Final Results - Part 1

17th May 2006 07:02

Land Securities Group Plc17 May 2006 17 May 2006 Land Securities Group PLC ("Land Securities" / "Group")Preliminary results for the year ended 31 March 2006 Highlights • 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) • The combined portfolio valuation increased by 15.3% over the reportingperiod to £12.9bn (2005: £9.4bn) with valuation uplift from retail warehouses of14.1%, shopping centres of 12.0% and London offices of 19.7% • Pre-tax profit rose 80.4% to £2,359.2m (2005: £1,307.5m), includingrevaluation surpluses and an exceptional profit of £293.0m on the sale of theGroup's share in Telereal • Revenue profit increased by 8.2% to £391.3m (2005: £361.8m) • 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) • Total dividend for the year of 46.70p, an increase of 8.0% compared tolast year (2005: 43.25p); lower final dividend of 28.55p (2005: 32.85p) morethan offset by the increased interim dividend, reflecting the board's decisionin 2005 to pay a greater proportion of the dividend at the interim stage • Major business development achievements included the successfulacquisition of Tops Estates PLC and the LxB portfolio. • Good progress within the Group's retail portfolio, which now comprises30 shopping centres, 30 retail parks and 11 supermarkets, and a retail leddevelopment pipeline totalling 364,000 sq m. Whitefriars, our major new retailscheme in Canterbury, was completed during the year and has won several notableindustry awards • Strong progress in London offices with a 19.7% increase in value, theacquisition of 15 properties at a total cost of £643.4m and notable advances inthe 301,000 sq m development pipeline. We reached practical completion atCardinal Place our retail and office development, where we are making goodprogress with letting. We started on site at New Street Square and One WoodStreet, which we let just after the year end • Significant strategic changes during the year for Land SecuritiesTrillium, with the sale of Telereal. Capital released to be invested intofurther development of its offer, including new sectors such as Defence andEducation. Commenting on the results, Peter Birch, Chairman of Land Securities, said: "We have made considerable progress on all fronts this year and, in particularhave positioned our London Portfolio business to benefit from the strong growththat the London office market is enjoying and which, we believe, it willcontinue to enjoy. Our Retail business now has a scale and quality of assetspositioning it to generate ongoing income growth in a more challenging retailenvironment, and Land Securities Trillium is now pursuing a wider range of newbusiness opportunities than at any time in the past. "We now also have the prospect of a thriving REIT sector in the UK and we areenthusiastic about the opportunities this will present to us. Our preliminaryassessment is that the regulations being introduced with REITs will notadversely inhibit flexibility and we believe that our existing strategy and mixof business can be accommodated within them. While we will not announce anyfinal decision on REITs in advance of legislation, our view at present is thatwe are ideally positioned to benefit from this status. I would hope to announceour intentions and the implications for shareholders in the coming months and,subject to any unforeseen obstacles, am of the view that it will be inshareholders' interests to convert as soon as is practical after 1 January 2007. "Land Securities has enjoyed a year of strong growth helped by continuing lowinterest rates. The outlook is positive for the business with a strongdevelopment pipeline, a high quality investment portfolio and an outsourcingbusiness which has growth potential. I would like to congratulate everyone whohas made this possible, most especially our people." For further information, please contact: Land Securities Financial DynamicsFrancis Salway/Emma Denne Stephanie Highett/Dido LaurimoreTel: 020 7413 9000 Tel: 020 7831 3113 Preliminary results for the year ended 31 March 2006Financial Highlights 31/03/06 31/03/05 % change £m £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% £m £mCombined 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 besummed up by the 28.5% growth in adjusted diluted net assets per share, drivenlargely by the 15.3% valuation surplus on our investment portfolio and the£293.0m profit on the sale of Telereal. Growth in net assets is one of theleading financial measures against which we are benchmarked and I am delightedwith this result in a year which was exceptional for both Land Securities andthe property industry. Under International Reporting Financial Standards ('IFRS') our pre-tax profit was £2,359.2m and now includes revaluation surplusesas well as exceptional items, providing a simple measure of the value we havecreated for shareholders. Revenue profit, our measure of underlying pre-taxincome, was up 8.2% to £391.3m and we are recommending a final dividend of28.55p 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 toevaluate our performance against our major competitors and the underlyingcommercial property market. Once again this year the Group outperformed all itskey benchmarks and given the important role benchmarks play, I hope you will notmind if I expand a little on these here. • Total shareholder return Total shareholder return is the most widely recognised way to compare returnsfrom one publicly quoted company against another. As a constituent of theFTSE100 we compare our performance against both this and the FTSE Real EstateIndex, over the 12 month period under review and since 1 April 2000 when weembarked upon the reinvigoration of the business. This year we produced a totalshareholder return of 54.3% compared to 25.5% for the FTSE100 and 48.6% for FTSEReal Estate Index. The returns over the six years since 1 April 2000 are evenmore impressive recording 224.4% for Land Securities compared to 9.8% for theFTSE100 and 210.9% for FTSE Real Estate. • Investment Property Databank The next benchmark we employ is an external commercial property benchmark, knownas the Investment Property Databank ('IPD'). By participating in thisbenchmark, which is the industry standard, we are able to compare theperformance of our underlying property portfolios against the commercialproperty industry average. It also enables us to set key performance indicatorsfor our Retail Property and London Portfolio business units. Our ungeared totalinvestment portfolio return was 23.3% as compared to 20.6% for the IPD quarterlybenchmark. • Weighted average cost of capital We also compare our return on average capital employed against our weightedaverage cost of capital ('WACC') which reflects the cost of the company's equityand debt capital. As well as providing a minimum hurdle rate for our investmentdecisions this also provides a sharp focus on the returns we make from ourproperty investment, development and outsourcing activities. This is essentialin a capital intensive industry. Over the past year our pre-tax WACC moved to7%, which is half a percent lower than it was a year ago as a result of a lowercost 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 todemonstrate to you why I believe that this business is truly different to theorganisation I joined when I became Chairman some eight years ago. I have,therefore, chosen three examples which not only demonstrate links to our sourcesof competitive advantage of scale, financial strength and skills but also oneswhich link clearly to our values. The first is our acquisition of Tops Estates PLC which was the first corporateacquisition made by us for over 35 years. The fact that we could purchase abusiness for over £0.5bn (including debt) and finance this out of existingresources is testament to our financial strength, particularly as we alsoinvested a further £1.8bn across our business in the same year. We now own 30shopping centres, which receive some 300 million visits per annum and providesome 5.8% of the retail accommodation across our core markets. This representsscale in a fragmented industry and can only be of benefit to our customers, theretailers. However, the reason that this acquisition so manifestly fulfils ourvalues criteria is because the founder Chairman and majority shareholder of TopsEstates, Everard Goodman, had sufficient confidence in our company values thathe recommended the sale to us of a business that he had spent a lifetimecreating. Second on my list is the completion of two of our substantial developments,namely the mixed-use development at Cardinal Place, London SW1 and Whitefriarsretail scheme in Canterbury. To date, we have invested a total of £369.8m indeveloping these two schemes and our development and project management teamsdelivered 46,580 sq m of retail space and 51,130 sq m of office space. Thereturn on our investment, including acquisition costs, was 46.3%. Cardinal andCanterbury are now in the top ten properties in our £12.9bn investmentportfolio. These schemes created 2,400 retail jobs and, at Cardinal Place, wewill provide new accommodation for some 4,000 office workers. The link herewith our values? Our values underpin our approach to development enabling us,in complex and difficult circumstances, to create attractive and economicallythriving environments. The third example is the sale of Telereal, which generated £293.0m of profit forshareholders. And while it is always difficult to sell-out of successfulventures, we made this decision in anticipation of future reinvestmentopportunities. The profit generated speaks volumes about the value LandSecurities Trillium has created for the Group, leaving it poised for furthergrowth from new business, the winning of which is supported by the excellentreputation for customer service that this business has developed. The Board We are fortunate to identify and recruit individuals to the Board withwide-ranging and complementary skills, who provide clear strategic direction,strong guidance and leadership to the Group. It is our primary responsibilityto support and challenge executive management as they pursue our strategicobjective of creating long-term sustainable returns for shareholders as well asensuring the governance of the business on your behalf. I would like to welcome our new finance director, Martin Greenslade (41) whojoined the Board earlier this year from BAE Systems and has supported theorganisation through the transition IFRS. Strategic direction Six years ago we set out a new strategic direction and embarked upon a series ofbusiness initiatives aimed at the transformation of the Land Securities Group.The ambition was to create a modern, dynamic property business with a strategicfocus on the customer and on income as well as asset value growth. We have beenvery successful in our ambitions. We have re-invigorated the investmentproperty business, through an active sales and acquisitions programme, creatingtwo highly-focused business units which, through scale, are now meaningfulproviders of accommodation to retail and London-based office occupiers. We havealso invested in our property outsourcing business, Land Securities Trillium,creating the market-leading property solutions provider. This represents realinnovation in an industry which can be slow to accept change. We have alsobecome a more demanding employer, focusing our people with stretchingperformance based reward schemes and challenging many to adopt new ways ofworking and new skills. Regulatory We were very pleased with the Government's proposed legislation for theintroduction of UK-REITs which it published in April 2006. This is likely to beenacted in the Finance Act in July 2006 allowing REITs to be formed from 1January 2007. UK-REITs will be publicly listed, limited liability companiesresulting in no change in the corporate status for quoted property companieslike us. Conversion to a REIT will involve a change in tax status, and is themeans by which the Government intends to create a level playing field in termsof taxation between owning shares in a quoted property company and directownership of property. In return for paying a conversion charge equal to 2% ofthe gross value of qualifying property assets, REITs will then be exempt fromboth corporation and capital gains tax on their qualifying property activitiesalthough dividends paid by REITs will be subject to withholding tax. We are waiting for final legislation to be enacted following which we willannounce whether the Board believes conversion to a REIT will be in the interestof our shareholders. At present, we consider it likely to be so. Should theBoard decide to make a positive recommendation we will need to alter ourMemorandum and Articles of Association which will need the approval of ourshareholders at an Extraordinary General Meeting. Outlook We have made considerable progress on all fronts this year and, in particularhave positioned our London Portfolio business to benefit from the strong growththat the London office market is enjoying and which, we believe, it willcontinue to enjoy. Our Retail business now has a scale and quality of assetspositioning it to generate ongoing income growth in a more challenging retailenvironment, and Land Securities Trillium is now pursuing a wider range of newbusiness opportunities than at any time in the past. However, over the next 12 months we expect certain aspects of our environment tobe more challenging. The Department for Work and Pensions, the largest of ourproperty outsourcing customers, has started to use its flexible accommodationallowance, so, as expected, income from that contract will decrease over thenext few years. We also do not believe that the unprecedented levels of growthin property values will continue at the same rate or necessarily be sustainableacross all property types, particularly more secondary buildings. This growthoccurred against a background of low interest rates which have increasedrecently in both Europe and America and it is for this reason that I sound anote of caution. At this time in the cycle we need to be particularly astutewhen purchasing standing investments and also take the opportunity to capturevalue through selective sales. However, if growth should slow or stall, we arein a strong financial position to be acquisitive once more while at the sametime continuing to use our skills to create value from within our portfolio. Wecan also invest more in development and property outsourcing, which rely moreheavily on our skills to deliver value to shareholders rather than the forces ofinvestment markets. We now also have the prospect of a thriving REIT sector in the UK and we areenthusiastic about the opportunities this will present to us. Our preliminaryassessment is that the regulations being introduced with REITs will notadversely inhibit flexibility and we believe that our existing strategy and mixof business can be accommodated within them. While we will not announce anyfinal decision on REITs in advance of legislation, our view at present is thatwe are ideally positioned to benefit from this status. I would hope to announceour intentions and the implications for shareholders in the coming months and,subject to any unforeseen obstacles, am of the view that it will be inshareholders' interests to convert as soon as is practical after 1 January 2007. Land Securities has enjoyed a year of strong growth helped by continuing lowinterest rates. The outlook is positive for the business with a strongdevelopment pipeline, a high quality investment portfolio and an outsourcingbusiness which has growth potential. I would like to congratulate everyone whohas made this possible, most especially our people. Operating and Financial Review Headline results Profit before tax increased by 80.4% to £2,359.2m as compared to £1,307.5m for2005. Revenue profit, our measure of underlying profit before tax, increased by8.2% from £361.8m to £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 £9.4bn to £12.9bn, which included avaluation surplus of £1,683.1m or 15.3%. More detail of this performance iscontained in the Investment Property Business review. Net assets per share roseby 23.5% to 1597p from 1293p, with adjusted diluted net assets per share risingby 28.5% to 1912p (2005: 1488p). Profit before tax Under IFRS, profit before tax effectively represents the total pre-tax return toshareholders for the year, including both realised and unrealised gains andlosses on the value of our investment properties. Previously, unrealised gainsand losses were taken directly to reserves without being recognised in theincome statement. In 2006, profit before tax increased by 80.4% to £2,359.2m,representing a pre-tax return of 39.0% on shareholders' equity at the beginningof the year. The principal drivers behind the increase in profit before tax aredetailed in Table A. Profit RevenueTable A - before tax profitPrincipal changes in profit before tax and revenue profit £m £mYear ended 31 March 2005 1,307.5 361.8Valuation 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 14.7Increase in capitalised interest (E) 9.4 9.4Amortisation 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 2.8Net rental income (J) 50.7 50.7Exceptional 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 £787.6m higher than last year as described inthe Investment Property Business review. (B) The disposal of our interest in the Telereal joint venture was completedon 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 toa part year in the prior period resulting from the debt restructuring inNovember 2004. (E) Capitalised interest is higher than last year due to greater levels ofinvestment in developments, principally at Cardinal Place and Bankside 2 and 3. (F) The debt instruments issued as part of the refinancing in November 2004do not meet the requirements of IAS 39 as they are not deemed to besubstantially different from the debt they replaced. As a result, the bookvalue of the new instruments is reduced to the book value of the debt itreplaced 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 priorperiod. (G) Higher levels of activity, primarily the recognition of profits from thedevelopment 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 todeferred tax on the revaluation of its investment properties. (I) Better performance on DWP contract, largely offset by the lowerunitary 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 notrepeated in the current year. Revenue profit Revenue profit is our measure of the underlying pre-tax income of the Group. Itis a financial measure we use internally to report our results and includes thepre-tax results of our joint ventures but excludes capital and other one-offitems 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 andlong-term contract income as both of these are considered more capital in naturethan revenue. Furthermore, unlike the majority of our revenue profit, tradingprofits and long-term contract income will remain taxable even if we convert toREIT status. Revenue profit for the year grew by 8.2% from £361.8m to £391.3m. The mainreasons for this increase are detailed in Table A. Under our old definition,revenue profit including trading profits and long-term contract income increasedby 8.4 % from £401.3m to £434.9m. A reconciliation between profit before tax and revenue profit is shown in TableB. Table B - Reconciliation of profit before tax to 2006 2005revenue profit £m £mProfit before tax 2,359.2 1,307.5Revaluation 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 12.7Exceptional costs of debt restructuring - 64.6Mark-to-market adjustment on interest rate swaps 2.2 2.7Eliminate effect of bond exchange de-recognition 28.1 11.2Credit 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 Telerealearnings from a distribution basis to an equity basis 5.0 (23.2)Joint venture tax adjustment 37.5 45.7 ----------- -----------Revenue profit (old definition) 434.9 401.3Profit 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 increasebeing mainly attributable to the same reasons as set out for profit before taxin Table A. The growth in earnings per share, however, has also been impactedby a rise in the tax rate. Reasons for the change in tax rate are set out inthe section on taxation. In the same way that we adjust profit before tax to remove capital and one-offitems to give revenue profit, we also report an adjusted earnings per sharefigure, 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 theguidance given by the EPRA (European Public Real Estate Association) with alimited number of further adjustments to reflect better our underlying earnings. Adjusted diluted earnings per share rose from 66.87p per share in 2005 to70.47p per share in 2006, a 5.4% increase. The growth in adjusted dilutedearnings per share is largely due to the items in Table A related to changes inrevenue profit as well as the lower profits on sale of trading properties andhigher long-term contract income. Adjusted diluted earnings per share has notgrown as strongly as revenue profit because of the higher current tax ratediscussed below. Dividend We are recommending a final dividend of 28.55p per share this year, compared to32.85p 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 lastyear's total of 43.25p. The lower proposed final dividend is more than offsetby this year's higher interim dividend, which reflected our move to payapproximately 40% of our total dividend at the interim stage. The total dividend for 2006 is covered 1.5 times by adjusted earnings (2005: 1.6times). Subject to approval by shareholders at the Annual General Meeting to beheld on 19 July 2006, the final dividend will be paid on 24 July 2006 toshareholders on the register on 23 June 2006. The decision to increase our dividend by 8% is both a reflection of the growthin revenue profit and our view that the introduction of REITs will increase thefocus of listed property companies on dividend payout ratios, irrespective ofwhether or not they convert to REIT status. Our aim will continue to be todeliver steady dividend growth, although we recognise the quantum of futuredividends 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 of304p. In common with other property companies, we also calculate an adjustedmeasure of net assets, which we believe reflects better the underlying netassets attributable to shareholders. IFRS has increased the number and value ofthese adjustments, the largest of which is to reverse out the requirement underIFRS to provide deferred tax on valuation surpluses. The adjustments requiredto 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, anincrease of 424p or 28.5% over the previous year end. Year ended Year endedTable C - Net assets 31/03/06 31/03/05 £m £mNet assets at beginning of year 6,050.3 5,152.2Profit after tax 1,675.9 1,060.9Dividends paid (238.9) (175.5)Other 6.6 12.7 -------------- --------------Net assets at end of year 7,493.9 6,050.3Deferred tax on investment properties 145.0 145.0Deferred tax on net revaluation surpluses 1,739.7 1,180.7Mark-to-market on interest rate hedges 8.6 3.6Debt 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 £972.6m from property disposals(including the disposal of our 50% share in the Telereal joint venture). Intotal we invested £2,353.4m in our properties including £1,429.2m on directacquisitions and £579.1m on corporate acquisitions. From our joint ventures, wereceived a net £133.8m, largely as a result of new financing that was put inplace during the year. At 31 March 2006, the Group's net debt was £3,685.9m,some £1,247.8m higher than 2005 (£2,438.1m). The factors contributing to thisincrease in net debt are shown in table D. Year ended Year ended 31/03/06 31/03/05Table D - Cash flow and net debt £m £m £m £mOperating cash inflow after interest and tax 375.9 216.6Dividends 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) 972.6 690.4Joint ventures 133.8 157.0Other movements (110.9) (125.0) -------------- --------------(Increase)/decrease in net debt (1,247.8) 50.6Opening 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, increasingnet debt by over 50%, gearing levels have only increased modestly. The mainreason for this is that the large valuation uplift has resulted in increased netassets which have largely offset the growth in net debt. Details of the Group'sgearing are set out in Table E, which includes the effects of our share of jointventure debt, although the lenders to our joint ventures have no recourse to thewider Group for repayment. At AtTable E - Gearing 31/03/06 31/03/05 % %Gearing - on book value of balance sheet debt 49.2 40.3Adjusted gearing (1) 46.9 43.0Adjusted 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 ofdebt 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 returnsfor shareholders as well as optimising our cost of capital. It has been ourstated intention over the last 12 months to increase gearing through investmentin our development programme and suitable investment properties. As noted above, we have successfully invested in the business but strong growthin the valuation of our portfolio has limited the increase in gearing. It isimportant, however, to put our gearing ratio into context. The gearing ratioonly reflects our year end net debt position and not the average net debt duringthe period, which was £3.1bn (2005: £2.7bn). Furthermore, the increase in valueof our properties is largely driven by yield shift as opposed to increasedrental income. The gearing ratio is not the key measure of our ability toservice 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 to2.65 times in 2006. This reflects our higher earnings, a full year of lowerinterest costs due to our debt refinancing and a smaller difference in theaverage net debt between 2005 and 2006 than the respective year end positionsmight suggest. While, Land Securities may have lower financial gearing than some other listedproperty companies, it has significant operational gearing through its exposureto a large development pipeline. Developments tend to provide a greaterpercentage valuation change than conventional investment properties, with thisbeing magnified by any change in yields or in occupier demand. Developmentsalso carry a higher risk around timing, cost to completion and subsequentletting. On the basis of our interest cover ratio and the significant amount of fundsavailable to us we would be prepared to see our financial gearing rise modestlyfrom its current position. However, given the recent strong rise in propertyvaluations and our caution about future growth prospects from investmentproperties, it may prove difficult for us to find suitable investment propertiesto acquire at this stage in the cycle. It is also becoming increasing difficultto acquire investment properties with good medium term prospects which yieldabove the marginal cost of our debt although we continue to invest heavily indevelopment and outsourcing activities. As well as having the right level of debt in the business, we also need toensure that we have a financing structure that is both flexible and costeffective. Both of these issues were addressed in the last financial year withthe introduction of a new funding structure. Operational flexibility isprovided through provisions which allow us to buy and sell assets easily as wellas maintain our development programme. A committed revolving credit facility as part of the funding structure providesus with the financial flexibility to draw and repay loans at will, and reactswiftly to investment opportunities. The cost effectiveness of the structure isachieved by providing lenders with security over a large proportion of ourinvestment properties, resulting in lower interest margins than an unsecuredstructure. During the course of the year, we issued our first two new sterling bonds withinthe secured structure through our £4bn Note programme. The first was an issueof £400m with a fixed coupon of 4.875% and an expected maturity of 2017. Thesecond was a £300m 4.625% fixed rate bond with an expected maturity of 2011. Toillustrate the efficiency and flexibility of our funding structure, the morerecent of the two bond issues took four working days from Board approval topricing at an effective spread to a prevailing LIBOR of 9 basis points. As at 31 March 2006 Land Securities total borrowing amounted to £3,701.5m, ofwhich £750.0m was drawn under our £2.0bn secured bank facility, and £74.6mrelated to finance leases. Committed but undrawn facilities amounted to£1,252.0m. The Group also has £123.5m of uncommitted facilities. Hedging We use derivative products to manage our interest rate exposure and have ahedging policy which requires at least 80% of our existing debt plus our netcommitted capital expenditure to be at fixed interest rates for the coming fiveyears. Specific hedges are also used in geared joint ventures to fix theinterest exposure on limited recourse debt. At the year end we had £858.2m ofhedges in place, and our debt was 92% fixed. Consequently, based on year enddebt levels, a 1% rise in interest rates would increase full year interestcharges by only £3.2m. Future funding The Group's modest gearing levels and interest cover provide significant debtcapacity to meet its projected capital requirements. Market capacity remains inSterling and the Group has the flexibility if necessary to tap other marketssuch as the Euro. With £1.25bn of committed but undrawn facilities, the Group is confident that itwill be able to finance its planned capital commitments. Taxation The tax charge for the year is £683.3m, giving an effective rate of 29.0% (2005:18.9%). The lower tax rate in 2005 was primarily due to higher prior yearadjustments 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 dueto the impact of the Tops Estates' goodwill impairment, which cannot be offsetagainst taxable profits. Table F - TaxationEffective tax rate Ordinary Exceptional TotalProfit before tax 2,130.7 228.5 2,359.2Tax charge 593.3 90.0 683.3Effective tax rate 27.8% 39.4% 29.0% ----------- ----------- ----------- IFRS requires that full provision is made for the deferred tax liabilityassociated with the revaluation of investment properties. Accordingly, the taxcharge includes deferred tax of £473.9m on revaluation gains arising in theperiod (2005: £248.3m). The current or 'cash' tax charge for the year, before tax on exceptional itemsand property disposals, is £76.9m. If we adjust this for tax related to prioryears and the IFRS bond amortisation which is not tax deductible, we have aneffective rate of 23.2%. This rate reflects the benefits of approximately £80mof gross capital allowances on developments as well as tax deductions availablefor capitalised interest. The equivalent rate for 2005 is not comparable due tothe losses generated by the Group refinancing in the period. Pension schemes The Group operates a number of defined benefit pension schemes which are closedto new members. At 31 March 2006 the schemes had a combined deficit, net ofdeferred tax of £4.5m (2005: £7.6m). During the year we made a further specialcontribution of £1.5m (2005: £11.5m) to the principal defined benefit pensionscheme and we are maintaining our enhanced contribution rate to address therelatively small deficit. During the year we introduced amendments to the mainscheme which were adopted by the Trustees for active members who have giventheir consent. As a result, active members will have their accrued entitlementat 31 March 2006 linked to inflation, with future benefits according to annualearnings. The effect of this has been a reduction of approximately £8.3m in theGroup's pension liability associated with funding future anticipated salaryincreases. Investment property business The performance of our £12.9bn combined investment portfolio is theresponsibility of our Retail and London Portfolio businesses, with propertymanagement and project management skills being provided to them by theprofessional services departments headed up by our Group Chief OperatingOfficer. The day-to-day responsibility for the performance of the London retailproperties, with the exception of £234.5m of retail and £14.5m of office assetsheld in the Metro Shopping Fund, is with the London Portfolio business. However, to assist comparison with our performance against the InvestmentProperty Databank ('IPD'), we include the performance of our London retailproperties under Retail in order to disclose our portfolio valuation statisticsaccording to the IPD categories. Performance The strong performance over the year of the combined investment portfolio, whichincludes our share of the value of joint ventures, reflects not only thecontinued yield shift but also the value we have created through our developmentand asset management activities with a particularly strong contribution fromdevelopment. We revalue our investment portfolio every six months. It wasvalued at £9.4bn at 31 March 2005, £11.4bn at 30 September 2005 and £12.9bn at31 March 2006. Part of the 37.7% increase in the size of the portfolio over theyear is attributable to our expenditure on acquisitions and developments, net ofdisposals. The like-for-like valuation surplus for the year was £1,047m or15.9% of which £573.9m or 8.7% occurred in the six months since 30 September2005. 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 £m £m % £m £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 -interestsDevelopment 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/aCombined investment portfolio - - - 600.8 516.2 16.4 ---------- ---------- ---------- ---------- ---------- --------- (1) The valuation surplus and rental income value are stated after adjustingfor the effect of spreading of rents and rent free periods over the duration ofleases in accordance with IFRS but before restating for finance leases. (2) Properties that have been in the combined investment portfolio for thewhole of the current and previous financial periods. (3) Development programme comprising projects which are completed but lessthan 95% let, developments on site, committed developments (approved projectswith the building contract let), and authorised developments (projects approvedby the Board, but for which the contract has not yet been let). As we have previously commented, continued yield shift was one of the factorsbehind the strong performance of the investment portfolio this year. For thewhole year we experienced a 13.2% uplift in value from compression in yields onthe 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 ourLondon Portfolio, which has delivered 24.2%, followed closely by retailwarehousing with 21.9% and shopping centres and shops with a 19.8% total returnover the period. Returns are boosted further when the £565.3m of completed developments areincluded. These comprise Empress State; Whitefriars, Canterbury; 40 EastbourneTerrace, W2 and the Ravenside Retail Park, Bexhill. In addition our ongoingextensive development programme, currently valued at £1.3bn, has delivered a32.9% valuation surplus, with the largest contribution from Cardinal Place, SW1.The overall total return from our combined investment portfolio over the last12 months, including acquisitions and developments, was 23.3%. Our contribution to performance In terms of ungeared total property return, our investment portfoliooutperformed the UK commercial property market, as represented by the IPDQuarterly benchmark, by 2.2%. Our London offices outperformed the equivalentsector benchmark by the substantial margin of 4.8% largely as a result ofdevelopment profits. Our combined retail portfolio delivered a total returnslightly ahead of its sector benchmark, up by 0.1%. While a combination offactors including yield shift contributed to the overall portfolio performancewe illustrate below how the application of skills can drive the creation ofvalue. Table P details the top six performing properties in each sector byrevaluation increase together with an explanation of the key drivers of thatperformance. It is clear that yield shift played only a part in the creation ofshareholder value. This table also demonstrates clearly the strong contributionfrom London development. Table H % % uplift in uplift inRetail value Description London value Description Meteor Centre, 34.5 Lettings, rental value 40 Eastbourne 80.5 Completion ofDerby growth and yield Terrace, W2 development and letting compression to CB&I Limited Ravenside Retail 31.3 Completed development Cardinal Place, 44.1 DevelopmentPark, Bexhill and new lettings driving SW1 rental growth Lakeside Retail 26.0 New lettings driving New Street 43.7 DevelopmentPark, West rental Square, EC4Thurrock growth White Rose 25.5 Reconfiguration and new 1 Theobald's 36.7 Rental value growth andCentre, Leeds lettings Court, WC1 yield compression Retail World, 24.3 Reconfiguration and new Devonshire 31.1 Reconfiguration, newTeam Valley, lettings House, W1 letting and yieldGateshead compression N1 Shopping 23.1 Rental value growth and 1 Wood Street, 30.1 DevelopmentCentre, yield compression EC2Islington At the year end the net reversionary potential of the like-for-like portfoliowas 6.5% slightly higher than the 5.5% 12 months ago. This improvement hasarisen from a reduction in the over-rented element of London offices, which arenow only slightly over-rented, and from continued rental growth on retailassets, which now have a net reversionary potential of 12.2%. Set against thispositive news on rental growth, voids on the like-for-like portfolio haveincreased from their historically low levels to 3.8%, although a proportion arestrategic voids where we are keeping units vacant prior to redevelopment. Over the past year we also completed 270 rent reviews at an average rental level11.7% ahead of ERV, generating £7.1m of additional income which will drive anincrease in the value of our assets. We have also grown income on thelike-for-like portfolio by 1.5% through a combination of new lettings andrenewals. Table I - Investment and development portfolio valuation movements Investment Development Total £m £m £m Net book value at 31/03/05 7,484.5 755.6 8,240.1 Purchases 2,006.7 24.7 2,031.4Disposals (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 78.8 239.3 318.1Valuation surplus 1,215.4 362.2 1,577.6Capitalised interest - 24.5 24.5Depreciation (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 £735.9m of property out of the combinedinvestment portfolio (including joint ventures and net of sale costs),generating a profit of £73.4m (11% above book value). We also had our mostactive year ever in terms of acquisitions with the purchase of £2.2bn ofinvestment properties (including assets bought by way of corporate acquisitionsand joint ventures), which have shown a valuation surplus of 5.7% over theperiod 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% excludingproperties acquired vacant. The purchase activity was principally accounted forby the acquisitions of Tops Estates, the LxB portfolio, and 15 London officeinvestments. Development Our development programme, including our share of joint ventures and thoseproperties completed and let in the year, produced a valuation surplus of£364.7m of which £181.3m occurred in the second half of the year. Four schemeswere transferred into the investment portfolio from the development programme.These were 99% let and generated rents of £9.4m in the year under review. In afull year these will contribute £14.4m of rental income. Including our share of joint ventures and land acquisitions we spent £313.6m(excluding capitalised interest) on the development pipeline on projectsincluding Cardinal Place, New Street Square, Bankside 2 and 3 in London andshopping centre developments in Bristol and Exeter. Cardinal Place has nowreached practical completion and we have therefore stopped capitalising intereston this project. However, during the year interest of £11.5m was capitalised onCardinal Place (31/03/05: £9.0m). We have an estimated further spend of £821mon the projects underway currently which, when complete and fully let, willproduce £144.2m of annual income (at today's ERV). Capital expenditure onproposed developments could total £973m if we proceed with these schemes, whichare held as part of the investment portfolio and have a current carrying valueof £383.8m. We have been undertaking two developments on behalf of the BBC. Their newheadquarters in Scotland at Pacific Quay in Glasgow is on programme forcompletion by the target date of mid July - and within budget. Of our variousprojects for the BBC, the only one which has shown some slippage has beenBroadcasting House. However, the first phase has now been completed andpreliminary works have started on the second and final phase. We, the BBC andBovis Lend Lease, our building contractor have agreed in principle theconstruction programme and costs for Phase 2 and we have also reached agreementon the final account on Phase I. The figures given above for capital expenditure represent the company's actualor forecast cash outlays on developments. Including land values and capitalisedinterest, the total development cost for the full development pipeline is£3.1bn, of which £1.8bn relates to our current development programme. Retail Our retail business represents 53.3% of the investment property business andproduces £243.7m of the Group's operating profit. We own 1.9 million sq m ofretail accommodation including 30 shopping centres and 30 retail parks whichrepresent a core market share of 5.8%. We have over 1,600 occupiers across thisportfolio. Many of our retail properties form the central shopping districts ofmajor cities and towns across the UK and, over a year, we estimate that some 300million visits are made by consumers to our locations. We are also investing£1bn to create the next generation of retail locations through a 340,000 sq mdevelopment pipeline. The retail market The past year was noticeably tougher for retailers as retail sales growth slowedand rising costs, price deflation and increasing competition made tradingconditions considerably more difficult than in previous years. The impact ofthis on like-for-like retail sales has been widely reported. Whilelike-for-like performance is an important indicator of the underlying health ofthe retail market the most important trend indicator for us, as a retailproperty owner, is absolute sales performance, since to grow absolute sales aretailer needs to take on new or improved floor space. The trend here remainspositive and our experience to date, especially when it comes to letting ourretail developments, is satisfactory. There has also been an increasing polarisation of spend away from thetraditional High Street towards supermarket and large format stores whichprovide consumers with more choice and perceived value for money while providingretailers with more cost effective trading formats. The internet, which is, forthe most part, focused on specific market segments is growing its market sharebut still has some way to go in terms of overall impact on retail sales. Recentresearch from Verdict showed that in 2005 the internet represented almost halfof retail sales growth but that it still only accounted for around 3% of totalretail sales. Although the long-term economic outlook at present is still reasonably benign,market conditions remain difficult for retailers. A further indicator ofconsumer confidence is the housing market and, while Government statistics showthat house price inflation has slowed, the market has not gone into a period ofdecline 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 leadingowner of retail property through: • Investment in dominant retail assets • Regeneration and renewal of the portfolio • Provision of market leading levels of customer service and propertymanagement In pursuit of the above we had an extremely active year. We made a further£1,543.3m of acquisitions, and sold £336.8m of properties. We invested £76.9min the development programme including the redevelopment of Exeter and startingon site at Bristol. Our performance In terms of valuation the retail portfolio continued to perform well. On alike-for-like basis this portfolio increased in value to £4.0bn with a 15.6%valuation surplus over the year. The retail park portfolio again demonstratedthe strongest absolute growth, driven by strong investment demand for this typeof asset and continued supply side constraints. While the continued yield shiftwas a factor in the performance of the retail portfolio, rental value growth of4.0% also made a contribution. In addition, our skills are also making adifference with the valuation increases of the five top performing propertiesbeing driven by development or asset management activity. The portfolio is 13.6% gross reversionary and void levels remain low at 3.4% ona like-for-like basis. Table J 31/03/06 31/03/05Total retail (a) Combined investment portfolio valuation £6,877.8m £4,750.4m Like-for-like investment portfolio valuation £3,978.5m £3,388.9m Rental income £207.4m £193.1m Gross estimated rental value £236.7m £223.8m Voids by estimated rental value £8.1m £4.9m Running yield 4.9% 5.6% ------------------ ------------------Shopping centres Combined investment portfolio valuation £3,816.5m £2,553.8m ------------------ ------------------ Like-for-like investment portfolio valuation £2,128.8m £1,816.4m Rental income £129.9m £122.5m Gross estimated rental value £139.5m £131.0m Voids by estimated rental value £4.2m £3.1m Running yield 5.4% 6.2% ------------------ ------------------Retail warehouses Combined investment portfolio valuation £2,298.8m £1,481.7m ------------------ ------------------ Like-for-like investment portfolio valuation £1,494.1m £1,254.6m Rental income £61.7m £56.6m Gross estimated rental value £74.5m £70.0m Voids by estimated rental value £1.9m £1.1m Running yield 4.1% 4.7% ------------------ ------------------ Combined investment portfolio extracted from Business Analysis and by referenceto the Reconciliation Tables. (a) The retail portfolio includes shopping centres, retail warehouses, shopsoutside London, shops held through the Metro Shopping Fund LP, regional officesand sundry other properties outside London Our contribution to performance Over the past few years we have focused our retail portfolio in response to thelonger-term trends in the retail markets, particularly retailers' desire formore efficient retail units. We have been successful in executing this strategyas we discuss in more detail in the sections below. Investment in dominant retail assets We have substantially restructured our retail portfolio which now predominantlycomprises larger and more dominant retail assets. The drivers behind thisapproach is our belief that these properties will perform better over the longterm and are more likely to benefit from changing consumer trends. Our researchshows that shopping is now the third most popular way that a family will spendtime together, with over 40% of respondents seeing shopping as a way in whichthey spend quality time together. It is our view that a great proportion ofthat 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 oneof our shopping centres are located in central in-town shopping districts, manyproviding the prime retail accommodation and main consumer shopping experience.As a result of our portfolio restructuring efforts, we no longer have anysubstantial exposure to High Street retail in smaller towns, the segment whichwe believe in the longer term will be most impacted by the changing retailenvironment. Over the year we invested further in shopping centre assets withthe acquisition of Tops Estates with a portfolio valued at £566.7m. This addeda further six properties to our shopping centre portfolio after the profitabledisposal of one of the centres. Since acquisition, the Tops Estates propertieshave shown a combined increase in underlying value of £43.0m, an uplift of 8%. A further manifestation of the changed nature of our shopping centre portfoliois our greater exposure to the leading retail destinations in the UK, which webelieve perform better in a less buoyant retail environment. Top 5 retail destinations Land Securities' ownership• London West End • Oxford Street and Tottenham Court Road• Birmingham • Bullring• Glasgow • Buchanan Galleries• Leeds • Leeds Plaza and White Rose• Nottingham • No major ownership Source: Experian retail ranking We are also keen to create strategic joint ventures to provide enhanced assetmanagement or development opportunities or to increase our exposure to specificmarket segments. The Scottish Retail Property Limited Partnership is an exampleof the former while the Metro Shopping Fund demonstrates the latter. In terms of changing consumer trends, consumers have more choice and are moremobile so it is important to provide an exceptional experience to attract themand 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 netincome over the year. In the period under review we acquired a further designeroutlet centre, The Galleria, Hatfield and agreed to forward purchase adevelopment at Banbridge in Northern Ireland. Another trend is for convenience, accessibility and good car parking. Here wehave invested significantly in retail parks and supermarkets. Bulky goodsretailers have found trade to be more difficult but High Street retailers havebeen keen to expand into this larger format with lower rents and operatingcosts. During the year we acquired the LxB retail park and supermarketportfolio, comprising 14 properties, all of which benefit from open A1 planningconsent. As a result of this acquisition, together with £108.6m of selectivedisposals, our retail park portfolio is now 70% open consent. Changing demand for retail park accommodation has helped us improve the averagepassing rent on this portfolio from £162 per sq m to £177 per sq m and combinedwith supply side constraints, make this segment one of the most attractiveproperty investments. This is evidenced by the 14.1% valuation surplus of thisportfolio driven partially by yield shift but also by our asset managementactivities. Regeneration and renewal of the portfolio In a competitive investment market, we are able to use our skills to develop newretail shopping centres of a calibre seldom available to purchase on the openmarket. We are fortunate to benefit here from the development opportunitiesinherent within the portfolio as well as our approach to developing inpartnership with other leading retail property owners. Our current development programme will provide 238,330 sq m of new retail andleisure accommodation with a further 143,110 sq m of proposed developments inthe pipeline. Schemes in progress today include Exeter, a 44,600 sq m scheme scheduled to opennext year. Our lettings programme is on target here, with 56% of the retailaccommodation already let or in solicitors' hands. At Bristol, a 140,000 sq mpartnership 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 planneddue to delays in obtaining freeholders' consent to redevelop. The 7,150 sq mmixed-use scheme, comprising eight shops, a cafe overlooking Christ's Pieces and15 residential apartments, has already secured lettings with H&M, Zara, Bank andGiraffe cafe ahead of its scheduled completion in Autumn 2007. We also have three further proposed developments which we are planning to startthis year. The St Davids 2 development, undertaken in partnership with CapitalShopping 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. Newretail, cafes, restaurants and 300 homes will be created and new public spacesand amenities will include a state-of-the-art public library. At Livingston, our proposals will create an additional 32,000 sq m of new retailspace, 5,670 sq m of leisure space, 28 one and two-bedroom flats, includingaffordable 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 retailaccommodation in 27 units, the first phase of our regeneration activity in thishigh-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 developmentover the next five years. These and other schemes at the feasibility stageshould provide a continued stream continued stream of future developmentopportunities, 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 scaledevelopment activities across our retail park and shopping centre portfolio toreconfigure and improve these properties. Such activities covered 26,300 sq mof accommodation in the past year. Two prime examples are: • White Rose, Leeds: we agreed a reduction in the size of the existingSainsbury's store from which an additional 6,720 sq m was created in five newunits with lettings to Next, River Island, Zara and Schuh. • Ravenside Retail Park, Bexhill: this 24,710 sq m park, comprising 14units, has recently undergone a 2,720 sq ft extension and facilities upgrade.These significant improvements attracted fashion retailer Next to a 930 sq munit. 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 andproduces £276.5m of the Group's underlying operating profit. We own 940,000 sqm of office accommodation and 90,000 sq m of retail floorspace. Our officeportfolio represents approximately 4% of the total London office floorspace withover 650 occupiers accommodating more than 50,000 people. We are also investing£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 therest of the UK in terms of its economy. It is undoubtedly one of the world'sleading financial centres but it is also the heart of Government and a majortourist destination with outstanding cultural, arts and retail experiences.More than that, it is home to some seven million people as well as numerousbusinesses 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 theUK being forecast to grow by 2.7% over the next four years compared to UK growthof 2.4%. As London grows it will need continued investment in new buildings,homes and infrastructure. We have been investing in London's commerciallandscape since 1944 and predict that over the next few years we will investmore in our Capital City than at any time previously, timing our investment tobenefit 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 tourismand trends in overseas visitors. So, for example we expect London retail tobenefit from the Olympic Games in 2012 as well as in the preceding and followingyears. Our strategy Against a background of more volatile markets in London we are seeking to: • Redeploy capital to maximise portfolio growth prospects whilerealising value as it is created • Enhance returns through development activities • Create strong relationships with occupiers in the London office andretail markets We have acquired £643.4m and sold £396.3m of property, including the £272.5msale of our recently completed development in Gresham Street. We have also madesubstantial progress on our development programme; we spent £185.2m over theyear on development, started 107,330 sq m of new projects, achieved 38,100 sq mof lettings (including those secured after our financial year end) and submittedplanning 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 yearwhich, on a like-for-like basis, increased in value to £3,658.2bn representing a16.3% valuation surplus over the year. Specific properties within the London office portfolio remain over-rented buthas reduced from 12.0% to 9.3%. Our acquisition programme has improved thereversionary potential of the London office portfolio from 5.4% to 6.0%. Voidlevels 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 31/03/05London Portfolio (a) Combined investment portfolio valuation £5,932.4m £4,486.8m ---------------- ---------------- Like-for-like investment portfolio valuation £3,658.2m £3,131.9m Rental income £213.0m £221.3m Gross estimated rental value £228.8m £217.8m Voids by estimated rental value £9.5m £9.9m Running yield 5.8% 6.7% ---------------- ----------------London offices Combined investment portfolio valuation £4,788.3m £3,585.2m ---------------- ---------------- Like-for-like investment portfolio valuation £2,710.4m £2,310.1m Rental income £167.3m £172.3m Gross estimated rental value £175.9m £165.4m Voids by estimated rental value £8.0m £9.6m Running yield 6.1% 7.0% ---------------- ----------------London shops Combined investment portfolio valuation £1,053.7m £820.8m ---------------- ---------------- Like-for-like investment portfolio valuation £865.6m £752.4m Rental income £41.8m £44.7m Gross estimated rental value £48.0m £47.6m Voids by estimated rental value £1.5m £0.2m Running yield 4.8% 5.8% ---------------- ---------------- Combined investment portfolio extracted from Business Analysis and by referenceto the Reconciliation Table. (a) The London portfolio includes London offices, London shops (with theexception of shops held through the Metro Shopping Fund LP) and sundry otherproperties in London. Our contribution to performance We recognised some time ago that the London occupational markets would bereturning to a period of growth and have targeted our activities to benefit fromthis. This is evidenced by the restructuring of our portfolio together with ourdevelopment activities where we were especially pleased to note that we createda 42.4% valuation surplus over the year. Redeploy capital to maximise future growth prospects while realising value as itis created An idiosyncracy of the institutional lease is that, in a market downturn, suchthat we experienced in London in 2002/2003, the investment value of a propertyis partially protected by the security of the underlying rental income,especially where this is higher than the current market rent. As occupationalmarkets improve, this over-renting creates a drag on future income growthresulting in lower levels of capital value growth. In anticipation of a returnto market growth and particularly given the very high levels of demand forwell-let London office investments, we have made and will continue to considerselective disposals from the portfolio to enable the redeployment of capital inproperties with better medium term growth prospects. Examples of this type ofcapital redeployment are purchases such as: • Ashdown House, SW1 acquired for £166.9m on an net initial yield of5.8% and a passing rent on the offices of £380 per sq m • Holborn Gate, WC1 acquired for £85.8m on an net initial yield of 6.2%at an average passing rent of £360 per sq m • 6/7 Harbour Exchange and 8/9 Harbour Exchange, E14. These propertieswere acquired for £82.6m at a combined net initial yield of 5.9% at an averagepassing rent of £200 per sq m In total our acquisitions during the year have been at an average initial yieldof 5.6% and have low average rents of only £307per sq m with good prospects forfuture 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 managedenvironments and an enhanced experience for our occupiers. In Victoria, forexample, Ashdown House is strategically located directly opposite our CardinalPlace development. Not only will the office element of this property benefitfrom the rental growth now emerging in this market, but we have the opportunityto improve the retail element of this scheme taking advantage of the renewedenthusiasm from retailers for this location as a result of the success ofCardinal Place's retail offer. A further example is at New Street Square in Mid-town where we have recentlyacquired two properties, IPC Tower and Hill House that will benefit from ourexpenditure on development and the subsequent regeneration of this location. The final strand to our investment approach in London is to ensure that wecrystallise value as it is created. This is demonstrated by Gresham Streetwhere, following the successful letting to Dresdner Kleinwort Wasserstein, wesold 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 Londondevelopment activities. Over the year, developments underway in Londoncontributed just under a third of the valuation surplus but represented only16.0% of the capital employed with a particularly strong performance fromCardinal Place which has now reached practical completion. Developmentscurrently on site will provide 143,050 sq m of new office accommodation togetherwith some 7,650 sq m of retail floorspace. At Cardinal Place, the retailelement which opened earlier this year is virtually fully let with only one unitavailable. Of the office accommodation, 52% is let or in solicitors' hands atan average rent of £600 per sq m. This is now the only Grade A newly-developedoffice accommodation available in the West End. It is interesting to note thatwe have attracted a new and diverse range of occupiers to Victoria includingWellington Asset Management, P&O, 3i and KCCI and we expect this trend tocontinue. At New Street Square, we initially started construction of three buildingstotalling 43,370 sq m, two of which have been pre-let to Deloittes and are duefor occupation in Spring 2008. To capitalise further on improving marketconditions, we have also started the fourth and final building comprising 21,950sq m of offices. On the South Bank, we completed Bankside 1 which we forwardsold to IPC and are making good progress with Bankside 2 and 3, where we arecreating some 35,550 sq m of speculative office accommodation together with3,170 sq m of retail accommodation in two buildings. The third development project we started during the year was One Wood Streetwhich 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 moffice accommodation and will occupy all eight floors, with an option to leaseback 1,860 sq m to Land Securities. In addition to the office space, thebuilding incorporates 1,500 sq m of ground floor retail which is being letseparately. As a result of our success to date in terms of both the timing and letting ofdevelopment, 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 provide30,790 sq m of office accommodation and 20,550 sq m of retail floorspace. Giventhe sensitive location of the site and our innovative proposals we were verypleased to achieve a resolution to grant planning consent for this project. As we progress our development programme, we are also looking to secure apipeline of future projects so that we are in a position to respond to occupierrequirements as appropriate. To this end we are advancing a further 109,000 sqm of schemes, in Oxford Street and Fenchurch Street, through the planningsystem. At Oxford Street, we have made a planning application for a 30,000 sqm mixed used scheme incorporating retail, office and residential accommodation.At Fenchurch Street, the City Corporation is currently considering ourapplication for a 79,000 sq m office tower, designed by Raphael Vinoly. We havealso contributed to the Victoria Station Area Planning Brief proposals for alarge site to the north of Victoria Station (Bressenden Place) where we havesignificant holdings. We are delighted with our progress to date on development and the level ofinterest in our current schemes. As with One New Change, we will only bring ascheme forward if we feel comfortable with the timing and fundamentals of theproject in the context of the market. Securing planning does not necessarilymean we will develop. Property Outsourcing Land Securities Trillium produced 16% (£96.6m) of the Group's operating profitafter the sale of its share of the Telereal joint venture in September 2005 andthe prior year disposal of Media Village, White City. This business has acommercial portfolio totalling 3.32 million sq m and six clients for whom weprovide business accommodation services to 175,000 people. Land Securities Trillium provides innovative property outsourcing solutionsoffering a more efficient approach to owning and managing property byeliminating the complexity of property management and provision of serviceswhile reducing the cost. Also known as property partnerships, we provideproperty outsourcing solutions to the corporate and the public sector. Our Strategy Land Securities Trillium has been pursuing a growth strategy and achieved itstarget of contributing 25% of the Group operating profit in 2005. It has firmlyestablished itself as the market leader in property outsourcing in terms of thenumber of contracts it has won to date and is seeking to maintain this positionby continuing to invest in the development of new property outsourcing models aswell as developing market leading technological and customer service solutions.Following this year's sale of our share of the Telereal joint venture, we arenow positioned to continue to grow our business by: • Accessing new opportunities for outsourcing contracts in existing andnew markets • Growing our business with existing clients • Leading innovation in the outsourcing industry Our performance The financial performance of Land Securities Trillium is measured differently tothat of the investment property business focusing more on income growth sinceits operating properties are not revalued. Once again this business had anexcellent year, driven by the sale of its share of the Telereal joint venturetogether with a strong performance from the DWP contract. 31/03/06 31/03/05Table L - Land Securities Trillium Financial results £m £mContract 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 30.5Net 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 £392.5m compared to £128.2mfor 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£96.6m (2005: £97.7m). This profit level was maintained despite the anticipatedreduction in the BBC profit following the disposal of White City which generatedcapital receipts of £321.5m. We achieved a stronger than expected performancefrom the DWP contract together with positive contributions from DVLA, NorwichUnion and Barclays in-line with our expectations. Following our exit from the Telereal joint venture, which generated anexceptional profit of £293.0m, after costs, we entered into new agreementsmaintaining our relationship with Telereal. These new agreements are calledTelereal II and, over the last six months, it has contributed £6.9m to operatingprofit. Operating profit from the BBC reduced to £0.5m as a consequence of the sale ofMedia Village White City and the subsequent reduction in the unitary charge paidto us by the BBC. As this left no real estate in the partnership we agreed withthe BBC that it would be better to re-tender the remaining facilities managementservices, reflecting the BBC desire for a shorter duration contract. We did notbid for that business and following a procurement exercise will be transferringour facilities management responsibilities to a new provider at the end of June2006. The projects at Broadcasting House and Pacific Quays are unaffected bythis change. The increase in bid costs reflects the considerable amount of activity on newbids, the largest of which, the Defence Training Review ('DTR'), is still inprogress. The DWP has not utilised as much of its vacation allowance as we anticipated 12months ago and additional services have also contracted giving rise to anincrease in the unitary charge. While this delay in using its flexibleaccommodation allowance has had a positive effect on our results to date, theimpact of this is to create a bigger future allowance which will decrease ourincome and profit more steeply as it is used. The DWP has indicated that itintends vacating some 150,000 sq m of free flexible space over the next twoyears and has given notice on 94,000 sq m as compared to 26,000 sq m this timelast year. Our contribution to performance When Land Securities acquired Land Securities Trillium, it had one contract ascompared to the six and the Investors in the Community joint venture today.Over the course of the past six years, Land Securities Trillium's performancehas exceeded our expectations and delivered early on the Group's growthambitions for this part of the business. We believe that this can be attributedto the way in which Land Securities Trillium pursues its strategic objectives asdetailed below. Accessing new opportunities for outsourcing contracts in existing and newmarkets We have developed substantial expertise in the Government outsourcing marketsand are now using that experience to bid for new contracts, examples of whichare: Northern Ireland Civil Service ('NICS') Workplace 2010 - a 20 year partnershipto transform the NICS office estate, improve the working environment for staffand facilitate new ways of working to enhance the delivery of services to thecitizens of Northern Ireland. This opportunity is likely to be delivered througha PFI solution. Building Schools for the Future ('BSF') - the Government intends to invest £40bnin the BSF programme which is the largest ever Government schools investmentinitiative. The programme aims to rebuild or renew every secondary school inEngland over the next 15 years. To support this initiative, Land Securities Trillium has made an initialinvestment of about £20m into a 50/50 joint venture with the Mill Group calledInvestors in the Community ('IIC'). IIC is the preferred bidder for thePeterborough schools PFI and Bristol BSF projects and is shortlisted on theLeeds and Waltham Forest BSF projects. In addition, IIC progresses severalfurther local government and health sector bids. Defence Training Review ('DTR') - DTR is a PPP programme developed to modernisethe delivery of professional and trade training in the military and thecontinued professional development of the armed forces. The DTR is beingprocured by the MoD in two packages, with a combined estimated total value ofabout £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 arebidding as part of the Metrix consortium, which is a special purpose 50/50 jointventure company between ourselves and QinetiQ. Metrix is the only providershortlisted in both packages. The MoD's timetable currently envisages anannouncement of Preferred Bidder in late 2006. During the year we were one of two shortlisted parties bidding for MoDEL, a£200m MoD project to rationalise land holdings in West London. Althoughunsuccessful in this bid we believe that the experience gained will assist us inappraising future opportunities arising around surplus land holdings. Growing our business with existing clients We have worked with our existing clients to deliver extensions to theircontracts to meet their changing needs. During the year we agreed threecontract extensions, the largest of which was the Telereal II agreement whichinvolves the continued management of leasehold risk on part of BT's estate andthe provision of other services. The leasehold estate agreement runs until theend of 2031 (although Telereal and Land Securities have the option to terminatethe agreement at any time on or after 31 March 2010 with not less than threemonths' notice). Under these new agreements we will receive annual revenues ofapproximately £50m leading to anticipated pre-tax profits of some £14m perannum. We also extended our relationship with Barclays Bank, where we assumedresponsibility for an additional 16 properties located across the UK, totalling6,347 sq m of accommodation. These are short-leasehold properties that aresurplus to Barclays' requirements and are largely vacant as a result of itsproperty rationalisation. Barclays made a capped payment to reflect the lettingrisk and we have assumed responsibility for all future benefits and liabilitiesrelating to the transferred interests. During the year we agreed an extension to our current Norwich Union operationsto include a project delivering a new working environment and comfort coolingscheme at their Colegate facility in Norwich. Our contract with Norwich Union isnow completing its second year, and we are working with them to explore how wemight extend further our partnership and service provision. Urban Community Development Our Urban Community Development activities represent long-term investment byLand Securities in non-core markets which will, we believe, deliver aboveaverage returns for shareholders. It is also an area where we can benefit fromour balance sheet strength and development skills. Our activities here haveprogressed from a predominantly strategic planning focus to a focus on deliveryon the ground. This is set against a background of lower growth but a stableresidential housing market in the south east. Kent Thameside Our efforts have been focused on concluding negotiations with Dartford BoroughCouncil on the planning gain package for our proposed development in EasternQuarry, where a resolution to grant planning permission was awarded in July2005. We have also made slow but steady progress in resolving outstanding issues withthe Highways Agency regarding their objections to our application and remainconfident that an acceptable solution will be found. We therefore committed toa £8.6m earth-moving contract which will see the creation of the new landscapeneeded for the development of the eastern end of the Quarry. We also completed the construction of and occupied our new 860 sq m marketingand management centre creating the hub for our future activities in KentThameside. At Ebbsfleet, where we have a 48.5% interest in the land surrounding the newChannel Tunnel Rail Link station opening in 2007, we have been working towardssecuring masterplan approval for part of the site. This will provide theframework against which our development partners, Countryside Properties, canmake a detailed application for the first phase of development of over 300 newhomes at Springhead. Our other joint venture with Countryside Properties at Waterstone Park continueswith the development of the latest phase of new homes and apartments, which areselling well and achieving premium values for the location. This supports ourcommitment to work with partners who share our aspirations to invest in anddeliver innovative and quality design. We agreed terms for the sale of our remaining interests at Crossways BusinessPark to Legal & General enabling a phased handover of the remaining developmentplots (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 arange of uses to serve the future expansion of Stansted Airport and the growthin housing being forecast by the Government in respect of the M11 Corridor. Wehave also entered into a new option agreement with Aggregate Industries PLC forthe rights to extract some four million tonnes of sand and gravel reserves onthe site. Business Analysis Further non-statutory information, relating to the Group's Investment Portfolioand Property Outsourcing Businesses, is available on the Group's website atwww.landsecurities.com/prelims2006. This includes more detailed information inrespect to the combined portfolio valuation and further detail on LandSecurities Trillium's existing contracts. This information is provided by RNS The company news service from the London Stock Exchange

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