Investment Adviser’s Report

Valuation methodology
Each of the external valuers have been required to reconsider their valuation approach with transactions few and far between creating an abnormal market environment. They have sought to use their market knowledge and professional judgement to endeavour to eliminate the effects of volatility rather than rely totally on negative market sentiment. Full detail on the valuation methodology applied to the REO properties is provided in Note 4.

Highlights in the period
Business Activity

Table 1:

Investment portfolio
The REO investment portfolio represents 50 per cent of the Company’s overall property portfolio by value and the Irish investment portfolio is 62 per cent of the total Irish portfolio; it is over 1.54 million square metres in size and includes over 100 occupiers. In the short term, the Irish market is experiencing a sharp slowdown following years of strong growth and high demand. As highlighted at the time of the Company’s interim results, recognising the relatively early signs of overheating in the market last year, REO adopted a cautious approach to its portfolio and focussed on consolidating its strong position in the market while also intensifying its strategy of targeting growth from the existing investment portfolio through active asset management and the retention of its high quality tenant base. This is a strong portfolio of buildings with an annualised rent roll of £39 million which has grown by 8 per cent from 2007.

Although the global financial crisis has contributed to the slowdown in the Irish market, the benefits of this strategy are seen in the relative performance of the Ireland investment portfolio, which showed an underlying valuation decline of 14 per cent, derived from a 14 per cent decline in office values and a 11 per cent fall in retail values in the year to 31 December 2008, significantly outperforming the market during the period. The investment portfolio continued to perform well owing to its prime office and retail locations and broad tenant base which deliver a solid income stream. The REO tenant mix ranges across a number of sectors, with blue chip occupiers such as Vodafone, KPMG and Marks & Spencer accounting for a significant proportion of the rent from the portfolio. Portfolio occupancy remains at over 95 per cent and rental weighted average lease length is 12 years. The Company actively monitors major tenants progress and currently there are no indications of material tenant defaults.

As previously advised, REO’s strategic emphasis continues to be focussed on the settlement of rent reviews and the Company settled 19 rent reviews in the year achieving an average increase of over 19 per cent compared with previous rents and an average of over 8 per cent above the Estimated Rental Values previously assumed by the Company’s valuers. This highlights the strength and resilience of the Irish investment portfolio. Rent reviews which took place on Russell Court and Mespil Road in the office sector of the investment portfolio mitigated valuation declines somewhat in the period. The upward rent reviews in Stillorgan during the period contributed to a valuation increase of 4 per cent, against an overall market decline in the Irish retail sector.

Table 2:

During the second half of the year, REO disposed of its interest in Northside Shopping Centre, Dublin for €29.75 million, representing a 60 per cent uplift over the property's valuation in the June 2008 accounts.

Development Portfolio
In spite of current market conditions, REO continues to see long term demand and growth in the commercial property sector and the timing of completions within its development portfolio has been structured to reflect this market cycle. Little development is due for completion in the next 18 months and there is appropriate flexibility on start dates. The focus of the business is therefore centred on the delivery of development projects after 2011.  The Company is actively pursuing appropriate planning permissions as well as working towards submitting planning applications in due course for various projects.

There are only two developments currently under construction.  Number 1, Central Park, Dublin 18, a 17,650 square metre office development, is expected to be completed in 2009 (excluding fit out until a pre-letting is secured). Montevetro, on Barrow Street, Dublin 4 (19,500 square metres) is expected to be completed in late 2010. The Montevetro office development is 50 per cent pre-funded while letting campaigns on both developments have recently been launched and there are early indications of potential occupier interest.

Progress on the development pipeline planning applications in the period include:

• Ballymun Shopping Centre: In October, the Company lodged a planning application to develop ‘Ballymun Town Centre’, an €800 million mixed use development in the heart of the Ballymun regeneration area in North Dublin.   The proposed new town centre is on a 5.9 hectare site. The development is strategically located in the heart of North Dublin and has easy access to the airport, Dublin City Centre and the M50, M1 and M2 motorways. It is at the heart of the economic corridor between Dublin Airport and Dublin City Centre, while a Metro station on the planned Metro North line will also be integrated into the development.  In addition, the town centre will only be a short distance from the only IKEA store in the Republic of Ireland which is opening in July 2009. The proposed development will comprise over 60,000 square metres of retail space, 27,883 square metres of office space and over 11,000 square metres of leisure facilities. Planning permission was granted in December 2008 (and is subject to appeal)
• Clonburris, Clondalkin: Following its designation as a Strategic Development Zone, the masterplan for this area was given approval by An Bord Pleanala in November 2008.  REO has assembled a design team with a view to lodging a full planning application for the development of a major town centre facility (Gross Floor Area: 237,000 square metres) on the Company’s land and this process is now underway.

Although the general trend of valuations of properties within the development portfolio have been downwards, the effect of falls in market values has been mitigated within the portfolio as a whole with some sites showing increased valuations. The value of Clonburris grew by 25 per cent based on the strength of a rezoning of the area to Strategic Development Zone status and confirmation that a train station will be sited there.

Battersea Power Station: 
The Company’s principal UK development, Battersea Power Station, deserves special mention as significant progress was made in 2008.  Following the public launch of the development masterplan in June 2008, plans have progressed well with consultation continuing throughout the second half of the year with The London Borough of Wandsworth and statutory consultees such as the Greater London Authority, the Mayor of London, English Heritage, the Commission for Architecture and the Built Environment and the Government Office for London. Their views have been taken into account in framing the design of the development resulting in an improved scheme. These plans include the important proposal for the extension of the Tube network to Battersea.

The scheme was also presented to a substantial number of members of the public with over 15,000 visitors to the public exhibition at the site, over two thirds of whom were supportive of the scheme.  Feedback on this extensive consultation process has been incorporated into an enhanced scheme design.

Good progress continues to be made towards submitting the formal planning application in 2009 and achieving anticipated transport improvements in the area. This progress has helped to offset the negative effects of the market environment such that the valuation has reduced from £450 million at 31 December 2007 to £406 million at 31 December 2008, representing a revaluation decline of 18 per cent after allowing for capitalised costs.

Economic Commentary

Irish economic commentary
As the effects of the international financial and banking crisis and a worldwide recession deepened throughout 2008, the Irish economy began to suffer from the aftermath of a large housing and construction boom which had resulted in a period of sustained growth. The crisis in financial markets prompted the Irish Government to initiate a number of packages to maintain financial stability, including a €400 billion guarantee to safeguard deposits and borrowings of four major Irish banks and two building societies in September. Further recent Government initiatives include the planned investment of €7 billion in the country’s biggest banks and building societies. It is hoped that these initiatives will go some way to stabilising the financial sector and ease the availability of credit and encourage flow of funds to the economy, restoring confidence domestically and internationally. In addition, the ECB has cut interest rates cumulatively by 200 basis points in recent months which will also contribute to enhanced affordability through lower mortgage and borrowing costs.

The downturn in the Irish economy gathered pace during the year driven by a range of factors including a significant slowdown in residential construction output in 2008 which is set to continue. Consensus estimates assume output levels will fall further in 2009. The speed with which the decline has occurred has led to a sharp drop in consumer confidence and expenditure, a rise in unemployment and falling GDP.

Irish Property Market
Office: The Dublin Office market had a mixed performance in 2008. The first six months of the year saw similar levels of activity to that of the 2007 peak year in terms of take-up. However, sentiment deteriorated rapidly in the second half of the year as the credit crunch intensified alongside a marked economic slowdown. As a result, office take-up stagnated, resulting in a level of approximately 160,000 square metres take-up recorded for the whole year, down 40 per cent compared to 2007(2). As market transactional activity weakened, new supply in 2008 and the release of second hand space back onto the market has increased city centre vacancy rates to 10 per cent and overall Dublin vacancy to 16 per cent in the final quarter of 2008(2). New Dublin office supply in the next two years will be very modest as output has been reduced significantly in the last 12 months. This will help the market move towards equilibrium in the medium term.

Retail:  The Irish retail market also experienced a sharp decline in performance in the second half as economic conditions deteriorated and consumer spending fell. Latest published data reported a year on year decline in spending volumes of 9 per cent in December sales in retail sectors have been mixed and those sectors linked to housing have been most adversely affected and are indicative of the falloff in residential construction(3). The short term outlook for retail sales is poor, putting significant pressure on retailers. As a result, a number of retail location decisions and expansion plans have been postponed in the short-term. However, some new entrants are still expected in the Irish market in 2009 and there are a number of international retailers, predominantly US and European, that still are interested in locating in the Irish market but are very location specific.

Financial Review
The Company has adopted International Financial Reporting Standards (IFRS) for the first time in 2008. The full effect of the changes associated with the reported financial position, performance and cash flows is set out clearly in the notes to the financial statements under “Explanation of transition to IFRS’s”.

Property income amounted to £32 million in the year to 31 December 2008, representing a significant increase from £20 million in the prior year period due to the benefit from the strength of the euro, the inclusion of 12 months rental income from Havenview Investments Limited and the additional 8 property companies purchased from Treasury Holdings in 2007 and the completion of a number of upward rent reviews in the period. After valuation losses and operating expenses, reported operating loss was £265 million. Net financial expenses increased to £121 million in the period, broadly driven by the negative movement in the fair value of financial derivatives of £76 million.  After accounting for the Company’s share in CREO’s after tax loss, this resulted in a REO loss after taxation of £371 million for the period.

The value of the portfolio as at 31 December 2008 amounted to £1,910 million, a reported increase of 8 per cent year on year which benefited from the strength of the euro against sterling, offset by a revaluation deficit after capitalised costs of 16 per cent year on year.

This has resulted in a Diluted EPRA Net Asset Value (NAV) per share of 104.1p, a reduction of 28 per cent year on year from 143.9p at 31 December 2007 and a decrease of 22 per cent from the 134.2p recorded at 30 June 2008.

The environment for generating and renewing financing facilities in the Group has changed markedly in the last twelve months. However, despite the difficulties currently experienced in the banking sector, the Company has successfully renewed its debt commitments due in the period and continues to operate within its LTV covenants.

Specifically, during the period the Company secured an increase of £40 million in the existing £185 million Battersea Power Station debt facility and the extension of the term of this facility from December 2009 to March 2011. The additional funds will be used to finance the costs of the Battersea Power Station planning application which is due to be lodged later this year.

In addition, the Company secured an increase of €50 million in an existing loan facility, secured against REO’s income producing investment portfolio in Ireland. This facility matures in 2013.

Loans amounting to £441 million and £197 million mature during 2009 and 2010 respectively. The majority of loans due for repayment in 2009 are due at the end of the year and the Company remains confident about reaching agreement on their renewal on broadly similar terms. It is not expected that there will be significant new facilities agreed during 2009 but sufficient cash does exist to progress certain development sites towards planning permission.

The overall debt level of £1,504 million, including loan notes and excluding Zero Dividend Preference Shares and Convertible Unsecured Loan Stock, equates to an LTV ratio of 79 per cent. 98 per cent of the Company’s debt is on fixed rates and weighted average cost of secured debt is 5.7 per cent per annum. In the event that there is a further decline in property values which would reduce the Group’s NAV and could result in breaches in the Group’s banking covenants, it is assumed that the existing bank facilities will remain in place and be renewed in such an environment, consistent with recent experience.

The Company has prepared a detailed financial plan to 31 December 2010 and the key assumptions made in that forecast include the renewal or roll over of the loans due in 2009 and 2010 and the completion of one of a number of transactions which are presently being explored. On this basis, the Board has reviewed the cash requirements for the business and as long as current market and business conditions prevail, believes that there is adequate working capital to fulfill the needs of the business for the foreseeable future.

There are capital commitments within the business of £89 million which are largely related to the continuing construction of existing developments in Central Park and Montevetro, both of which are in Dublin. These projects have already secured committed bank facilities.

(1) Source: SCS/IPD Irish Quarterly Property Index: Q4 2008
(2) CBRE Market View Dublin Offices Q4 2008
(3) Central Statistics Office, February 2009