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“We entered 2006 in good shape and we left it in even better shape.” With our clear strategic focus on Flexible Business Space, a highly motivated team and the right organisational structure, we have consolidated on the strengthened position of recent years. Given the scale of our expansion in Continental Europe we are particularly pleased to be able to report that the European business delivered an outstanding performance in 2006. The 19 per cent increase in underlying adjusted profit before tax highlights another strong operating performance in 2006. Group lettings in the year increased to 440,000 sq m, with a further 159,000 sq m in pre-lets for the future benefit of the business. Robust customer demand, our active management of assets and our sharpened focus on customer needs were the main factors behind this strong performance. Continental Europe alone delivered an excellent 169,000 sq m. Across the Group, we invested £243 million in developments and £216 million in acquisitions, with £173 million of disposals crystallising £43 million of gains in value from previous investment. In the UK we recycled over £170 million of capital but we were net sellers of assets. The Group valuation surplus was 11.0 per cent, with the major UK industrial element of our portfolio up 11.5 per cent - ahead of the equivalent IPD industrial index which increased by 11.3 per cent. Even allowing for the non-cash effects of new shares issued for the preference share conversion and deferred tax charges, adjusted EPS growth was 3.3 per cent. Implementation of strategy During 2006 the UK team has concentrated on shaping the portfolio to produce stronger returns by four primary routes. We acquired estates or assembled a critical mass of properties in areas that enabled customers to expand their businesses within our holdings and for the most cost-effective provision of services. We disposed of underperforming or non-conforming assets where there was limited opportunity to add value – with £173 million of disposals. We aggressively pursued and delivered redevelopments that allowed us to effectively replace older buildings and recycle the portfolio whilst retaining key holdings. We also worked closely with our customers to provide a level of service that contrasts positively with other landlords. Opportunities in Continental Europe currently offer attractive yields, low borrowing costs and strong prospects for growth. Employing fundamentally the same model as in the UK, the strategy has been to identify the areas with the best growth potential in each country and then to assemble a critical mass or ‘cluster’ of properties in these locations. We have already secured this critical mass in the northern sector of Paris, France, and in the Düsseldorf region, Germany, where SEGRO is now established as the leading provider of modern and flexible light industrial, office and logistics space. We are also already very well established in the vicinity of Brussels airport in Belgium and Schiphol airport in the Netherlands where further land and income-producing properties have been acquired in these important strategic areas. During 2006, SEGRO made some major and highly-successful inroads into Central European locations providing a platform for future growth in that region. As our strategy evolves, we seek to acquire and develop industrial and logistics space, as well as land for development, in the growth zones of key markets across Continental Europe. A £70 million acquisition and leaseback agreement with Antalis, was largely complete by 31 December 2006. This agreement included properties in two new major target countries, Italy and Spain, and provides SEGRO with a platform in key locations, including potential to make further strategic acquisitions. In the USA, the business focuses on the implementation of the biotechnology strategy and on value-adding opportunities in major biotechnology clusters in the San Francisco Bay Area and San Diego County. The business model concentrates on development, redevelopment, conversions and strategic acquisitions. In 2006 investment momentum accelerated in response to biotechnology industry activity during the year, buoyed by increased funding from the major pharmaceutical companies and the venture capital community. During the year, we have added several new clients to the portfolio: clients who have the potential to provide opportunities for future expansion. “With our clear strategic focus on Flexible Business Space, a freshly invigorated team and the right organisational structure, we have made good progress on all fronts. It’s particularly encouraging that in the first year after a significant expansion in the scale of its operations, our business in Continental Europe has delivered well ahead of our own expectations.” back to top 2006 performance review UK With most commentators forecasting the end of yield compression in the UK and in the context of the generally positive rental levels, the UK team is demonstrating the quality of its core property skills. In 2006 we recycled capital, completed the latest phase of the development programme and implemented our asset management strategy, successfully driving gross property rental income up by £10 million. UK underlying year on year vacancy levels by space remained unchanged at 8 per cent, but we generated an extra £4 million of rental income from space let over space returned. We achieved overall rental growth of 3.7 per cent on rent reviews, ahead of the IPD industrial figure of 1.4 per cent. Rental growth on new lettings was flat, consistent with the priority we give to generating cash from unoccupied space. As expected, the potential from development completions coming on stream and from vacancy actively acquired with major new properties resulted in headline vacancy in the UK increasing, from 10.9 per cent to 11.6 per cent. We selectively acquired £145 million of properties in the UK, in attractive locations. Continental Europe Having doubled in size and firmly established a presence in Central Europe at the start of the year, our Continental European business delivered an outstanding performance in 2006. Its excellent 169,000 sq m of lettings increased the rent roll by over £7 million pa and brought investment property vacancy levels down from 10.2 per cent to 8.7 per cent, with overall vacancy levels – including trading properties – down from 12.3 per cent to 7.5 per cent. 77 per cent of our pre-lettings were delivered in Continental Europe. USA In the USA, the business had a good year with the£0.9 billion book valuation at the end of 2006 representing a 28 per cent increase on the end of 2005, reflecting development completions and yield compression in a market which is increasingly seeing biotech real estate as an attractive asset class. Gross rental income increased 25.3 per cent to £76 million, reflecting the full year effect of some strong lettings in 2005 and the benefit of development completions in 2006. Further progress was made with lettings and with new acquisitions for future developments, although the market in San Diego County, unlike the San Francisco peninsula, has remained somewhat subdued, leaving the USA vacancy high at 18.9 per cent. back to top REIT Conversion Slough Estates became a Real Estate Investment Trust (REIT) on 1 January 2007. We believe SEGRO is well placed to deliver superior shareholder returns as a REIT, with its strong development pipeline and pan-European business model. In addition to the UK tax advantages which REIT status provides for most eligible companies, the UK REIT legislation also enhances our ability to implement an efficient international tax structure – enabling us to take greater advantage of the already stronger yields and lower borrowing costs available in Continental Europe. The Board announced its new post REIT dividend policy in November 2006. In future the Board ordinarily expects total dividends to exceed the mandatory 90 per cent Property Income Distribution (PID) element, and to comprise between 85 per cent and 95 per cent of the worldwide recurring property rental earnings plus a proportion of trading property profits and other income from non-property activities. This new policy will take effect during 2007 and is not reflected in the proposed final dividend for 2006. back to top Development Our £3 billion development pipeline, a key driver of our future returns, is building momentum. With 154,000 sq m of developments completed during 2006 and 338,000 sq m of construction in progress at the year end, the pipeline now stands at 2.4 million sq m with £226 million of rental income potential. back to top Outlook Market conditions are encouraging. In the UK, enquiry levels are in line with last year, with some areas seeing particular strength in rental levels – such as Bristol, Heathrow and the Thames Valley. Conditions are generally stronger across Continental Europe. Our Central European locations are seeing continuing strong demand across the board, there are also some specific areas of strength in Western Europe, such as in light industrial markets in France and in the logistics market in France and in Belgium. In the USA, demand for SEGRO’s biotech product remains strong in the San Francisco Bay area, but there has been little pick up as yet in San Diego. The momentum in the development pipeline continues to grow, with 338,000 sq m under construction at the end of 2006 and with 734,000 sq m of construction starts expected during 2007 – 515,000 sq m of it in Continental Europe alone – underpinned by the healthy occupier demand levels across the Group. The sale and leaseback agreement with Antalis in late 2006 moved us into a number of high growth European business centres – including key locations in two new countries, Italy and Spain – and gave us another important partnership relationship with a substantial corporate occupier, thereby enhancing our platform for growth. We continue to see a steady flow of attractive investment and acquisition opportunities. With our strategy and structure now firmly in place, we are meeting or beating our targets and our growth plans remain firmly on track. back to top USA Strategic Review In November 2006 SEGRO announced that, consistent with its previously-stated strategy of focusing on the provision of Flexible Business Space in the UK and in Continental Europe, it was exploring the strategic options for its USA business. It was announced that the process involved consideration of a range of possible options, including an immediate or phased divestment and also joint venturing or merging SEGRO's USA business with a third party. In assessing the options the Board has regard to all relevant considerations including the current and potential future value of the business as well as the tax implications of the various options. The process is well underway and we anticipate making a further announcement during the second quarter of the year. back to top Strategy and Business Model The Group’s principal objective is the generation of shareholder value through the investment, development and management of commercial real estate. Our chosen sector is Flexible Business Space, which encompasses the provision of business accommodation to a wide range of users – from sectors as diverse as research, manufacturing, data centres, light assembly and distribution – in pan-European and US locations, or clusters, which we believe will outperform over the longer term. We believe that we diversify our business and development risk through the breadth and spread of not only the geographic reach of our portfolio but also the variety and quality of our customer base. Given the differing local dynamics of the property markets, we manage the business through three geographic business units – the UK, Continental Europe and the USA. We currently have a presence in strategic locations in 11 countries. Our strategy is to build critical mass in each of our existing markets and to identify and enter new markets where there are attractive growth prospects and the potential to achieve attractive returns. Whilst scale and access to international customers is an important dimension of our business, property is ostensibly a local business and our philosophy, therefore, is to employ people with expert local knowledge who understand the dynamics, drivers and characteristics of each local market. Existing Markets – France – Ile de France,Paris – Belgium – Brussels, Antwerp, Ghent triangle – Germany – Cologne, Düsseldorf, Frankfurt, Berlin and Hamburg – The Netherlands – Schiphol, Amsterdam – Poland – Poznan, Strykow, Warsaw, Silesia – Czech Republic – Prague – Hungary – Budapest Future Markets – Key Target Locations – France – Lyon, Marseille and Lille – Spain – Madrid, Barcelona, Valencia – Italy – Milan/Turin – Germany – Munich – The Netherlands – Randstad – Poland – Gdansk Our strategy for achieving our objectives has three main elements: 1. Proactive asset management – focusing on our customers’ needs – delivering a strong leasing programme – the ongoing refurbishment and redevelopment of our buildings – recycling capital by selling mature assets where there is limited potential for SEGRO to add further value 2. Property acquisitions – acquiring income producing assets, which are undermanaged and/or can be developed – Corporate partnering (sale and leaseback) transactions with income and scope for development – Taking advantage of higher yields and lower borrowing costs in Continental Europe 3. Development – Executing the current programme of pre-let and speculative developments under construction – Preparing sites and seeking pre-lets to support the projects due to be started in 2007/8 – Acquiring new greenfield and brownfield sites for future development. We assess all potential investment opportunities according to their strategic rationale, their risk profile and their expected financial returns – both income and total un-geared return. Our current targets are to achieve total pre-tax returns of 8 per cent to 10 per cent from investment activities and 9 per cent to 14 per cent from development projects. We set different target return levels according to the tax profile of each particular investment and according to our assessment of the individual project risk. We normally apply a premium to the minimum return that we expect from an investment, to reflect: |
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| We believe the key differentiators of SEGRO’s business compared to its competitors are its growth in Continental Europe, its very strong development pipeline and its core skills in asset management. SEGRO announced its intention to grow its Continental European business in 2005. This focus was chosen because the Group believes superior returns are available from investing in major European business markets rather than being purely a UK player. These expected superior returns are driven by the higher investment yields available in most Continental European markets, the expectation that yields will compress – leading to capital growth, and the superior economic growth prospects in several markets – particularly in the emerging central and eastern European countries. We also believe there are synergies available by providing a consistent approach and service level to our growing number of international customers. back to top Development Pipeline |
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| All amounts are indicative only and are liable to change. Certain properties included above are currently income producing and are expected to be redeveloped; such properties have a current book value of £288 million and produce current rental income of approximately £12 million pa. Our pan-European strategy is supported by the operation of an efficient tax and capital structure. With REIT status in the UK, and soon with SIIC status in France and the efficient use of lower-cost borrowings in Continental Europe, SEGRO operates with a low overall tax charge and an efficient cost of capital. SEGRO has one of the largest development pipelines in the industry, with the potential to build up to 2.4 million sq m of Flexible Business Space, equivalent to 64 per cent of the current built portfolio. This could produce, at today’s rental values and assuming full letting, incremental annual rental income of approximately £226 million (including our share of joint venture developments and after deducting rents currently passing on buildings that are expected to be redeveloped) – 82 per cent of the current annual rent roll. Risks associated with the development pipeline are carefully managed: |
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| All development projects are subject to strict financial targets, as described above. SEGRO’s asset management skills are based upon: |
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| back to top Market Context From the perspective of global trading volumes and pricing, 2006 was a record year for property investors. In the key markets of Asia, Europe and the USA, commercial property investment totalled US$645 billion, some 33 per cent ahead of 2005 (source: Cushman and Wakefield). Furthermore, the data reveals the extent to which the markets have evolved over recent years. Trading volumes in the second half of 2006 were nearly equal to the annual total for 2004 and indeed the quarterly average for 2006 exceeded the full year total for 2001. Investment in Europe totalled US$295 billion and the region accounted for six of the top ten global investment markets, with the UK second behind the USA and Germany in third place. Within Europe, the share of investment accounted for by Central and Eastern Europe has risen from 1 per cent in 2001 to 5.5 per cent in 2006, driven by increased investment in Poland and an increasing interest in Russia. The flow of money targeting real estate continues to increase as the populations of many of the mature economies increasingly focus on pension provision and these institutional investors are drawn to real estate for its transparency, lease structure, relatively stability and recent strong returns. Over the past year demand for commercial property in the UK has been driven primarily by institutions. However, commercial property prices are high and, looking forward, this may restrict the activity of some investors. As prices have risen, particularly over the past year, yield convergence across the globe has been evident not only in the emerging markets of Rumania, Bulgaria and the Ukraine, but more significantly in the more established markets of the USA, western Europe and the UK. Whilst there is some evidence that the rate of yield decrease is now slowing, particularly in the UK, unless interest rates are quickly reversed, to secure good returns investors will become increasingly reliant on good management, development programmes and growth in rental income. In the UK, as a result of the recent interest rate rises, property is no longer self financing. Looking ahead most commentators are expecting a slowdown in returns in 2007 as the fall in yields, which has underpinned much of the investment performance over the past five years, comes to an end. UK All Property Total Returns (%) |
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| Source: Capital Economics The graph featured above from Capital Economics (independent macroeconomic research consultants) shows their forecast of a cooling investment market with total returns falling from an anticipated 18.7 per cent in 2006 to around 9 per cent in 2007 and then falling further to an average of 4 per cent in the period 2008 to 2010. Given recent performance this could be viewed as a bearish outlook, but in such an environment investors are likely to focus on the property fundamentals of location, customer covenant strength and targeted development to drive performance. back to top Key Performance Indicators SEGRO has a comprehensive suite of measures which Management and the Board use to set targets and assess performance in the context of our strategic objectives. These measures are cascaded throughout most areas of the business and cover financial and non-financial matters, including corporate and social responsibility measures. Work is ongoing to develop and evolve the capture and use of ‘KPI’s throughout all areas of the business and to ensure that they are fully aligned with the Group’s objectives as a REIT. The key measures currently used at Group level, and our performance achieved in 2006, are as follows: |
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| back to top Risk Management Identifying and evaluating risks is a fundamental element of managing SEGRO’s business to achieve our objective of creating shareholder value. The Group views effective risk management as integral to the day-to-day business decisions and encourages all its managers to asses risk on a continuous basis. In addition, we carry out regular, formal risk assessments to identify and evaluate risks and to identify controls and other risk management techniques in place. These assessments involve four key elements, as follows: |
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| To assist the risk identification process, we categorise risks into three areas of; the external environment, operational risks (ie the internal management processes and structures), and risks related to the production and use of management information. As a property investment and development company, the main business risks we face on an ongoing basis are in the following table, along with their potential impact and any mitigating factors or risk management strategies we have in place. Environmental, Social and Governance risks are separately addressed on pages 44 to 47 of this report. back to top Key Business Risks |
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| back to top Customers SEGRO provides accommodation for more than 1,760 businesses across the UK, Continental Europe and the USA. Our customers range from small organisations moving into their first business premises to major international companies for whom we provide bespoke space designed to suit specific requirements. Our commitment remains the same – to be transparent, honest and helpful in all our dealings across the portfolio. We are mindful of the fact that improving occupier retention and attraction is one of the main ways we can distinguish our property from the competition and drive stronger returns. The value of this approach is confirmed by the fact that more than 30 per cent of our lettings by rent are to existing customers seeking new or additional space. Particular ways in which we have forged stronger relations with customers include: |
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