Chairman's Statement

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It is pleasing to be able to report in a period of considerable economic uncertainty and with subdued forecasts for economic growth in both the near and medium-term, that Development Securities has been able to grow its business so substantially. This could not have been done without shareholder support and we remain grateful for the confidence you have shown in us. Strategically, we have maintained a consistent business model over the last 15 years or so, especially with regard to the management of our risk profile. It was this prudent strategy that enabled the business to survive the acute stresses of recent years. On the other hand, there have been recent tactical changes in our approach to the market which we believe will assist us in capturing improved returns.

Given our enhanced financial strength and stability, the Board has recommended the payment of a final dividend for the year of 2.4 pence per share payable on 6th July 2011 to shareholders on the register on 3rd June 2011. This brings the total dividend payment for the year to 4.8 pence per share, equivalent to that paid in respect of the previous year.

The first step change in the level of our business occurred when we raised equity of £100.0 million in July 2009, which subsequently proved to be the low point of the real estate markets. As we had intended, we have now deployed this capital into the market, together with appropriate leverage where applicable and none of it was utilised to pay down debt. Since July 2009, the Investment Property Databank Index (IPD) had shown a recovery in capital values of 8.8 per cent to December 2009. The increase of this Index in calendar 2010 was 8.3 per cent. Accordingly, by the end of the year, the markets which had fallen originally by some 44 per cent from their peak in 2007 had recovered 18.1 per cent from that low point.

The second recent step change occurred twelve months later with our next equity raise of £100.2 million in July 2010. The proposition this time was different; we had identified early in 2010 that the recovery in the banking sector was likely to be a long and drawn out process and that, until the banks’ balance sheets, capital ratios and reserves were properly reinstated, there would be a continuing reluctance of the banks to advance fresh capital to the real estate sector. Indeed, subsequent events have borne this out and it is noticeable that, probably for the first time, the amount of net new bank lending to the property sector has been negative for six consecutive quarters. Notwithstanding this withdrawal of capital, the proportion of commercial property loans to the total loan books of the banks is still uncomfortably high and we anticipate that the banks’ relative inability to provide fresh capital to the market will continue well into the medium-term. Accordingly, we believe that those property businesses such as ourselves with equity able to invest in the near-term into the markets should be able to transact at favourable levels of return.

There are still clouds on the horizon, however. The austerity programme now being introduced in the UK will have an impact which is not easy to predict. Increased levels of taxation, both direct and indirect, together with significant reductions in Government expenditure are likely to reduce domestic consumption and encourage the restoration of savings levels as the consumer battles to survive the storm. Unsurprisingly, these current difficulties are also adversely affecting levels of business confidence and are likely to continue to do so until the way ahead has greater clarity. Rental growth in the occupational markets has reduced by some 15.1 per cent over the last three years and whilst that fall appears now to have levelled out, it will likely take many years before any significant rental growth reappears.

I am pleased to report that our IPD investment portfolio performance for 2010 equalled that of the IPD UK Quarterly Property Index for that year notwithstanding that our portfolio of real estate investments does not include any element of Central London weighting. Whilst it was clear that Central London was the sector with the strongest capital and rental growth during 2010, our more than acceptable comparative performance to the benchmark confirms our long-held contention that, in current market conditions, terms of trade in the secondary markets have moved towards those with appropriate expertise and capital. We expect this to continue. The valuation uplifts in our Balance Sheet of course take no account of improvements in the development and trading portfolios, which are reported only on ultimate sale. 2010 saw us continue with our strategy of focusing our investment portfolio on property assets that represent a mix of core defensive income and asset management initiatives. We have no present plans to change this approach. We do, however, have a considerable amount of equity remaining available in cash to invest into the marketplace as and when suitable opportunities arise and we remain alert to allocate this capital into a market which is likely to remain constrained of cash for some time.

Active development on a substantial scale is normally seen in the second half of an economic cycle when demand for retail and office accommodation is strengthening, vacancy rates are falling and capital availability is expanding. It is therefore unsurprising that we have not been recently engaged in any major development activity in the UK’s largest cities although we continue to seek out sites that could represent profitable developments for future years. On the other hand, the rapid recovery in rental values in the City of London together with both a perception of reduced supply and the weight of inward investment have conspired to raise values of prime development sites to levels which would appear to be hard to justify in such an early stage of the current economic cycle. Whilst we continue to pursue opportunities in this particular market, we are apprehensive both with regard to the underlying strength of demand and also the quantum of supply that may be brought to the market in the medium-term. We suspect that the City of London will remain a market for those with deep pockets and a longer-term investment horizon.

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Outlook

Monetary policy is hard to predict, perhaps even by those who pull the levers, but we do anticipate that interest rates will remain at minimal levels for some time yet to come. It is quite likely that both the Government and the Bank of England will seek to maintain interest rates at around current levels as and until stronger economic growth in the UK is initiated. To date, the two major domestic UK banking groups with significant government equity ownership have only gradually released troubled loans and foreclosed real estate into the market and it is arguable this has had minimal impact on pricing such has been the strength of investor demand for product. It would appear that these UK banking groups have now realised the value from the larger, better located and better let properties and that the next few years will see them work harder to maintain the same level of capital release from smaller loans. It perhaps follows that the next tranche of loans to be realised by the banks will be within the secondary rather than the prime sector. The availability of capital to acquire these assets will be reduced since investors with an appetite for prime property are unlikely to have the same risk profile on assets which are noticeably inferior in terms of location, tenant covenant strength and lease maturity profile.

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Conclusion

To say that we have clarity in all aspects of the marketplace would be wrong. However, we do have clarity with regard to the opportunity and returns that will be available to us as we apply our cash and expertise into those stressed areas of the market that lack adequate capital. If significant large-scale development projects need to await the next phase of the economic cycle, so be it. We will maintain the risk profile of our business model within the constraints in which we have operated for many years.

On behalf of the Board, I would again like to record my welcome to Sarah Bates, our new Board member, who brings with her an outstanding record of experience and skills, some of which we have now seen close at hand during the past year.

It remains for me to thank all of our Directors, management and staff for their valued contributions. Their professionalism and standing in the marketplace has undoubtedly been the key to our success through the last few years and will represent the base on which we will move forward with growing success.

David Jenkins
Chairman
1st March 2011

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Further reading

• Chief Executive's Statement