Finance Director's Review
Above: John Lelliott
Finance Director
Introduction
The excellent results this year have been discussed in the Chief Executive's Review. The purpose of this review is to develop some of the elements that contributed to the year's success and highlight areas receiving special consideration going forward. The results are underpinned by both investment activity and asset management initiatives across the entire estate.
As a long-term landowner we have obligations to achieve year–on–year long-term growth. Over the past 10 years we have seen revenue growth of 76.7% delivering to the Treasury £1.6 billion, capital growth of 134.9% and a total return that has outperformed IPD over the past one, three and five years.
Source: The Crown Estate performance calculated internally.
IPD = Quarterly Universe to March 2007.
The Crown Estate Act 1961
It is important to understand the provisions of the Act and especially how we report our financial results. The Crown Estate Act 1961 places certain obligations and restrictions on the way we do business. In particular we are unable to borrow to finance investment and we have special accounting arrangements that are specifically aimed at maintaining a balance between revenue and capital, which is similar to a trust.
Given these arrangements our results are all the more impressive. In particular, if our revenue results were fully presented under UK GAAP and unencumbered by the restrictions of the Crown Estate Act, they would increase by £89.4 million from £200.1 million to £289.5 million. The majority of this relates to profit on sales of freeholds of £56.6 million which is retained within the capital account for re-investment in the estate. Full details of this are given in note 3 to the financial statements.
Property Valuation
The total value of the estate rose by 15.6% to £6,572 million for the year ending 31 March 2007. Our commercial urban properties delivered the strongest growth at 17.5% but there was also significant growth across the remainder of the portfolio with residential at 11.6%, rural at 6.1% and marine at 13.2%.
In line with the rest of the market these increases have been driven by yield compression plus growth in rental values, particularly in central London offices. Indeed, despite reducing our exposure by 1%, the rental value of our London offices has risen by 9.4% and its share of the total capital value of our urban commercial portfolio has risen by 3% to 47.6%.
The continuing weight of money in the investment market has driven yields down. This is reflected in the IPD Quarterly Index where the equivalent yield for all property has fallen from 5.7% to 5.3% over the year to 31 March 2007. Similarly, the equivalent yield across our commercial portfolio has fallen from 5.3% to 5%.
The total return on the entire property portfolio was 25.7%. This compares favourably with the IPD Quarterly Index which recorded an all property return of 15.8% for the year to March 2007.
Since last year we have agreed a bespoke benchmark with IPD based upon quarterly valued long-term funds in excess of £200 million. We now submit the whole of our urban commercial portfolio for analysis on a six monthly basis. As at 31 March 2007 this amounted to 423 properties with a total value of £4,753 million, or 70% of the entire estate by value. The total return from these properties for the year to 31 March 2007 was 30.6% which compares to the benchmark of 16.3%.
As in previous years we commissioned independent check valuations of a sample of our urban and rural properties (7.9% by value of the whole estate). The results of this exercise reassuringly supported the tone of the main valuation. In addition, all purchases and developments completed during the year were valued independently of the acting investment advisers, which represents a further 2% of the estate.
As a publicly accountable body, transparency of disclosure and the pursuit of best practice is a key priority to us. In furtherance of this aim we have appointed DTZ and Jones Lang LaSalle as independent valuers across nearly 90% of the value analysed by the IPD and 60% of the estate as a whole. Their first valuation will be in September 2007.
Investment in English Limited Partnerships
During the year and as part of the process of revising our investment strategy we undertook a close analysis of alternative approaches to investment, in particular third party investments which might be available to the Crown Estate bearing in mind the constraints of the Crown Estate Act. This involved detailed legal analysis with external lawyers and leading counsel, an assessment of the accounting impact with our accountancy advisors, and discussion with HM Treasury. The analysis concluded that we may invest in land through the structure of limited partnerships.
In light of this conclusion we acquired a 4.7% share of the Lend Lease Retail Partnership in September for £39 million and took steps to form a 50:50 joint venture partnership with Hercules Unit Investment Trust (HUT) with a combined total value of £680 million that completed in early April 2007.
Cash Flow
Maintaining capital liquidity is very important in taking forward our investment strategy, which includes our future development plans. This year we have taken advantage of a very buoyant market and have made disposals of non-performing assets. During the year there was significant cash generated from the commercial and residential portfolios with total receipts of £418 million. Investment in the estate was £186 million leading to a net inflow of capital of £232 million compared with a net outflow of cash of £60 million in 2005/06.
Accounting and Regulatory Issues
There have been no changes in accounting policies during 2006/07. Additional disclosure notes have been included to analyse the adjustments that are made between revenue and capital and to give details of our investment in English Limited Partnerships. The introduction of International Financial Reporting Standards (IFRS) is now firmly established for listed companies. We along with other public sector organisations will follow the Accounting Standards Boards convergence timetable and are not expected to be IFRS compliant until 2008/09. This will result in significant changes not only in the presentation of financial information but also our accounting policies and disclosures.
Risk Factors and Risk Management
We continue to develop and embed the risk management process within The Crown Estate. Risk management is becoming an effective planning tool as well as a means of reviewing our strategic and operational risks throughout the organisation.
Risk registers are held and maintained for each department and risk reporting is based around internal control statements that are regularly completed by each department. The cross-departmental review group, whose aim is to ensure consistency and best practice, reviews the risks and opportunities that may arise across all areas of operation and escalates them where necessary to the management board. Strategic risks and their assessment are the responsibility of the management board and are reviewed quarterly.
Insurance
Following a tender exercise Willis Ltd was appointed as insurance advisor to The Crown Estate for a three-year term with effect from January 2007. As a result enhancements have been introduced to extend and improve the scope of cover across the estate.
The Crown Estate strongly supports the New Code for Leasing Business Premises provisions on disclosure of commission. At 8.5%, our commission is considered to be at the lower end of commission retained by our property peer group and has been capped expressly to cover only the work carried out on the administration of the insurance programme.
Charitable Donations
The Crown Estate provided donations to a range of bodies, including charities, totalling £5,950 in 2006/07 (£7,467 in 2005/06), as permitted by the Crown Estate Act 1961, section 4(206).
Supplier Payment Performance
The Crown Estate's payment policy is to pay all suppliers within 30 days of receipt of a correctly documented invoice, or on completion of service where a fee is recoverable from a third party, or according to contract where a shorter payment period is agreed. During the year The Crown Estate paid 72% (74% in 2005/06) of invoices from suppliers within this period. This percentage includes invoices under dispute and amounts recoverable from third parties. On average, invoices from suppliers are paid within 26 days of receipt (30 days in 2005/06). The Crown Estate observes the principles of the 'Better Payment Practice Code'.
Information Systems – Financial Systems
In December 2006 The Crown Estate embarked on a project to replace its existing finance system with a new system provided by software suppliers Agresso. The new system will enable The Crown Estate to fulfil its future business and corporate objectives in a more streamlined manner than is currently possible. It is estimated that the cost of the new system will be £3.8 million and it is anticipated that it will be delivered by June 2008.
Looking Ahead
Last year we forecast that conditions would remain conducive to the selective disposal of properties within our central London office portfolio. This proved to be the case as we realised proceeds of some £278.0 million across 25 properties. These properties were identified as not being core to our business and their disposal also incrementally increased our average lot size.
Whilst we did not expect quite such strong performance in 2007 we did believe that we would outperform the market due to our high exposure to the London office market. It is clear now that the yield impact on capital values has been on the wane since June 2006 and therefore we do not expect such strong total returns next year.
Looking forward to 2008, we believe that we are well positioned for the year ahead. In particular, steady demand and an acute lack of supply should continue to support West End office rents. We are also optimistic about our rural holdings due to the resurgence in commodity prices and the increasing global volatility of food supply. In addition new investment opportunities that are starting to emerge from the marine estate hold the prospect of further income growth. However, we have concerns about the residential market due to interest rate rises this year and affordability levels. A slowing housing market and a tightening of disposable income will have a consequential impact on the level of retail consumption. Retail and residential may therefore be poorer performing sectors but again we believe that London, where we have the majority of our holdings, will be amongst the most resilient regions. The residential letting sector should be supported by a continuing supply/demand imbalance and in Regent Street we have the considerable advantage that we can continue to add value through active asset management.
John Lelliott
Finance Director