||In 2006 our total return was 15.5%. This return comfortably exceeded our cost of capital and reflects rapidly rising values of office buildings (in contrast to the rises in prior years in residential and retail property values). The occupational market for offices is strong in most parts of the world, reflecting the business cycle, and this provides some justification for investors to pay more for investments.
This result is after making a substantial provision on Liverpool One of £140m. This net provision is made up of a projected trading loss on completion of building works and a current valuation gain. It is not every day that one has to face up to errors on this scale, but we have adopted a prudent approach in estimating the loss.
The causes of the loss have been carefully analysed and generally relate to the time pressures on the project, which led us to make critical decisions without adequate detail in design. The Group is able to absorb this financial setback without any impact on the progress of the project itself or on the rest of the business. We remain fully committed to the project, which we believe will be an outstanding success for the people of Liverpool. If ever there has to be a trade-off between short and long term returns, we will always give precedence to the long term. More generally I am confident that our experience of the project and the difficulties encountered will make us better still and mean that we go forward with greater skill and assurance.
As we and other property investors enjoy runaway gains in value, it is a moot point whether market conditions are really ‘good’ or ‘bad’. It has become too easy to make high ‘double digit’ returns from investing in property and for many new investors attracted to the sector the results are self-fulfilling. There is a real danger of delusion as this additional capital chases a total stock of investments which can only grow very slowly. The inevitable result is rising prices: as capitalisation rates have dropped, experienced investors have been buying with the expectation of lower returns; some others assume there are more valuation increases to come – but history shows that a heavy price is often paid by those who presume that income growth and capital growth can become detached.
Undoubtedly the change of stance towards property of many professional and institutional investors in the last 10 years has led to a ‘permanent’ re-rating of property prices (made possible by the dousing of inflation around the world). When the rapid capital gains cease – which they probably already have – the damage caused by speculators departing the sector is likely to be greater than the market currently expects. As it is, these market conditions are not the best for us and we would like to see a return to times when real property skills are needed to deliver extra value.
In the meantime, our strategy is not to withdraw from the market or to sell up – we are a real estate business – but to take exceptional profits more frequently and to keep searching for the opportunities to create long term value by building income returns. The difficulty in finding such opportunities has resulted in an increase in cash at the year end. Above all, we will be ready to take advantage of any changes of circumstances in the market whenever they might arrive.
In 2006 our concentration on income delivered an underlying increase in ‘revenue profit’ of 9.5% to £62.0m.
||We create new income by improving assets in our existing portfolio and creating new buildings. When we have a ‘core’ asset, with lower risk and opportunity characteristics, we will typically sell it to recycle the capital into a property with potential for income growth. Appropriate assets may be sold to funds managed by Grosvenor Fund Management under strict guidelines supervised by our investors.
Our emphasis on development in the past decade has led to a unique collection of projects underway or planned around the world, where Grosvenor is seen as a local developer. Taken together they represent a very wide skill base, something which could be criticised as ‘unfocused’; however, in our structure, property strategy is determined locally and in each place it is clear, focused and consistent.
Our projects include four town centre regeneration schemes in Britain (the active schemes in Cambridge and Liverpool and the proposed schemes in Crawley and Preston); nine shopping centres under construction in Continental Europe (through Sonae Sierra); a 38 storey residential tower in Hong Kong; a 45 unit block of high end apartments in Tokyo; a 33 storey office building in Brisbane and a 279,000 sq ft mixed use development in Vancouver. These, together with other smaller projects throughout the group, add up to a total of about 20m sq ft under construction or due to commence construction in the next two years.
As local developers our function is to help local communities to evolve. We do this by creating new buildings of value and distinction. We also continue to manage most of the buildings we complete, which reinforces the motivation not to take ‘short cuts’ which could undermine long term value.
We completed the acquisition of an additional 17% of Sonae Sierra in the early part of 2006 and the company continues to perform to our highest expectations.
We also completed the acquisition of Legg Mason Real Estate Services Inc. to increase the scale of Grosvenor Fund Management in North America. The new business has been integrated with a high degree of co-operation from the fund management teams in all regions. The launch of new funds helped Grosvenor Fund Management to achieve good growth in turnover and funds under management. We recognised a significant performance fee in 2006, making Grosvenor Fund Management profitable last year although it is not yet profitable on an underlying basis. We are on target for this to occur in 2008.
All of the Operating Companies reported returns of between 12.5% and 20%, driven by strong valuation gains. Details of their operations are found in the Operating Company sections of this report.
Shareholders, Directors and senior management of the Group meet triennially to review and debate long term strategy and new opportunities. In 2006 we endorsed the high level strategy to maintain our international diversification: over the next few years we expect to add capital in the Australia Asia Pacific region and in the Americas, while reducing the exposure to Continental Europe and Britain & Ireland. However, we expect overall activity to continue to grow in all regions as we carry out more joint venture activity and expand the fund management business.
The current distribution of Group equity between our proprietary businesses is:
||Britain & Ireland
||Australia Asia Pacific