2006 marked another strong year in the property investment
market with total returns reaching 18.5 per cent. This is the third consecutive
year where returns have reached these exceptional levels and against a backdrop
of solid, if not spectacular, economic growth, the future would appear to
be set fair.
Once again, financial performance was driven primarily by falling investment
yields as the weight of money targeting the real estate sector remained
strong. Yield compression has been a global phenomenon, reflecting the glut
of savings in Asia and energy-producing countries. This further compression
continued in the face of rising interest rates, such that the IPD Initial
Yield*, of 4.6 per cent finished the year 70 basis points below the five-year
finance swap rate, making the leveraged investor a reticent participant.
Risk aversion may return if perceptions change regarding UK monetary policy.
We are beginning to see the early signs of this particular reverse yield
gap impacting on secondary property values, which comprise the bulk of investment
stock, as the market becomes more selective where rental growth prospects
look limited and where yield compression is no longer seen to be the apparent
indiscriminate driver of enhanced returns. Yield differentials will eventually
adjust to reflect the realities of the occupational market as compared to
the current exuberance of the investment market. We have sought to close
out our exposure in this sector of the market since values of these assets
may deteriorate rapidly, depending on the cost and availability of money.
It is worth reflecting that whilst markets can take a long time to rise,
they can reverse at a more alarming rate.
The value of prime property, by virtue of location, covenant or asset management
opportunities, will remain stable. There remains a wall of money chasing
a finite property supply. We have increasingly focused our portfolio towards
assets with one or all of these characteristics.
As the capital markets plateau, the focus will once again turn to the income-related
element of returns which involves the demand and supply balance in occupational
markets. Encouragingly, 2006 saw rental growth contributing to returns,
with offices doing notably well relative to retail and industrial property.
We feel that the Company’s exposure to the office market is best
achieved through its development business where we can, through new build
and refurbishment projects, provide high quality accommodation which will
have enhanced letting and performance prospects. We are uncertain as to
whether the recovery in this sector will spread to Grade B and C quality
buildings which form the bulk of investment grade stock.
Despite a softening retail sector, we remain focused within our investment
portfolio on the convenience shopping market, where consumer expenditure,
by its nature, is more stable. The key component of the strategy is a food
retail offer either within or adjoining the scheme. Since this is the one
area of the retail market enjoying both volume and value growth, our focus
remains on shopping centres which offer a combination of secure income and
significant asset management opportunities compared to the traditional High
Street, which we feel is more threatened. We have sold all of our remaining
unit shop exposure during the course of 2006 except those assets with short-term
value potential.
These various themes make the investment market difficult to predict. We
therefore remain even more committed to our three key investment principles
of sector rotation, stock selection and proactive management. Of these,
we remain convinced that stock selection is the key to performance. In addition,
we remain focused on releasing value from the assets we own.
In general, 2006 could be characterised as a year in which we reduced exposure
to vulnerable assets, replenished our pipeline of opportunities and above
all maximised value through our management activities. In total during 2006,
we disposed of £45 million of property in eight transactions which
included the Princess of Wales Centre, Dewsbury. The key to achieving future
out-performance will be the intensive asset management of each holding and
we believe, perhaps justified by our long term out-performance of the investment
market, that we possess the requisite skills to achieve this.
A remarkable £4.0 million of value was created over the year at The
Furlong Centre, Ringwood where 2006 saw the continuation of our active strategy
to take back units and re-let to aspirational retailers, thereby driving
rental values further. Rental levels have broken through the £60 per
sq. ft. Zone A level and we are hopeful of achieving in excess of £70
per sq. ft. Zone A with our next letting. In addition, the turnover provisions
that we secured in some leases, based on our confidence in the trading potential
of the Centre, are starting to generate additional income and should increase
the rental levels to an effective £100 per sq. ft. So successful have
we been in recent years, that we now have few units remaining with which
to implement this strategy. Consequently, we have secured adjoining land
for further phases of development at The Furlong Centre. The additional
critical mass thus created will improve dwell times within the scheme and
further improve the rental tone. This process of further land assembly is
almost complete and we are hopeful of securing planning consent and commencing
on site during 2007.
We continue a similar process at Thatcham where, during 2006, we also acquired
adjoining land. Here again we hope to make a planning application shortly
and are close to securing those final land acquisitions required for implementation.
We have been encouraged by the lettings achieved in 2006, which have seen
rents improve by 11 per cent, and believe there is latent demand for the
new space to be created.
At Swanley Shopping Centre, we intend to submit a planning application
shortly for the comprehensive redevelopment of the entire scheme. Not only
is a positive dialogue underway with the Local Authority and local interest
groups, but pre-letting interest is encouraging us to maintain the initiative.
This retail development strategy coupled with a defensive investment strategy
is an evolving area of our business in which we prefer to work in conjunction
with smaller, specialist partners who assist in facilitating these opportunities.
We have long recognised the need to ensure that we have a clear pipeline
of opportunities that will deliver value whether or not the investment market
continues its current strength. Sourcing these deals is the current challenge
and we are pleased with our progress to date.
During the course of 2006, we acquired interests worth £4.3 million
in two other schemes. In one, we are in advanced negotiations to pre-let
a food store, with a favourable planning decision anticipated by mid-2007.
The other project should provide medium-term pipeline product and, when
considered alongside our projects at Ringwood, Thatcham and Swanley, is
ample confirmation of an enviable stream of such projects.
Other asset management initiatives completed during 2006 included the restructuring
of retail leases at Bexleyheath which contributed to the 23 per cent increase
in the property’s value. At our retail warehouse in Formby, we agreed
with the tenant a surrender and re-grant of the occupational lease, which
allowed us to agree a sale just before the year-end in a difficult market,
thus removing a problematic covenant exposure from our balance sheet. Completion
of this transaction occurred in February 2007.
Significant progress has been achieved at Peacock Place, Northampton, our
joint venture shopping centre project with Capmark, acquired in December
2005. The refurbishment of the internal areas commenced in January 2007
and we are now starting to reposition and re-market the Centre to access
latent demand within the town. Discussions are also ongoing with the major
Centre occupiers to enlarge their holdings, thereby strengthening and re-anchoring
the scheme.
We have completed the refurbishment of our vacant warehouse in Wigan, acquired
early in 2006. Demand in the logistics market has been patchy, but we are
beginning to see a resurgence in demand in the 100,000 sq. ft. size range
as distributors look to acquire sub-regional facilities. In addition, there
are tentative signs of demand from manufacturers seeking to upgrade facilities.
We are optimistic that an occupier for the unit will be secured during 2007.
* refer to note 1(p)
