Retail in order to disclose our portfolio valuation statistics according to the IPD categories. Performance The strong performance over the year of the combined investment portfolio, which includes our share of the value of joint ventures, reflects not only the continued yield shift but also the value we have created through our development and asset management activities with a particularly strong contribution from development. We revalue our investment portfolio every six months. It was valued at Â£9.4bn at 31 March 2005, Â£11.4bn at 30 September 2005 and Â£12.9bn at 31 March 2006. Part of the 37.7% increase in the size of the portfolio over the year is attributable to our expenditure on acquisitions and developments, net of disposals. The like-for-like valuation surplus for the year was Â£1,047m or 15.9% of which Â£573.9m or 8.7% occurred in the six months since 30 September 2005. Table G Open Open Rental Rental market market income income value value Valuation year to year to 31/03/06 31/03/05 surplus (1) 31/03/06 31/03/05 Â£m Â£m % Â£m Â£m % Retail Shopping centres and shops 2,335.1 1,996.3 14.2 140.7 133.6 5.3 Retail warehouses 1,494.1 1,254.6 18.3 61.7 56.6 9.0 London retail 865.6 752.4 14.7 41.8 44.7 (6.5) London offices 2,710.4 2,310.1 16.9 167.3 172.3 (2.9) Other 292.9 264.8 11.7 13.1 11.2 17.0 ---------- ---------- ---------- ---------- ---------- --------- Like-for-like investment portfolio 7,698.1 6,578.2 15.9 424.6 418.4 1.5 (2) ---------- ---------- ---------- ---------- ---------- --------- Completed developments 565.3 437.6 21.4 26.1 12.5 - Purchases 3,337.6 970.4 7.6 123.0 22.5 - Disposals and restructured - 627.5 - 20.8 56.9 - interests Development programme (3) 1,291.9 752.1 32.9 19.5 16.8 - ---------- ---------- ---------- ---------- ---------- --------- Combined investment portfolio 12,892.9 9,365.8 15.3 614.0 527.1 16.5 ---------- ---------- ---------- ---------- ---------- --------- Adjustment for finance leases - - - (13.2) (10.9) n/a Combined investment portfolio - - - 600.8 516.2 16.4 ---------- ---------- ---------- ---------- ---------- --------- (1) The valuation surplus and rental income value are stated after adjusting for the effect of spreading of rents and rent free periods over the duration of leases in accordance with IFRS but before restating for finance leases. (2) Properties that have been in the combined investment portfolio for the whole of the current and previous financial periods. (3) Development programme comprising projects which are completed but less than 95% let, developments on site, committed developments (approved projects with the building contract let), and authorised developments (projects approved by the Board, but for which the contract has not yet been let). As we have previously commented, continued yield shift was one of the factors behind the strong performance of the investment portfolio this year. For the whole year we experienced a 13.2% uplift in value from compression in yields on the like-for-like portfolio where the net equivalent yield is now 5.3%. On the like-for-like portfolio we have seen the strongest total return from our London Portfolio, which has delivered 24.2%, followed closely by retail warehousing with 21.9% and shopping centres and shops with a 19.8% total return over the period. Returns are boosted further when the Â£565.3m of completed developments are included. These comprise Empress State; Whitefriars, Canterbury; 40 Eastbourne Terrace, W2 and the Ravenside Retail Park, Bexhill. In addition our ongoing extensive development programme, currently valued at Â£1.3bn, has delivered a 32.9% valuation surplus, with the largest contribution from Cardinal Place, SW1. The overall total return from our combined investment portfolio over the last 12 months, including acquisitions and developments, was 23.3%. Our contribution to performance In terms of ungeared total property return, our investment portfolio outperformed the UK commercial property market, as represented by the IPD Quarterly benchmark, by 2.2%. Our London offices outperformed the equivalent sector benchmark by the substantial margin of 4.8% largely as a result of development profits. Our combined retail portfolio delivered a total return slightly ahead of its sector benchmark, up by 0.1%. While a combination of factors including yield shift contributed to the overall portfolio performance we illustrate below how the application of skills can drive the creation of value. Table P details the top six performing properties in each sector by revaluation increase together with an explanation of the key drivers of that performance. It is clear that yield shift played only a part in the creation of shareholder value. This table also demonstrates clearly the strong contribution from London development. Table H % % uplift in uplift in Retail value Description London value Description Meteor Centre, 34.5 Lettings, rental value 40 Eastbourne 80.5 Completion of Derby growth and yield Terrace, W2 development and letting compression to CB&I Limited Ravenside Retail 31.3 Completed development Cardinal Place, 44.1 Development Park, Bexhill and new lettings driving SW1 rental growth Lakeside Retail 26.0 New lettings driving New Street 43.7 Development Park, West rental Square, EC4 Thurrock growth White Rose 25.5 Reconfiguration and new 1 Theobald's 36.7 Rental value growth and Centre, Leeds lettings Court, WC1 yield compression Retail World, 24.3 Reconfiguration and new Devonshire 31.1 Reconfiguration, new Team Valley, lettings House, W1 letting and yield Gateshead compression N1 Shopping 23.1 Rental value growth and 1 Wood Street, 30.1 Development Centre, yield compression EC2 Islington At the year end the net reversionary potential of the like-for-like portfolio was 6.5% slightly higher than the 5.5% 12 months ago. This improvement has arisen from a reduction in the over-rented element of London offices, which are now only slightly over-rented, and from continued rental growth on retail assets, which now have a net reversionary potential of 12.2%. Set against this positive news on rental growth, voids on the like-for-like portfolio have increased from their historically low levels to 3.8%, although a proportion are strategic voids where we are keeping units vacant prior to redevelopment. Over the past year we also completed 270 rent reviews at an average rental level 11.7% ahead of ERV, generating Â£7.1m of additional income which will drive an increase in the value of our assets. We have also grown income on the like-for-like portfolio by 1.5% through a combination of new lettings and renewals. Table I - Investment and development portfolio valuation movements Investment Development Total Â£m Â£m Â£m Net book value at 31/03/05 7,484.5 755.6 8,240.1 Purchases 2,006.7 24.7 2,031.4 Disposals (655.8) (7.8) (663.6) Transfers into development (102.4) 102.4 - Transfers out of development 271.6 (271.6) - Transfers to trading properties and surrender premiums received (84.7) - (84.7) Capital expenditure 78.8 239.3 318.1 Valuation surplus 1,215.4 362.2 1,577.6 Capitalised interest - 24.5 24.5 Depreciation (2.9) - (2.9) Net book value at 31/03/06 10,211.2 1,229.3 11,440.5 ------------- ------------- ------------- Combined investment portfolio at 31/03/06 (including joint ventures) 11,601.0 1,291.9 12,892.9 ------------- ------------- ------------- Investment During the year we sold a total of Â£735.9m of property out of the combined investment portfolio (including joint ventures and net of sale costs), generating a profit of Â£73.4m (11% above book value). We also had our most active year ever in terms of acquisitions with the purchase of Â£2.2bn of investment properties (including assets bought by way of corporate acquisitions and joint ventures), which have shown a valuation surplus of 5.7% over the period since acquisition. The average yield on the properties sold was 3.3% (the low figure being explained by the rent free period on 30 Gresham Street) and the average initial yield on the assets acquired was 5.2% or 5.4% excluding properties acquired vacant. The purchase activity was principally accounted for by the acquisitions of Tops Estates, the LxB portfolio, and 15 London office investments. Development Our development programme, including our share of joint ventures and those properties completed and let in the year, produced a valuation surplus of Â£364.7m of which Â£181.3m occurred in the second half of the year. Four schemes were transferred into the investment portfolio from the development programme. These were 99% let and generated rents of Â£9.4m in the year under review. In a full year these will contribute Â£14.4m of rental income. Including our share of joint ventures and land acquisitions we spent Â£313.6m (excluding capitalised interest) on the development pipeline on projects including Cardinal Place, New Street Square, Bankside 2 and 3 in London and shopping centre developments in Bristol and Exeter. Cardinal Place has now reached practical completion and we have therefore stopped capitalising interest on this project. However, during the year interest of Â£11.5m was capitalised on Cardinal Place (31/03/05: Â£9.0m). We have an estimated further spend of Â£821m on the projects underway currently which, when complete and fully let, will produce Â£144.2m of annual income (at today's ERV). Capital expenditure on proposed developments could total Â£973m if we proceed with these schemes, which are held as part of the investment portfolio and have a current carrying value of Â£383.8m. We have been undertaking two developments on behalf of the BBC. Their new headquarters in Scotland at Pacific Quay in Glasgow is on programme for completion by the target date of mid July - and within budget. Of our various projects for the BBC, the only one which has shown some slippage has been Broadcasting House. However, the first phase has now been completed and preliminary works have started on the second and final phase. We, the BBC and Bovis Lend Lease, our building contractor have agreed in principle the construction programme and costs for Phase 2 and we have also reached agreement on the final account on Phase I. The figures given above for capital expenditure represent the company's actual or forecast cash outlays on developments. Including land values and capitalised interest, the total development cost for the full development pipeline is Â£3.1bn, of which Â£1.8bn relates to our current development programme. Retail Our retail business represents 53.3% of the investment property business and produces Â£243.7m of the Group's operating profit. We own 1.9 million sq m of retail accommodation including 30 shopping centres and 30 retail parks which represent a core market share of 5.8%. We have over 1,600 occupiers across this portfolio. Many of our retail properties form the central shopping districts of major cities and towns across the UK and, over a year, we estimate that some 300 million visits are made by consumers to our locations. We are also investing Â£1bn to create the next generation of retail locations through a 340,000 sq m development pipeline. The retail market The past year was noticeably tougher for retailers as retail sales growth slowed and rising costs, price deflation and increasing competition made trading conditions considerably more difficult than in previous years. The impact of this on like-for-like retail sales has been widely reported. While like-for-like performance is an important indicator of the underlying health of the retail market the most important trend indicator for us, as a retail property owner, is absolute sales performance, since to grow absolute sales a retailer needs to take on new or improved floor space. The trend here remains positive and our experience to date, especially when it comes to letting our retail developments, is satisfactory. There has also been an increasing polarisation of spend away from the traditional High Street towards supermarket and large format stores which provide consumers with more choice and perceived value for money while providing retailers with more cost effective trading formats. The internet, which is, for the most part, focused on specific market segments is growing its market share but still has some way to go in terms of overall impact on retail sales. Recent research from Verdict showed that in 2005 the internet represented almost half of retail sales growth but that it still only accounted for around 3% of total retail sales. Although the long-term economic outlook at present is still reasonably benign, market conditions remain difficult for retailers. A further indicator of consumer confidence is the housing market and, while Government statistics show that house price inflation has slowed, the market has not gone into a period of decline and has recently picked up in London and parts of the south-east. Our strategy Over the last year we have continued to strengthen our position as a leading owner of retail property through: â€¢ Investment in dominant retail assets â€¢ Regeneration and renewal of the portfolio â€¢ Provision of market leading levels of customer service and property management In pursuit of the above we had an extremely active year. We made a further Â£1,543.3m of acquisitions, and sold Â£336.8m of properties. We invested Â£76.9m in the development programme including the redevelopment of Exeter and starting on site at Bristol. Our performance In terms of valuation the retail portfolio continued to perform well. On a like-for-like basis this portfolio increased in value to Â£4.0bn with a 15.6% valuation surplus over the year. The retail park portfolio again demonstrated the strongest absolute growth, driven by strong investment demand for this type of asset and continued supply side constraints. While the continued yield shift was a factor in the performance of the retail portfolio, rental value growth of 4.0% also made a contribution. In addition, our skills are also making a difference with the valuation increases of the five top performing properties being driven by development or asset management activity. The portfolio is 13.6% gross reversionary and void levels remain low at 3.4% on a like-for-like basis. Table J 31/03/06 31/03/05 Total retail (a) Combined investment portfolio valuation Â£6,877.8m Â£4,750.4m Like-for-like investment portfolio valuation Â£3,978.5m Â£3,388.9m Rental income Â£207.4m Â£193.1m Gross estimated rental value Â£236.7m Â£223.8m Voids by estimated rental value Â£8.1m Â£4.9m Running yield 4.9% 5.6% ------------------ ------------------ Shopping centres Combined investment portfolio valuation Â£3,816.5m Â£2,553.8m ------------------ ------------------ Like-for-like investment portfolio valuation Â£2,128.8m Â£1,816.4m Rental income Â£129.9m Â£122.5m Gross estimated rental value Â£139.5m Â£131.0m Voids by estimated rental value Â£4.2m Â£3.1m Running yield 5.4% 6.2% ------------------ ------------------ Retail warehouses Combined investment portfolio valuation Â£2,298.8m Â£1,481.7m ------------------ ------------------ Like-for-like investment portfolio valuation Â£1,494.1m Â£1,254.6m Rental income Â£61.7m Â£56.6m Gross estimated rental value Â£74.5m Â£70.0m Voids by estimated rental value Â£1.9m Â£1.1m Running yield 4.1% 4.7% ------------------ ------------------ Combined investment portfolio extracted from Business Analysis and by reference to the Reconciliation Tables. (a) The retail portfolio includes shopping centres, retail warehouses, shops outside London, shops held through the Metro Shopping Fund LP, regional offices and sundry other properties outside London Our contribution to performance Over the past few years we have focused our retail portfolio in response to the longer-term trends in the retail markets, particularly retailers' desire for more efficient retail units. We have been successful in executing this strategy as we discuss in more detail in the sections below. Investment in dominant retail assets We have substantially restructured our retail portfolio which now predominantly comprises larger and more dominant retail assets. The drivers behind this approach is our belief that these properties will perform better over the long term and are more likely to benefit from changing consumer trends. Our research shows that shopping is now the third most popular way that a family will spend time together, with over 40% of respondents seeing shopping as a way in which they spend quality time together. It is our view that a great proportion of that time is spent in shopping destinations similar to those that we own - dominant shopping centres. A dominant shopping centre is one which has a large local population (' catchment' area) for whom it is their primary shopping destination. All but one of our shopping centres are located in central in-town shopping districts, many providing the prime retail accommodation and main consumer shopping experience. As a result of our portfolio restructuring efforts, we no longer have any substantial exposure to High Street retail in smaller towns, the segment which we believe in the longer term will be most impacted by the changing retail environment. Over the year we invested further in shopping centre assets with the acquisition of Tops Estates with a portfolio valued at Â£566.7m. This added a further six properties to our shopping centre portfolio after the profitable disposal of one of the centres. Since acquisition, the Tops Estates properties have shown a combined increase in underlying value of Â£43.0m, an uplift of 8%. A further manifestation of the changed nature of our shopping centre portfolio is our greater exposure to the leading retail destinations in the UK, which we believe perform better in a less buoyant retail environment. Top 5 retail destinations Land Securities' ownership â€¢ London West End â€¢ Oxford Street and Tottenham Court Road â€¢ Birmingham â€¢ Bullring â€¢ Glasgow â€¢ Buchanan Galleries â€¢ Leeds â€¢ Leeds Plaza and White Rose â€¢ Nottingham â€¢ No major ownership Source: Experian retail ranking We are also keen to create strategic joint ventures to provide enhanced asset management or development opportunities or to increase our exposure to specific market segments. The Scottish Retail Property Limited Partnership is an example of the former while the Metro Shopping Fund demonstrates the latter. In terms of changing consumer trends, consumers have more choice and are more mobile so it is important to provide an exceptional experience to attract them and encourage longer stays and repeat visits. At Gunwharf Quays, for example, the unique environment and mix of uses has resulted in a 16% increase in net income over the year. In the period under review we acquired a further designer outlet centre, The Galleria, Hatfield and agreed to forward purchase a development at Banbridge in Northern Ireland. Another trend is for convenience, accessibility and good car parking. Here we have invested significantly in retail parks and supermarkets. Bulky goods retailers have found trade to be more difficult but High Street retailers have been keen to expand into this larger format with lower rents and operating costs. During the year we acquired the LxB retail park and supermarket portfolio, comprising 14 properties, all of which benefit from open A1 planning consent. As a result of this acquisition, together with Â£108.6m of selective disposals, our retail park portfolio is now 70% open consent. Changing demand for retail park accommodation has helped us improve the average passing rent on this portfolio from Â£162 per sq m to Â£177 per sq m and combined with supply side constraints, make this segment one of the most attractive property investments. This is evidenced by the 14.1% valuation surplus of this portfolio driven partially by yield shift but also by our asset management activities. Regeneration and renewal of the portfolio In a competitive investment market, we are able to use our skills to develop new retail shopping centres of a calibre seldom available to purchase on the open market. We are fortunate to benefit here from the development opportunities inherent within the portfolio as well as our approach to developing in partnership with other leading retail property owners. Our current development programme will provide 238,330 sq m of new retail and leisure accommodation with a further 143,110 sq m of proposed developments in the pipeline. Schemes in progress today include Exeter, a 44,600 sq m scheme scheduled to open next year. Our lettings programme is on target here, with 56% of the retail accommodation already let or in solicitors' hands. At Bristol, a 140,000 sq m partnership development with Hammerson plc, due to complete in Autumn 2008, 36% of the retail accommodation is let or in solicitors' hands. Christ's Lane, Cambridge started around 15 months later than originally planned due to delays in obtaining freeholders' consent to redevelop. The 7,150 sq m mixed-use scheme, comprising eight shops, a cafe overlooking Christ's Pieces and 15 residential apartments, has already secured lettings with H&M, Zara, Bank and Giraffe cafe ahead of its scheduled completion in Autumn 2007. We also have three further proposed developments which we are planning to start this year. The St Davids 2 development, undertaken in partnership with Capital Shopping Centres, will bring the first John Lewis department store to Wales, anchoring the 103,600 sq m retail-led scheme in Cardiff's city centre. New retail, cafes, restaurants and 300 homes will be created and new public spaces and amenities will include a state-of-the-art public library. At Livingston, our proposals will create an additional 32,000 sq m of new retail space, 5,670 sq m of leisure space, 28 one and two-bedroom flats, including affordable housing, an 84-bed hotel and new public spaces in the town centre. At Corby our proposals for Willow Place comprise 16,260 sq m of retail accommodation in 27 units, the first phase of our regeneration activity in this high-growth town. We are also in the process of carrying out development appraisals in Leeds, Liverpool and Glasgow which could offer a further 100,000 sq m of development over the next five years. These and other schemes at the feasibility stage should provide a continued stream continued stream of future development opportunities, even though, due to the complexities of the UK planning system, it may be several years until we actually start on site. In addition to our major new development schemes we carry out smaller scale development activities across our retail park and shopping centre portfolio to reconfigure and improve these properties. Such activities covered 26,300 sq m of accommodation in the past year. Two prime examples are: â€¢ White Rose, Leeds: we agreed a reduction in the size of the existing Sainsbury's store from which an additional 6,720 sq m was created in five new units with lettings to Next, River Island, Zara and Schuh. â€¢ Ravenside Retail Park, Bexhill: this 24,710 sq m park, comprising 14 units, has recently undergone a 2,720 sq ft extension and facilities upgrade. These significant improvements attracted fashion retailer Next to a 930 sq m unit. In addition, the main anchor, Tesco, has occupied a 1,115 sq m extension. This activity has improved ERV's by 30%. London Portfolio Our London business represents 46.0% of the investment property business and produces Â£276.5m of the Group's underlying operating profit. We own 940,000 sq m of office accommodation and 90,000 sq m of retail floorspace. Our office portfolio represents approximately 4% of the total London office floorspace with over 650 occupiers accommodating more than 50,000 people. We are also investing Â£1.5bn on development, responding to our customers' needs with innovative, relevant buildings and top quality customer service. London economy It is worthwhile considering what it is that makes London so different to the rest of the UK in terms of its economy. It is undoubtedly one of the world's leading financial centres but it is also the heart of Government and a major tourist destination with outstanding cultural, arts and retail experiences. More than that, it is home to some seven million people as well as numerous businesses and benefits from a highly-skilled and flexible workforce. London's economy is also growing at a faster rate than that of the rest of the UK being forecast to grow by 2.7% over the next four years compared to UK growth of 2.4%. As London grows it will need continued investment in new buildings, homes and infrastructure. We have been investing in London's commercial landscape since 1944 and predict that over the next few years we will invest more in our Capital City than at any time previously, timing our investment to benefit from London's forecast growth. London retail We have discussed in detail the market conditions facing retailers at present. It is worth noting, however, that in London retail is also dependent on tourism and trends in overseas visitors. So, for example we expect London retail to benefit from the Olympic Games in 2012 as well as in the preceding and following years. Our strategy Against a background of more volatile markets in London we are seeking to: â€¢ Redeploy capital to maximise portfolio growth prospects while realising value as it is created â€¢ Enhance returns through development activities â€¢ Create strong relationships with occupiers in the London office and retail markets We have acquired Â£643.4m and sold Â£396.3m of property, including the Â£272.5m sale of our recently completed development in Gresham Street. We have also made substantial progress on our development programme; we spent Â£185.2m over the year on development, started 107,330 sq m of new projects, achieved 38,100 sq m of lettings (including those secured after our financial year end) and submitted planning applications for a further 118,480 sq m of commercial accommodation. Our performance We were very pleased with the performance of the London Portfolio this year which, on a like-for-like basis, increased in value to Â£3,658.2bn representing a 16.3% valuation surplus over the year. Specific properties within the London office portfolio remain over-rented but has reduced from 12.0% to 9.3%. Our acquisition programme has improved the reversionary potential of the London office portfolio from 5.4% to 6.0%. Void levels remain low at 4.5% on a like-for-like basis. London retail is 10% reversionary and void levels remain low at 3.1% on a like-for-like basis. Table K 31/03/06 31/03/05 London Portfolio (a) Combined investment portfolio valuation Â£5,932.4m Â£4,486.8m ---------------- ---------------- Like-for-like investment portfolio valuation Â£3,658.2m Â£3,131.9m Rental income Â£213.0m Â£221.3m Gross estimated rental value Â£228.8m Â£217.8m Voids by estimated rental value Â£9.5m Â£9.9m Running yield 5.8% 6.7% ---------------- ---------------- London offices Combined investment portfolio valuation Â£4,788.3m Â£3,585.2m ---------------- ---------------- Like-for-like investment portfolio valuation Â£2,710.4m Â£2,310.1m Rental income Â£167.3m Â£172.3m Gross estimated rental value Â£175.9m Â£165.4m Voids by estimated rental value Â£8.0m Â£9.6m Running yield 6.1% 7.0% ---------------- ---------------- London shops Combined investment portfolio valuation Â£1,053.7m Â£820.8m ---------------- ---------------- Like-for-like investment portfolio valuation Â£865.6m Â£752.4m Rental income Â£41.8m Â£44.7m Gross estimated rental value Â£48.0m Â£47.6m Voids by estimated rental value Â£1.5m Â£0.2m Running yield 4.8% 5.8% ---------------- ---------------- Combined investment portfolio extracted from Business Analysis and by reference to the Reconciliation Table. (a) The London portfolio includes London offices, London shops (with the exception of shops held through the Metro Shopping Fund LP) and sundry other properties in London. Our contribution to performance We recognised some time ago that the London occupational markets would be returning to a period of growth and have targeted our activities to benefit from this. This is evidenced by the restructuring of our portfolio together with our development activities where we were especially pleased to note that we created a 42.4% valuation surplus over the year. Redeploy capital to maximise future growth prospects while realising value as it is created An idiosyncracy of the institutional lease is that, in a market downturn, such that we experienced in London in 2002/2003, the investment value of a property is partially protected by the security of the underlying rental income, especially where this is higher than the current market rent. As occupational markets improve, this over-renting creates a drag on future income growth resulting in lower levels of capital value growth. In anticipation of a return to market growth and particularly given the very high levels of demand for well-let London office investments, we have made and will continue to consider selective disposals from the portfolio to enable the redeployment of capital in properties with better medium term growth prospects. Examples of this type of capital redeployment are purchases such as: â€¢ Ashdown House, SW1 acquired for Â£166.9m on an net initial yield of 5.8% and a passing rent on the offices of Â£380 per sq m â€¢ Holborn Gate, WC1 acquired for Â£85.8m on an net initial yield of 6.2% at an average passing rent of Â£360 per sq m â€¢ 6/7 Harbour Exchange and 8/9 Harbour Exchange, E14. These properties were acquired for Â£82.6m at a combined net initial yield of 5.9% at an average passing rent of Â£200 per sq m In total our acquisitions during the year have been at an average initial yield of 5.6% and have low average rents of only Â£307per sq m with good prospects for future rental income growth and asset management opportunities. A further strand to our investment approach is our desire to acquire or develop 'clusters' of properties in key locations enabling us to provide managed environments and an enhanced experience for our occupiers. In Victoria, for example, Ashdown House is strategically located directly opposite our Cardinal Place development. Not only will the office element of this property benefit from the rental growth now emerging in this market, but we have the opportunity to improve the retail element of this scheme taking advantage of the renewed enthusiasm from retailers for this location as a result of the success of Cardinal Place's retail offer. A further example is at New Street Square in Mid-town where we have recently acquired two properties, IPC Tower and Hill House that will benefit from our expenditure on development and the subsequent regeneration of this location. The final strand to our investment approach in London is to ensure that we crystallise value as it is created. This is demonstrated by Gresham Street where, following the successful letting to Dresdner Kleinwort Wasserstein, we sold this property to GIC Real Estate. Enhance returns through development activities At this stage in the cycle it is also opportune that we have expanded our London development activities. Over the year, developments underway in London contributed just under a third of the valuation surplus but represented only 16.0% of the capital employed with a particularly strong performance from Cardinal Place which has now reached practical completion. Developments currently on site will provide 143,050 sq m of new office accommodation together with some 7,650 sq m of retail floorspace. At Cardinal Place, the retail element which opened earlier this year is virtually fully let with only one unit available. Of the office accommodation, 52% is let or in solicitors' hands at an average rent of Â£600 per sq m. This is now the only Grade A newly-developed office accommodation available in the West End. It is interesting to note that we have attracted a new and diverse range of occupiers to Victoria including Wellington Asset Management, P&O, 3i and KCCI and we expect this trend to continue. At New Street Square, we initially started construction of three buildings totalling 43,370 sq m, two of which have been pre-let to Deloittes and are due for occupation in Spring 2008. To capitalise further on improving market conditions, we have also started the fourth and final building comprising 21,950 sq m of offices. On the South Bank, we completed Bankside 1 which we forward sold to IPC and are making good progress with Bankside 2 and 3, where we are creating some 35,550 sq m of speculative office accommodation together with 3,170 sq m of retail accommodation in two buildings. The third development project we started during the year was One Wood Street which we pre-let in its entirety to Eversheds just after the financial year-end. This global law firm has taken an 18-year lease on all of the 15,020 sq m office accommodation and will occupy all eight floors, with an option to lease back 1,860 sq m to Land Securities. In addition to the office space, the building incorporates 1,500 sq m of ground floor retail which is being let separately. As a result of our success to date in terms of both the timing and letting of development, we have decided to proceed with our development at One New Change, close to St Paul's Cathedral, a Jean Nouvel designed scheme which will provide 30,790 sq m of office accommodation and 20,550 sq m of retail floorspace. Given the sensitive location of the site and our innovative proposals we were very pleased to achieve a resolution to grant planning consent for this project. As we progress our development programme, we are also looking to secure a pipeline of future projects so that we are in a position to respond to occupier requirements as appropriate. To this end we are advancing a further 109,000 sq m of schemes, in Oxford Street and Fenchurch Street, through the planning system. At Oxford Street, we have made a planning application for a 30,000 sq m mixed used scheme incorporating retail, office and residential accommodation. At Fenchurch Street, the City Corporation is currently considering our application for a 79,000 sq m office tower, designed by Raphael Vinoly. We have also contributed to the Victoria Station Area Planning Brief proposals for a large site to the north of Victoria Station (Bressenden Place) where we have significant holdings. We are delighted with our progress to date on development and the level of interest in our current schemes. As with One New Change, we will only bring a scheme forward if we feel comfortable with the timing and fundamentals of the project in the context of the market. Securing planning does not necessarily mean we will develop. Property Outsourcing Land Securities Trillium produced 16% (Â£96.6m) of the Group's operating profit after the sale of its share of the Telereal joint venture in September 2005 and the prior year disposal of Media Village, White City. This business has a commercial portfolio totalling 3.32 million sq m and six clients for whom we provide business accommodation services to 175,000 people. Land Securities Trillium provides innovative property outsourcing solutions offering a more efficient approach to owning and managing property by eliminating the complexity of property management and provision of services while reducing the cost. Also known as property partnerships, we provide property outsourcing solutions to the corporate and the public sector. Our Strategy Land Securities Trillium has been pursuing a growth strategy and achieved its target of contributing 25% of the Group operating profit in 2005. It has firmly established itself as the market leader in property outsourcing in terms of the number of contracts it has won to date and is seeking to maintain this position by continuing to invest in the development of new property outsourcing models as well as developing market leading technological and customer service solutions. Following this year's sale of our share of the Telereal joint venture, we are now positioned to continue to grow our business by: â€¢ Accessing new opportunities for outsourcing contracts in existing and new markets â€¢ Growing our business with existing clients â€¢ Leading innovation in the outsourcing industry Our performance The financial performance of Land Securities Trillium is measured differently to that of the investment property business focusing more on income growth since its operating properties are not revalued. Once again this business had an excellent year, driven by the sale of its share of the Telereal joint venture together with a strong performance from the DWP contract. 31/03/06 31/03/05 Table L - Land Securities Trillium Financial results Â£m Â£m Contract level operating profit - Barclays 2.5 - - BBC 0.5 20.6 - DVLA 1.0 - - DWP 97.7 81.4 - Norwich Union 5.0 6.1 - Telereal II 6.9 - Bid costs (7.4) (2.6) Central costs (9.6) (7.8) -------- -------- 96.6 97.7 -------- -------- Profit on sale of fixed asset properties 1.0 30.5 Net surplus on revaluation of investment property 1.9 - Profit on disposal of joint venture (Telereal) 293.0 - -------- -------- Segment profit 392.5 128.2 -------- -------- Distribution received from Telereal 11.7 65.4 -------- -------- Land Securities Trillium made a segment profit of Â£392.5m compared to Â£128.2m for the year to 31 March 2005. Excluding profit on the sale of fixed assets, net surplus on revaluation and profit on disposal of Telereal segment profit was Â£96.6m (2005: Â£97.7m). This profit level was maintained despite the anticipated reduction in the BBC profit following the disposal of White City which generated capital receipts of Â£321.5m. We achieved a stronger than expected performance from the DWP contract together with positive contributions from DVLA, Norwich Union and Barclays in-line with our expectations. Following our exit from the Telereal joint venture, which generated an exceptional profit of Â£293.0m, after costs, we entered into new agreements maintaining our relationship with Telereal. These new agreements are called Telereal II and, over the last six months, it has contributed Â£6.9m to operating profit. Operating profit from the BBC reduced to Â£0.5m as a consequence of the sale of Media Village White City and the subsequent reduction in the unitary charge paid to us by the BBC. As this left no real estate in the partnership we agreed with the BBC that it would be better to re-tender the remaining facilities management services, reflecting the BBC desire for a shorter duration contract. We did not bid for that business and following a procurement exercise will be transferring our facilities management responsibilities to a new provider at the end of June 2006. The projects at Broadcasting House and Pacific Quays are unaffected by this change. The increase in bid costs reflects the considerable amount of activity on new bids, the largest of which, the Defence Training Review ('DTR'), is still in progress. The DWP has not utilised as much of its vacation allowance as we anticipated 12 months ago and additional services have also contracted giving rise to an increase in the unitary charge. While this delay in using its flexible accommodation allowance has had a positive effect on our results to date, the impact of this is to create a bigger future allowance which will decrease our income and profit more steeply as it is used. The DWP has indicated that it intends vacating some 150,000 sq m of free flexible space over the next two years and has given notice on 94,000 sq m as compared to 26,000 sq m this time last year. Our contribution to performance When Land Securities acquired Land Securities Trillium, it had one contract as compared to the six and the Investors in the Community joint venture today. Over the course of the past six years, Land Securities Trillium's performance has exceeded our expectations and delivered early on the Group's growth ambitions for this part of the business. We believe that this can be attributed to the way in which Land Securities Trillium pursues its strategic objectives as detailed below. Accessing new opportunities for outsourcing contracts in existing and new markets We have developed substantial expertise in the Government outsourcing markets and are now using that experience to bid for new contracts, examples of which are: Northern Ireland Civil Service ('NICS') Workplace 2010 - a 20 year partnership to transform the NICS office estate, improve the working environment for staff and facilitate new ways of working to enhance the delivery of services to the citizens of Northern Ireland. This opportunity is likely to be delivered through a PFI solution. Building Schools for the Future ('BSF') - the Government intends to invest Â£40bn in the BSF programme which is the largest ever Government schools investment initiative. The programme aims to rebuild or renew every secondary school in England over the next 15 years. To support this initiative, Land Securities Trillium has made an initial investment of about Â£20m into a 50/50 joint venture with the Mill Group called Investors in the Community ('IIC'). IIC is the preferred bidder for the Peterborough schools PFI and Bristol BSF projects and is shortlisted on the Leeds and Waltham Forest BSF projects. In addition, IIC progresses several further local government and health sector bids. Defence Training Review ('DTR') - DTR is a PPP programme developed to modernise the delivery of professional and trade training in the military and the continued professional development of the armed forces. The DTR is being procured by the MoD in two packages, with a combined estimated total value of about Â£13bn over a 25-year term. Package 1 is primarily technical training, including aeronautical engineering and communications and information systems. Package 2 incorporates logistics, joint personnel administration, security, languages, intelligence and photography as well as supply training. We are bidding as part of the Metrix consortium, which is a special purpose 50/50 joint venture company between ourselves and QinetiQ. Metrix is the only provider shortlisted in both packages. The MoD's timetable currently envisages an announcement of Preferred Bidder in late 2006. During the year we were one of two shortlisted parties bidding for MoDEL, a Â£200m MoD project to rationalise land holdings in West London. Although unsuccessful in this bid we believe that the experience gained will assist us in appraising future opportunities arising around surplus land holdings. Growing our business with existing clients We have worked with our existing clients to deliver extensions to their contracts to meet their changing needs. During the year we agreed three contract extensions, the largest of which was the Telereal II agreement which involves the continued management of leasehold risk on part of BT's estate and the provision of other services. The leasehold estate agreement runs until the end of 2031 (although Telereal and Land Securities have the option to terminate the agreement at any time on or after 31 March 2010 with not less than three months' notice). Under these new agreements we will receive annual revenues of approximately Â£50m leading to anticipated pre-tax profits of some Â£14m per annum. We also extended our relationship with Barclays Bank, where we assumed responsibility for an additional 16 properties located across the UK, totalling 6,347 sq m of accommodation. These are short-leasehold properties that are surplus to Barclays' requirements and are largely vacant as a result of its property rationalisation. Barclays made a capped payment to reflect the letting risk and we have assumed responsibility for all future benefits and liabilities relating to the transferred interests. During the year we agreed an extension to our current Norwich Union operations to include a project delivering a new working environment and comfort cooling scheme at their Colegate facility in Norwich. Our contract with Norwich Union is now completing its second year, and we are working with them to explore how we might extend further our partnership and service provision. Urban Community Development Our Urban Community Development activities represent long-term investment by Land Securities in non-core markets which will, we believe, deliver above average returns for shareholders. It is also an area where we can benefit from our balance sheet strength and development skills. Our activities here have progressed from a predominantly strategic planning focus to a focus on delivery on the ground. This is set against a background of lower growth but a stable residential housing market in the south east. Kent Thameside Our efforts have been focused on concluding negotiations with Dartford Borough Council on the planning gain package for our proposed development in Eastern Quarry, where a resolution to grant planning permission was awarded in July 2005. We have also made slow but steady progress in resolving outstanding issues with the Highways Agency regarding their objections to our application and remain confident that an acceptable solution will be found. We therefore committed to a Â£8.6m earth-moving contract which will see the creation of the new landscape needed for the development of the eastern end of the Quarry. We also completed the construction of and occupied our new 860 sq m marketing and management centre creating the hub for our future activities in Kent Thameside. At Ebbsfleet, where we have a 48.5% interest in the land surrounding the new Channel Tunnel Rail Link station opening in 2007, we have been working towards securing masterplan approval for part of the site. This will provide the framework against which our development partners, Countryside Properties, can make a detailed application for the first phase of development of over 300 new homes at Springhead. Our other joint venture with Countryside Properties at Waterstone Park continues with the development of the latest phase of new homes and apartments, which are selling well and achieving premium values for the location. This supports our commitment to work with partners who share our aspirations to invest in and deliver innovative and quality design. We agreed terms for the sale of our remaining interests at Crossways Business Park to Legal & General enabling a phased handover of the remaining development plots (approx 15% of the overall area of the park) to take place this year. Stansted As part of the review of the Regional Spatial Strategy for the East of England (RSS 14), we have promoted our 650 hectare (1,625 acre) site at Stansted for a range of uses to serve the future expansion of Stansted Airport and the growth in housing being forecast by the Government in respect of the M11 Corridor. We have also entered into a new option agreement with Aggregate Industries PLC for the rights to extract some four million tonnes of sand and gravel reserves on the site. Business Analysis Further non-statutory information, relating to the Group's Investment Portfolio and Property Outsourcing Businesses, is available on the Group's website at www.landsecurities.com/prelims2006. This includes more detailed information in respect to the combined portfolio valuation and further detail on Land Securities Trillium's existing contracts. This information is provided by RNS The company news service from the London Stock Exchange

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