Accounting and regulatory issues

There have been no changes in accounting policies or disclosures during 2005/06. Looking ahead, we will need to keep under review the adoption of International Financial Reporting Standards (IFRS) which potentially could have a significant effect on the way in which our financial information is reported in the future. With effect from 2005/06 compliance with IFRS is mandatory for listed companies, but in common with all public sector organisations the expectation is that we will follow the more extended timetable of the Accounting Standards Board’s convergence strategy, which currently anticipates implementation within a year.

Risk factors and risk management

We continue to develop and embed the risk management process within The Crown Estate. Risk management is now becoming an effective planning tool as well as a means of reviewing our strategic and operational risks throughout the organisation. It has been strengthened by the introduction of a cross-departmental review group whose aim is to ensure consistency and best practice, and to look at the risks and opportunities that may arise across all areas of operation.

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. Strategic risks and their assessment are the responsibility of the management board and are reviewed quarterly.

Cash flow

Under the provisions of The Crown Estate Act 1961, we are unable to borrow to finance investments and therefore we continue to maintain a high level of cash reserves. This liquidity enables us to take advantage of market opportunities in line with our investment strategy, as well as development opportunities and asset management initiatives on our existing holdings.

During 2005/06 there was a net outflow of capital cash due to the significant acquisition activity, particularly on our regional portfolio where we purchased 92 acres of Cabot Park, Avonmouth and 140-145 New Street, Birmingham. However, our net revenue surplus, after working capital movements, generates a positive cash flow for the year of £209 million, compared to £198 million in 2004/05.

Property valuation

The total property value of the estate rose by 18.1% to £5,685 million for the year ending March 2006. In line with the wider investment market this has been driven by yield compression across the entire portfolio. We benefited particularly from our current high weighting in central London offices, which account for 38.5% of our urban estate. Indeed our urban commercial holdings increased in value by 24%, up to £3,911 million.

Yield compression, stock specific asset management initiatives and a number of disposals, taking advantage of the strong investment market, resulted in strong performance with a total return of 21.6% for the entire portfolio (capital growth 16.9%, income return 4.7%) and 24.8% for the urban portfolio. Both of which compare favourably with the Investment Property Databank (IPD) Quarterly Universe to 31 March 2006 of 20.6%. Indeed over one, three, five and 10 years our performance has exceeded the Quarterly Universe.

The annual valuation and the subsequent benchmarking of our performance is of the utmost importance in understanding how well we are managing our property holdings. Therefore, as in previous years we commissioned independent valuations of a sample of our rural and urban estates (8% 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 (10% of the estate).

This year we have been working closely with IPD. The size of our submission of properties for external performance measurement and benchmarking has increased considerably from £2.25 billion up to £4 billion. We are also working with them to agree a bespoke benchmark with the intention that performance on our commercial properties is benchmarked on a half yearly basis.

Looking ahead

Like many others we were surprised at just how strong property returns have been over the last year, although we were confident that our high central London weighting would benefit our performance. The strength of the market has enabled us to undertake some re-balancing of the portfolio and we expect conditions to remain conducive to the selective disposal of properties within our central London office portfolio during the remainder of 2006. Beyond 2006 we are more cautious due to a possible slowdown in the economy, a continuing squeeze on consumer spending and the strong development pipeline in both the retail and the London office sectors.

Regardless of yield movements we are conscious that the underlying driver of long-term performance is the improvement of the quality of our income stream. To this end we remain confident that we can continue to add value through strategic purchases and investment in our existing stock, through active asset management and by creating products that will strengthen our customer base.

The charts below show annual capital growth and total return 2002-2006 for The Crown Estate as a whole and the individual performance of the urban, rural and marine estates compared to Investment Property Databank (IPD) indices. Please see table of relevant figures below, for a breakdown of the charts.

Capital growth by activity

Source: The Crown Estate performance calculated internally.
IPD = Quarterly Universe to March 2006.