UK Commercial Property REIT Ltd - Final Results

Guernsey:  26 April 2019

UK Commercial Property REIT Limited

(“UKCM” or the “Company”)

LEI: 213800JN4FQ1A9G8EU25

FINAL RESULTS FOR THE YEAR ENDED 31 DECEMBER 2018

UK Commercial Property REIT Limited (FTSE 250, LSE: UKCM) which is managed and advised by Aberdeen Standard Investments and owns a diversified portfolio of high quality income-producing UK commercial property announces its final results for the year ended 31 December 2018.

Four important initiatives delivered in 2018 and into 2019 which are expected to strengthen the business and enhance future returns for shareholders

·     Conversion to a REIT on 1 July 2018, safeguarding the Company from future changes in legislation that would have negatively impacted returns. UKCM is now one of the largest diversified REITs in the UK.

·     In December, the Company completed its largest acquisition to date through the purchase of an earnings enhancing portfolio of distribution units in the Midlands for £85.4 million.

·     In February 2019, the Company refinanced its debt facilities at a reduced cost, extending the maturity dates, increasing both the flexibility and quantum of debt available.

·     In April 2019, Shareholders approved the expansion of the Company’s investment policy allowing the Investment Manager the flexibility to invest further into alternative property assets such as healthcare, student housing, hotels, car parks, pubs, petroleum and automotive and the commercially-managed private rental residential sector.

Financial Highlights – Positive returns and attractive dividend yield

·     NAV total return of 4.5% (2017: 12.2%) delivered with continued low net gearing of 14.6% which remains one of the lowest in the Company’s peer group and the wider REIT sector.

·     Portfolio total return of 5.9% (MSCI IPD benchmark of 6.7%) as real estate returns continued to prove resilient. Over three years the portfolio has returned 24.0% (MSCI IPD benchmark 22.2%).

·     Attractive dividend yield of 4.4% in an environment where interest rates are forecast to stay low.

·     Share price total return of -2.0% in the year comparing favourably to the minus 12.4% on the FTSE All-Share REIT Index and -9.5% on the FTSE All Share Index.

·     £95 million of financial resources available for investment opportunities following the debt refinancing in February 2019.

·     EPRA earnings per share (excluding non-recurring tax items) of 3.03p (2017: 3.42p), equating to a dividend cover of 82% which is expected to grow given acquisition of Midlands portfolio in December 2018.

Investment activity continues to drive valuation and improve long term income returns

·     3.4% increase in portfolio valuation to £1.45 billion as at 31 December 2018 (2017: £1.40 billion).

·     £329 million of investment transactions during the year, selling retail and low yielding peak-cycle assets, and buying higher yielding, largely industrial, stock where we see further value potential is anticipated.

·     16.5% of portfolio income now derived from leases with fixed or inflation-linked uplifts

Positive leasing momentum with portfolio offering strong reversionary potential.

·     Over £7.7 million of the annual income was secured after rent free periods and incentives through 19 new leases and 19 lease renewals / rent reviews.

·     Occupancy rate increased to 93.1% in the year (2017: 92.4%) and compares favourably to the benchmark occupancy rate of 92.8%. Over half the remaining vacancy is in well located units in the industrial sector which offer opportunities to improve future returns. Less than 20% of the vacancy is in the retail sector.

·     99% of rent collected within 21 days underlining the continued strength of a tenant base that has an unexpired lease term of 9.4 years.

·     Portfolio yield of 4.5% with reversionary yield of 5.3% highlighting the reversionary nature of the portfolio and scope for future earnings growth.

Commenting on the results, Andrew Wilson, Chair of UKCM, said:

“During the past year the Company has completed on a number of strategic initiatives to ensure that UK Commercial Property REIT remains well positioned for growth despite the current climate of political uncertainty. This includes the Company’s conversion to REIT, as well as a debt refinancing which concluded post the year end and will provide greater flexibility and firepower whilst reducing borrowing costs. The Company has continued to reduce its exposure to the retail sector and to sell out of ex-growth assets, recycling proceeds into opportunities with sustainable income characteristics whilst maintaining low gearing. As a result, an increasing percentage of portfolio income is subject to fixed uplifts, underpinning an attractive dividend yield and the potential for improving dividend cover.”

Will Fulton, Lead Manager of UKCM at Aberdeen Standard Investments  added:

“Investment activity during the year saw the percentage of UKCM’s portfolio weighted towards the favoured industrial sector increase to 46%, following the Company’s largest acquisition to date of a distribution portfolio in the Midlands. We have also secured shareholder approval to expand UKCM’s investment policy, which coupled with a strong balance sheet, provides us with greater flexibility to further expand our well-diversified portfolio by deploying capital into opportunities where we see value for shareholders. Occupancy across the portfolio remains high at 93.1%, with the majority of vacancy in well located industrial units, where we have already secured a significant pre-let at Wembley, and which is the focus of our ongoing active asset management strategy.”

For further information:

Will Fulton/Graeme McDonald, Aberdeen Standard Investments
Tel: [phone] 245 3151

Richard Sunderland /Claire Turvey/Eve Kirmatzis, FTI Consulting
Tel: [phone]

PERFORMANCE SUMMARY

CAPITAL VALUES AND GEARING	31 December 2018	31 December 2017	% Change
Total assets less current liabilities (excl Bank loan & swap) (£’000)	1,462,982	1,457,262	0.4
Net asset value (£’000)	1,212,619	1,206,046	0.5
Net asset value per share (p)	93.3	92.8	0.5
Ordinary Share Price (p)	83.2	88.6	(6.1)
Discount to net asset value (%)	(10.8)	(4.5)	n/a
Gearing (%):  Net*                         Gross**	14.6 17.1	12.8 17.2	n/a n/a
TOTAL RETURN	1 year % return	3 year % return	5 year % return
NAV †	4.5	21.7	59.0
Share Price †	(2.0)	11.3	35.1
MSCI (IPD) Balanced Monthly and Quarterly Funds	6.7	22.2	61.8
FTSE All-Share Real Estate Investment Trusts Index	(12.4)	(8.6)	25.1
FTSE All-Share Index	(9.5)	19.5	22.1
EARNINGS AND DIVIDENDS	31 December 2018	31 December 2017
Net profit for the year (£’000)	53,005	131,562
EPRA Earnings per share (p)	3.03	3.42
IFRS Earnings per share (p)	4.08	10.12
Dividends declared per ordinary share (p)	3.68	3.68
Dividend Yield (%) ***	4.4	4.2
IPD Benchmark Yield (%)	4.7	4.8
FTSE All-Share Real Estate Investment Trusts Index Yield (%)	4.7	3.4
FTSE All-Share Index Yield (%)	4.5	3.6
ONGOING CHARGES AND VOID RATE
As a % of average net assets including direct property costs	1.5	1.5
As a % of average net assets excluding direct property costs	0.9	0.9
Vacancy rate (%)	6.9	7.6

*        Calculated as net borrowings (gross borrowings excluding swap valuation less cash) divided by total assets less cash and less current liabilities (excluding any borrowings and swap valuation).

**     Calculated as gross borrowings (excluding swap valuations divided by total assets less current liabilities (excluding borrowings and swap).

***  Based on an annual dividend of 3.68p and the share price at 31 December.

†       Assumes re-investment of dividends excluding transaction costs.

Sources: Aberdeen Standard Investments, MSCI Investment Property Databank (“IPD”)

Chairman’s Statement

In what has been a pivotal period I am pleased to report that your Company has continued to make good progress at both a corporate and portfolio level. In 2018 and into 2019 we completed four important initiatives, all of which were undertaken to strengthen the business and are expected to enhance future returns for shareholders.

·     The first of these was our conversion to a REIT, safeguarding the Company from future changes in legislation that would have negatively impacted returns. Having also changed our name to UK Commercial Property REIT Limited (“UKCM”) to reflect this change, we are now one of the largest diversified REITs in the UK.

·     In December, we completed the Company’s largest acquisition to date through the purchase of an earnings enhancing portfolio of distribution units in the Midlands for £85.4 million. Throughout the year we concluded £329 million of sales and acquisitions as we continued to rotate our portfolio.

·     In February 2019, we refinanced our debt facilities at a reduced cost, extending the maturity dates, increasing both the flexibility and quantum of debt available.

·     Finally, at the time of our year end NAV statement in February, we announced that we would seek shareholder approval to expand the Company’s investment policy to provide the Investment Manager with the flexibility to invest across the full spectrum of commercial property including property assets known as ‘alternatives’.

Over the course of 2018, our portfolio of 43 investments, which is now valued at £1.45 billion, delivered a total return of 5.9% compared to the Company’s benchmark total return of 6.7%.Performance was driven mainly by an overweight position to the strongly performing industrial sector which accounted for 46% of the portfolio by capital value at the year end and delivered a total return of 16.0% in 2018. The strong performance of our industrial assets was partially offset by the ongoing challenges faced by the retail sector and one off transaction costs in Q4 2018.

Sentiment turned increasingly negative over the year stoked by a number of well-known company voluntary arrangements and the general trend towards online retail. Distribution warehousing has been reaping the benefit of this adjustment, evidenced most recently for your Company when it announced the pre-letting of  its entire 180,000 sq ft  industrial unit in Wembley, North London, ahead of the current occupier moving out in March 2019 upon lease expiry. The new 10-year index linked lease was signed with an international business that is due to take occupation in October after a full refurbishment of the building.

Portfolio Activity

2018 was also a busy year in the continued repositioning of the UKCM portfolio in reducing its retail weighting and increasing industrial exposure. A key part of this has been realising gains on assets where there is limited future return prospects and re-investing proceeds into higher yielding assets.

The Company sold £173 million of property in 2018 including the disposal of the Company’s retail holdings in Shrewsbury for £49 million early in the year. This was followed by the sale of a High Street retail asset in Exeter for £23.5 million. As a consequence, the Company’s retail exposure reduced to 27% of the capital value of the portfolio. Profits were also crystallised in the office portfolio through the sale of 15 Great Marlborough Street in London’s West End and 1 Rivergate in Bristol for a combined £100 million, both being lower yielding assets.

We also acquired over £156 million of properties during the year, predominantly in the industrial sector. In June, the Company purchased for around £51 million the White Building in Reading, a multi let office investment that is well set to benefit from the opening of Crossrail. This was followed by two acquisitions in the industrial sector: the M8 industrial estate near Glasgow for £24.6 million, yielding 5.9%; and, just prior to the year end, a portfolio of five Midlands distribution units for £85.4 million. The net initial yield of this latter purchase was 5.5% with an unexpired lease term of 7.4 years to expiry and, as well as being reversionary in nature, offers attractive asset management opportunities.

Overall the transactions undertaken in the year have reduced potential portfolio risk by removing assets where future returns were limited; most notably in the retail sector. The proceeds have been re-invested into higher yielding assets that offer greater security of income in favoured sectors and locations.

Additionally, we invested some £41 million of capital expenditure into maintaining or enhancing the value of the retained assets in our portfolio.

The average lease length increased in 2018 and the void rate reduced while the passing rental income at the year-end was £69 million (contracted rental income £71.9 million after expiry of rent free periods) with the estimated rental value of the portfolio being £81.4 million.

Corporate Performance

The Company achieved a net asset value (“NAV”) total return of 4.5% in 2018, accomplished with low net gearing of 14.6%. The share price total return for the year was lower at -2.0% as the discount widened in the year to 10.8% at the year end. However, the share price has risen in 2019 with the discount at 15 April being reduced to 3.7%. Both the NAV and share price total returns exceeded those of the FTSE All-Share REIT Index (-12.4%) and FTSE All-Share Index (-9.5%) over the same period.

Over the longer term the Company has produced stable performance with NAV and share price total returns of 91.9% and 69.0%, respectively, since inception compared with a return on the FTSE All- Share REIT Index of -16.3%.                                   

The Company is now also a member of the Aberdeen Standard Investments Trust Share Plan, Children’s Plan and ISA which should increase the Company’s visibility amongst potential new retail shareholders.

Financial Resources

The Company continues to be in a financially strong position, having been further bolstered by the debt refinancing undertaken in February 2019. At the year end the Company’s net gearing was 14.6% at a blended rate of interest of 2.89% per annum with a revolving credit facility (“RCF”) of £50 million still available for investment. The debt refinancing enabled the Company to increase the amount of the variable rate RCF available by £100million. This increased the flexibility of the overall debt profile and allows the Company to move quickly to take advantage of attractive opportunities that may well occur in the present uncertain economic environment. The business also benefited from the low level of gilt rates taking out £100 million of additional 12 year fixed interest debt using the proceeds to repay partially the £150 million Barclays term loan which was due to mature in March 2020with £50million of the RCF being used to repay the remaining amount. Overall, the debt refinancing has resulted in the Company having £95 million of RCF available for investment for the next 5 years and a reduced blended rate of interest on its drawn debt of 2.79% per annum with a weighted maturity on its fixed interest rate debt of 10 years. Importantly, the Company remains one of the lowest geared companies in the REIT sector, a sensible defensive

strategy given the current economic situation and the forecast moderation of capital returns in the real estate sector.

Dividends

The Company declared and paid dividends totalling 3.68p in 2018. This equated to a yield on the year end share price of 4.4%. In an environment where interest rates are forecast to stay lower for longer, this is a healthy return underpinned by a strong tenant base that pays 99% of its rent within 21 days and a portfolio with an increased weighted average lease length of 9.4 years and 14% of its income in fixed or inflation linked leases.

One of the key objectives of the Board is earnings growth to underpin and drive future dividend policy. The acquisition of the Midlands distribution portfolio towards the year end will add £5 million to the annual rent roll after rent free periods expire. Rental income should also grow as a result of the lettings completed in Wembley, North London and Radlett in Hertfordshire in the first quarter of 2019, and the fact that over half the Company’s voids are in the industrial sector at strong locations, coupled with the reversionary nature of the portfolio. The previously announced reduction in the Investment Manager’s fee, and the absence of a number of non-recurring costs in relation to the REIT conversion, as incurred in 2018, should combine to increase both our EPRA earnings per share (3.03p in 2018) and dividend cover towards 100% in the medium term.

Investment Policy

On 14 February 2019, the Company announced its intention to amend its investment policy. This modernisation of the policy, which was approved by shareholders at a General Meeting on 18 April 2019, provides the Investment Manager with the flexibility to invest across a wider spectrum of commercial property which encompasses what have been termed alternative property assets including healthcare, student housing, hotels, car parks, pubs, petroleum and automotive and the commercially-managed private rental residential sector. Whilst there are no immediate plans to invest in these assets, the usual research and due diligence will be undertaken should suitable opportunities arise.

Environmental and Social Governance (“ESG”)

I would also highlight the positive ESG work that is being undertaken by the Investment Manager in the portfolio. A particular highlight was the award of a Green Star ranking from the Global Real Estate Sustainability Benchmark 2018, with the Company improving its score by 9% compared with 2017 and receiving a European Sector Leader award as the top performer in its peer group.

Board

As reported in the 2016 Annual report, the Board’s succession plan resulted in Mr John Robertson retiring in March 2018 and Ms Margaret Littlejohns and Mr Robert Fowlds being appointed in January and April, respectively. As previously announced, my intention was to step down from the Board at the AGM in 2019. However, in order to ensure a smooth handover of responsibilities, I will retire from the Board at the end of 2019. I am pleased to announce that my successor will be Mr Ken McCullagh, the current Audit Committee Chair and Senior Independent Director who has served on the board for six years, thereby providing valuable continuity. Mr McCullagh’s knowledge of real estate coupled with his financial expertise makes him an ideal candidate to lead your Company forward.

Mr Michael Ayre, a Certified Accountant, will replace Mr McCullagh as Audit Committee Chair. The Board, through its Nominations Committee, intends to appoint a further UK based Director during the course of this year. These changes have and will continue to refresh the Board but without a sudden loss of invaluable knowledge and collective experience.

Outlook

The ongoing Brexit debate and our future relationship with the European Union has caused a period of political uncertainty which has not been seen for a generation. Irrespective of the outcome, this lack of clarity has impacted the economy with both business investment and consumer spending muted. Companies triggering Brexit contingency plans may well result in parts of their businesses moving outside the UK. GDP growth in 2018 was a below-trend at 1.4%, with our Investment Manager forecasting the same level for 2019. This compares to an average forecast of 2.0% across the developed economies.

In this environment, real estate, and UKCM in particular, have a lot to offer. While poorly located retail will continue to struggle, the underlying fundamentals of the UK commercial property market remain compelling, particularly in the industrial sector. Compared to previous cycles, commercial real estate is far more prudently geared, has high occupancy levels and limited supply risk due to low levels of development. A further attraction is the ongoing and significant differential between property yields and gilts in an environment where interest rates are forecast to remain lower for longer.

Against this backdrop, UKCM is very well positioned. The portfolio is of institutional quality and geared towards the industrial sector, with a declining proportion in retail and now just 3% in shopping centres. In addition, over half of the Company’s low void level is in the industrial sector which we see as an opportunity to deliver increases in capital value and income through successful asset management initiatives, as demonstrated by the recent letting at Wembley, North London. The Company has also enhanced its financial position with the recent debt refinancing which has delivered additional, more flexible resources for investment while increasing the maturity profile, reducing the cost of our debt and allowing us to remain one of the lowest geared companies in the REIT sector. Finally, with income forecast to be the main driver of property performance in the next phase of the property cycle, UKCM generates a secure and sustainable dividend yield supported by a strong tenant base with an income profile that is reversionary in nature.

Overall, I believe that UK Commercial Property REIT, one of the UK’s largest diversified REITs, with a continued strategy of producing income led total returns, is very well placed to continue to deliver value for its shareholders.

Andrew Wilson
Chair of UKCM
25 April 2019

Investment Manager Review

Market Review

2018 UK economic growth was fairly uneven. After a weak, weather-affected start to the year, third quarter growth was well above trend at 0.6%, however this appears to have been a temporary spike rather than a decisive strengthening of the economy with indicators in the fourth quarter turning down sharply.

The ongoing uncertainty surrounding Brexit negotiations appears to be restraining business investment and household spending. With trend growth estimated to be lower, the output gap largely closed, and a relatively weak global backdrop, it is hard to see a substantial acceleration in economic growth, which slowed to just 0.2% increase to GDP in the final quarter.

The real estate market has largely followed suit with returns slowing as each quarter of 2018 passed to reach only 6% for the calendar year, with no capital growth in the second half of the year. However the average masks major differences at the sector level. While industrial real estate had another strong year and delivered returns of 16.4%, retail’s return for the year was negative at -0.5%, according to the MSCI IPD Quarterly Index. This represented the largest spread of returns across the three traditional commercial sectors in any 12-month rolling period since Index began in 2000. The FTSE UK REIT index deteriorated significantly in the second half of the year to record a -12.8%

total return in 2018. This was weaker than the wider stock market, where the FTSE 100 and the FTSE All-Share returned -8.7% and -9.5% respectively. The hierarchy of preferred real estate sectors remains largely unchanged with industrials and income-focused stocks remaining the top picks, and wide discounts for the major retail specialists.

Occupational markets continue to behave quite differently across sectors, with structural forces being the key drivers. The familiar pattern of falling retail rents, modest upticks in office rents and robust growth in industrials is little changed. However, the risk of more serious declines in the retail sector is affecting investor sentiment. The structural challenges facing the retail sector are now beginning to be reflected in MSCI IPD data with the majority of retail experiencing declining rental values. With few retailers expanding, aside from the value operators, this rental trend is expected to continue through 2019.

The industrial sector continues to be the stand-out performer in the UK real estate market, although MSCI IPD data suggests that rental growth is beginning to moderate. However, with vacancy rates remaining exceptionally low and interest in available industrial space healthy, the necessary drivers are still in place to support further rental growth for the sector.

At £62.1 billion, according to Property Data, UK real estate investment volumes in 2018 were only down 5% on 2017, itself a very strong year, and substantially more than 2016’s total of £52 billion. This high level of activity came despite the uncertainty facing the market and increasing caution and selectivity among investors towards the end of the year. Notably, 2018 saw the highest ever volume of transactions in the alternative space, at nearly 30% of all deals by value. This sector is fast becoming mainstream and represents the property types falling outside the traditional ‘Retail’, ‘Office’ or ‘Industrial’ definitions. Meanwhile, retail volumes were less than 10% of the total and the £1.3 billion of shopping centre transactions was the lowest annual sum since Property Data’s records began in 2000.

In contrast with the net disinvestment of the previous two years, UK institutions were net investors to the tune of £2.3 billion in 2018. This took up some of the slack from a notable drop in net investment by overseas investors from £12.6 billion in 2017 to just £4.2 billion in 2018, which was the second lowest figure since 2006 but remains significant with 44% of buyers being overseas. This was driven by nearly £6 billion of net disinvestment by US investors and a slowdown in investment from the Far East. It is likely that Brexit concerns played a part in this trend but the stronger economy and higher yields in the US may also have been a factor. Furthermore, some very large disposals, such as Goldman Sachs’ sale and leaseback of its new European headquarters in London, skewed the figures somewhat.

Review by Sector

Retail — Structural change bites

According to MSCI IPD, retail performance lurched into negative territory in 2018, which is the first time since 2008 that a sector has delivered a negative total return in the calendar year. Investor sentiment in the sector has deteriorated as has liquidity. With the share prices of Intu and Hammerson falling by 55% and 40% respectively in 2018, the listed market has led the way in reflecting the structural challenges in the sector. The outlook for retail tenants has become more challenging as time has gone on and this is now weighing on performance, with all forms of retail experiencing declining rental values. With few retailers expanding, aside from the value operators, and further distress and store rationalisation in the sector anticipated, it is expected that this trend will continue through 2019. There are specific concerns around department stores, which are weighing heavily on the value of the shopping centres they anchor. Supermarkets have become the best performing part of the retail market and, with a 6.4% total return, outperformed the wider UK real estate market average in 2018. There are undoubtedly challenges around store count, store sizes, over-renting and more intense competition pushing down margins. However, there remains a strong reliance on physical stores evidenced by online sales growing notably slower compared to non-food retail while long leases, often with indexation, and strong covenants have supported values. While the top-down view of the retail sector is unfavourable, many retail locations continue to perform well for retailers and offer robust income for discerning investors. Forensic stock selection and a focus on active asset management are ever more important for the delivery of performance from this evolving sector.

Office — Brexit and structural change holding London back

For the second successive year, regional offices were the best performing geographical region in the sector, delivering a total return of 8%. London’s City and West End/ Mid-Town sub-markets produced total returns of 6.9% and 4.6% respectively, while assets in the rest of the South East returned 6.5%. Rental value growth has slowed markedly in Central London, turning negative in the West End in 2018 despite low vacancy rates, even with a reasonable near-term pipeline of speculative construction. Take-up in 2018 was strong, with nearly 18 million square feet let across Central London, according to CoStar. In such conditions, slow growth or even falling rental values are unusual. However, Brexit uncertainty is likely to be contributing to some occupier caution, as well as incentivising landlords to secure lettings rather than push for the highest rent possible. Furthermore, a growing share of take-up is accounted for by flexible office providers, which ultimately adds to rather than absorbs supply, as those operators re-let the space back into the market at higher head count densities, competing with traditional space. While vacancy is higher in the regions, the recent trend has been much more positive in the ‘Big Six’ office markets (Birmingham, Bristol, Edinburgh, Glasgow, Leeds and Manchester), with vacancy falling sharply, permitted development rights further reducing supply, very strong net absorption and some modest rental value growth, in addition to higher income returns than in Central London. The investment market continues to support pricing in Central London but remains heavily reliant on overseas investors, who have a different cost of capital and a different universe of investment targets compared with UK investors. But as the year drew to a close there were signs of greater caution, with investors adopting a ‘wait and see’ approach ahead of the Brexit deadline.

Industrial — Continued rental value growth supporting strong pricing

The industrial sector outperformed the wider market for the seventh successive year in 2018 and by its largest ever margin, delivering a total return more than 10 percentage points greater than all property. Rents grew by 4.6% at the headline sector level and yields moved in to a record low. Rental performance was once again stronger in the South East than the rest of the country, with rents being 30% higher than five years ago, compared with a 14% increase in the rest of the UK. Constrained supply remains the key to this growth, with industrial stock in London shrinking against a backdrop of robust demand created by the growing requirement for ‘last mile’ logistics space driven by retail sales transitioning to online. Outside of the South East, the market is more in balance and supply has increased in response to the rapid absorption of logistics stock between 2014 and 2017. Whilst vacancy has stabilised in the core distribution markets, the absolute level is low and still supportive of growth. There were signs towards the end of 2018 that investors were becoming more discerning around industrial investment. Interest in the strongest occupational markets remains undimmed but the pricing of some riskier and more compromised assets, in areas with less demand, may be softening.

Alternatives – Income-focused investors abound

Alternative property types are fast becoming conventional and are loosely grouped together as “Other Property” by MSCI IPD. This sector performed marginally ahead of the market average in 2018, continuing a pattern of strong relative performance in weaker return environments. With much of the sample of properties on long leases, often to secure covenants and with guaranteed but usually capped uplifts to income, values in the sector tend to be less

volatile than the traditional commercial sectors. This has historically led to relative outperformance when absolute returns are lower and underperformance when absolute returns are higher. However, there are also significant structural drivers at play, such as demographics and technology, working in favour of many of these property types. The proportion of real estate investors prioritising income has increased in recent years, diverting investor interest into areas of the market offering sustainable income through either shorter leases where the fundaments of the sub-sector are strong, or through long secure income streams. While MSCI IPD includes leisure property within its “Other Property” sample, some aspects of it, especially the food and beverage elements, are more similar to retail than other alternatives. Given its reliance on consumers’ disposable income and the complementary nature of retail and leisure uses, there are concerns that retail oversupply will dampen leisure growth. Rapid restaurant expansion has absorbed some retail vacancy in recent years but this has largely been fuelled by debt and many locations would appear to be saturated. Increasingly, highly leveraged, low margin operators look vulnerable, intensifying the investor’s focus on covenant strength when investing in buildings with long leases.

Market Outlook

There is significant uncertainty around the near term political outlook and, by extension, the economic outlook. Sustained uncertainty implies elevated risk and this is impairing liquidity in the UK real estate market. The paucity of buyers is affecting pricing visibility and that may ultimately lead to a lack of confidence in valuations, with little evidence to base them on. With the risk that this uncertainty is prolonged the short-term outlook for UK real estate carries risk to values. However, absent Brexit risks, fundamentals in the market are generally robust. Low vacancy and the structural support for demand are set to drive industrial rents higher, while office vacancy is low in Central London and has fallen significantly in the regions, which should support occupational markets despite caution on the part of tenants. We expect further declines in value across the retail sector in 2019 and an end to Brexit uncertainty is unlikely to offset the market’s concerns around the sector’s structural issues or nervousness around some key tenants. After a long period of strong total returns, with 10.6% per annum delivered from September 2009 to September 2018, it is intuitive that value across the market is now hard to unlock. But with prices now falling in many segments, some investors may be insufficiently discerning to accurately price assets relative to their true long-term worth in a turbulent market. While buyers will always be wary of further post-purchase falls in value in such a market, strong performance over the medium to long term can still be achieved, if assets are purchased below their long-term worth. Fundamentally good quality assets can be swept up in negative sentiment and may transact at levels that look favourable in the longer term offering good opportunities for shrewd investors.

Portfolio Performance

During the reporting period the Company’s property portfolio generated a total return of 5.9% versus 6.7% for its MSCI IPD Balanced Monthly & Quarterly Funds benchmark. The portfolio delivered outperformance for the first nine months of the year but fell behind in Q4 due to one-off transaction costs, the timing of asset management events in the industrial portfolio and valuation adjustments across the retail portfolio. At the year end the portfolio’s net initial yield was 4.5% with a reversionary yield of 5.3%, illustrating the strong potential for earnings growth through the leasing of void properties and realisation of latent income, discussed later in the Review.

Over three years the portfolio has outperformed its MSCI IPD benchmark. The table opposite sets out the components of these returns for the year to 31 December 2018 with all valuations undertaken by the Company’s valuer, CBRE Ltd.

	Total Return		Income Return		Capital Growth
	UKCM	Benchmark	UKCM	Benchmark	UKCM	Benchmark
	%	%	%	%	%	%
Industrials	16.0	16.3	3.1	4.4	12.5	11.4
Office	10.8	6.9	4.2	4.0	6.4	2.8
Retail	-7.3	-0.4	5.3	5.3	-12.1	-5.4
Alternatives	4.3	7.8	4.4	4.5	-0.1	3.2
Total	5.9	6.7	4.1	4.6	1.8	2.0

Source: MSCI/IPD, Aberdeen Standard Investments

Multi-period capital growth and income return may not sum perfectly to total return due to the cross product that occurs as income is assumed to be reinvested on a monthly basis and is subject to capital value change.

The portfolio’s income profile has continued to be the main driver of total returns, delivering 4.1% compared to a capital return of 1.8% for the 12 month period. This trend, of a reliance on income to be the dominant generator of total returns, is expected to continue. In response, the Company has continued to align the portfolio to the strongly performing industrial sector, increasing weighting to 46% with the purchase of a higher yielding regional portfolio to balance the strong but lower yielding South East portfolio. It has also decreased exposure to the retail sector, which carries the greatest level of income risk, to 27%. This strategic restructuring, combined with a high occupancy rate of 93% and attractive asset management opportunities, places the Company in a good position to deliver a sustainable income return under the prevailing market conditions.

Industrial

The industrial portfolio, which now represents just under half of the Company’s holdings by capital value, has delivered a total return for the year of 16.0% against the benchmark return of 16.3%. This strong performance has been driven by the completion of significant leasing activity at Ventura Park, Radlett, Newton’s Court, Dartford and The Dolphin Estate, Sunbury on Thames. These properties represent the top three performing assets in the portfolio over the year, each delivering returns in excess of 20%. Sector level performance has temporarily been impacted by two assets: XDock 377, Magna Park, Lutterworth and Wembley180, London. XDock 377 is a distribution warehouse, located in the logistics ‘Golden Triangle’ of the Midlands in close proximity to the M1 and M6 Motorways, which has recently been refurbished and is currently the Company’s largest vacant property, representing just under half of the portfolio’s 6.9% vacancy position. This prime property represents an excellent asset management opportunity to capture the rental growth being delivered in the sector and, upon letting, is forecast to generate a boost to capital performance and a robust income profile. Wembley180 is a prime London distribution warehouse single let to M&S on a lease which expired in March 2019. The asset’s short income profile suppressed performance during the year. However, during the first quarter of 2019 the property has been pre-let to an international occupier on a 10- year index-linked lease, subject to a comprehensive refurbishment. This is due to be completed in October 2019 and is anticipated to deliver significant value together with strong income.

Office

The Company’s office portfolio has performed strongly during the course of the year, delivering a total return of 10.8% compared to the benchmark return of 6.9%. This outperformance has been driven by the profitable sales of 1 Rivergate, Bristol and 15 Great Marlborough Street, London, together with the completion of lettings ahead of estimated rental values at Eldon House, London and Central Square, Newcastle. During the year the Company purchased the White Building in Reading, which provides robust income and good asset management opportunities to take advantage of the attractive local market dynamics with the forthcoming delivery of the Elizabeth Line planned for autumn 2019. The Company now only holds two Central London office buildings: Craven House in the West End and Eldon House in the City. Combined, these assets represent just under 5% of the portfolio by capital value, placing the Company in a strong, defensive position towards the uncertain risks presented by Brexit.

Retail

The Company has sold two retail assets during the year: three shopping centres assets in Shrewsbury, treated as one sale, and 16–20 High Street Exeter, reducing the exposure to the retail sector to just 27% by capital value. The retail portfolio delivered a total return of -7.3% compared to -0.4% for its benchmark. This performance has been driven by valuation adjustments in response to established headwinds in the sector. Two assets were particularly impacted: the Company’s one remaining ‘shopping centre’ in Swindon and St George’s Retail Park, Leicester, one of the Company’s smallest retail parks, which was impacted disproportionately by CVA (Company Voluntary Arrangement) activity over the year. However, with the benefit of a focused asset management agenda, the Company has completed significant leasing activity at St George’s Retail Park, Leicester, Kew Retail Park, Richmond and The Parade, Swindon, resulting in a high occupancy level of 96% across the Company’s retail portfolio at the year end as discussed in more detail below.

Alternatives

The Company’s leisure assets, which collectively represent 11% of the portfolio by capital value, delivered a total return of 4.3% compared to the benchmark return of 7.8%. The Company’s performance has been impacted by a weakening in the casual dining sector with two CVAs at Regent Circus, Swindon and two small vacancies at The Rotunda in Kingston-upon-Thames. Shortly before the year end the Company’s forward funding of the Maldron Hotel in Newcastle was completed with the hotel element now fully income producing. This provides an attractive 35 year index linked income which further bolsters the portfolio’s income profile.

Investment Activity – Delivering on Strategy

As you will read below, we have had an active year manoeuvring the portfolio in line with our strategy to position for an attractive and, we anticipate, growing level of income together with the potential for capital growth. This has taken the form of £329 million worth of investment transactions – selling retail and low yielding peak-cycle assets, and buying higher yielding, largely industrial, stock where we see further potential. We have also invested £41 million into improving property we already own the fruits of which we expect to benefit from during 2019 and beyond.

Sales

One of our key objectives since 2015 has been to reduce retail exposure. We continued this at the start of the year in January when we completed on the strategic disposal of the Charles Darwin, Pride Hill and Riverside shopping centres in Shrewsbury to Shropshire Council for approximately £51 million, ahead of the 2017 year-end valuation, leaving us just one relatively small shopping centre. In the final quarter we also completed the sale of a retail asset at 16–20 High Street, Exeter, to a UK pension fund for £23.5 million; let to H&M and Barclays Bank the sale reflected a net initial yield of 4.75%.

During the summer, having completed our asset management plan to extend the occupational lease, we sold 1 Rivergate, a single let office building on Temple Quay, Bristol, to a pension fund for a net price of £26.6 million (net after a rental top up), which was ahead of the asset’s latest valuation.

In the final quarter, we completed on our largest sale of the year at 15 Great Marlborough Street, Soho, London, in an off market transaction to a major UK Insurance Company for £73.2 million. This met our twin goal of strong pricing and risk mitigation. We sold ahead of valuation capturing what we believe to be peak London office pricing, represented by a very low yield, and removed the risk of our tenant, Sony, exercising an option to break the lease and so stop paying what was a significant rent for the Company in November 2019.

Purchases

During the first half of the year we completed the acquisition of The White Building, Reading, for approximately £51 million, based upon a topped-up net initial yield of 5.75%. This multi-let office recently emerged from a £16 million refurbishment by the vendor and is proving very popular amongst tenants. It is in line with our strategy to acquire prime assets with an earnings focus and we expect the property will continue to benefit from the wider infrastructure investment being undertaken in Reading, most significantly when the new Elizabeth Line opens linking the town to Central London. The property is 82% let to nine tenants and at purchase had a weighted average unexpired lease term of five years to break. It is expected to deliver an annual rental income of around £3.0 million once fully let.

In September we acquired the M8 Industrial Estate, near Glasgow, from a private property company for a headline price of £24.6 million, based on a topped up net initial yield of 5.9%. The asset has 92% occupancy and is well let to tenants including Boots UK and Rentokil with an attractive average lease term of seven years at purchase. With an affordable rent of £5.25 per sq ft across the estate, there is an opportunity to let up the small amount of vacant space and grow income.

Close to the year end we capitalised on the opportunity to acquire a portfolio of five distribution warehouses in strategic locations across the Midlands, close to the M1 and M6 motorways. The portfolio totals 909,030 sq ft and is 100% let to a diverse mix of tenants with a low average headline rent of £5.52 per sq ft, as well as an attractive unexpired lease term of 7.4 years to break and 9.6 years to expiry. This reversionary portfolio provides secure, diversified income and attractive asset management opportunities to capture rental growth and extend lease terms. Bought from Clipstone Logistics REIT for a headline price of £85.4 million, reflecting a headline net initial yield of 5.5%, the acquisition increased our exposure to the strongly performing industrial sector to 46%.

Collectively these transactions represent a recycling of capital from mature-cycle and expensive markets into higher yielding assets offering better risk-adjusted and sustainable earnings potential.

Asset Management Activity

During the year the Company continued its drive to strengthen income streams, extend lease lengths and add value to the portfolio, which now has an annual rent roll of £69 million (£71.9 million after expiration of rent free periods). Over £7.7 million of the annual income was secured after rent free periods and incentives through 19 new leases and 19 lease renewals / rent reviews.

The Company is also pleased to report that, on average, 99% of rent was collected within 21 days of each quarterly payment date during 2018.

It was good to witness the majority of open market rent reviews agreed this year generating rental increases, especially within the South East industrial sector where rents grew significantly, often ahead of Estimated Rental Value (ERV). Rent review uplifts within the Company’s strongly performing industrial portfolio totalled £496,505 p.a., 16% ahead of the previous rents and 12% ahead of ERVs at the time of review.

During the year, the weighted average unexpired lease term across the portfolio remained steady at 8.8 years at the end of the year compared to 8.9 years in December 2017, with 16.5% of portfolio income now derived from leases with fixed or inflation-linked uplifts.

Thematically we have experienced strong rental growth from the significant London based element of our industrial portfolio with good demand across both London and regional stock. Retail ERVs, particularly in the single shopping centre and most of the retail parks, have dropped through the year however our leasing experience to date has been encouraging with our overall retail occupancy level at 94% at the year end and a relatively limited impact from Company Voluntary Arrangements (CVAs) with a reduction of only 1.5% of rental income from the total portfolio. The leisure portfolio is predominantly well let on medium to long term leases and has seen minimal change in ERV although there is leasing friction on the elements of food and beverage within this subsector. The office portfolio has experienced good demand for the limited availability we had in the City of London and strong regional demand at the start of the year, waning in the autumn and winter months, but picking up in the first part of the New Year; ERVs remaining broadly flat.

The following asset management activity, grouped by sector with percent occupied shown as at 31 December 2018, represents a summary of noteworthy transactions:-

Offices – 93% Occupied

Eldon House, City of London

The Company took its only City of London property, Eldon House, to 100% let at the year end with lettings

to Proclinical Ltd, MLM Building Control Ltd and Civilised Bank secured at rents between 5–10% ahead of ERV. Also at this mixed use investment a rent review was agreed with William Hill, which occupies an external shop unit, securing a new rent of £79,000 p.a., 22% ahead of the previous passing rent.

1 Rivergate, Temple Quay, Bristol

Just before the summer we completed a new eight year lease with Ovo Energy Ltd at this property, at a new rent of £1.7 million p.a., facilitating the sale of this investment ahead of valuation.

Central Square, Newcastle

A new five year lease renewal was completed with Cushman & Wakefield, at this property. The new rent of £95,400 p.a. reflects an uplift of 18% ahead of ERV and the lease also improved the weighted average unexpired lease term at the building.

Retail & Leisure – 95% Occupied

Cineworld Complex, Glasgow

With completion in Q4 of the rearrangement and restructuring of the basement, ground and first floor leases of this property beneath Cineworld our short term asset management programme is now complete. We have replaced a short term lease at £200,000 p.a. for all three floors, with a new 25 year lease at a rent of £250,000 p.a. over the ground and first floors only with The Stone Gate Pub Company, incorporating RPI increases capped and collared at between 1% and 4%. The pub group has also invested its own money in an extensive refurbishment which further improves the facility. We then also secured a lease on the returned basement space in The Glee Club, a national comedy club, for 15 years, with a break after year three, at a rent of £100,000 p.a. extending the investment’s lease term and increasing income.

The Parade, Swindon

Following completion of landlord’s works, the new 15 year lease completed with Wilko on the majority

of the former BHS unit, secured a headline rent of £385,000 p.a. In addition the Company renewed a Tesco supermarket lease for a 10 year term, with a break option in year five, at a rent of £200,000 p.a., in line with ERV. Finally, following landlord’s works, the Company completed a new lease with NatWest bank, delivering £170,000 p.a. on a 10 year lease. Kew Retail Park, Richmond In line with our asset management plans for this investment we concluded a lease renewal with GAP at a rent 8.5% ahead of ERV securing £439,600 p.a. for a ten year term, incorporating some landlord flexibility, and let our former Mothercare unit to Sports Direct on a short term basis.

St George’s Retail Park, Leicester

2018 has been a busy year for St George’s with construction work completed in relation to the creation of three new units that are prelet to Wren Kitchens, Tapi Carpets and Laura Ashley. Importantly these works also included

improvements to customer road access and egress from the park. The three stores opened in Q1 2019 and, with a new Costa Coffee also financed by the Company and about to open providing a much needed facility, interest from retailers in leasing the remaining vacancy has increased. St George’s has been impacted by a disproportionate number of CVAs over 2018. However, at year end, two of the three units affected here were relet to Dreams and Card Factory for a combined £140,000 p.a. in line with ERV. At the year end St. George’s was 17% vacant and, ahead of the expiry of a large Wickes’ 25,000 sq ft ‘anchor store’ in January 2019, the Company exchanged an agreement for a new lease with Home Bargains at ERV on a 15 year term with fixed rental uplifts, commencing on completion of refurbishment works in April 2019.

Motor Park, Portsmouth

Testament to the strength of this location we successfully restructured the occupation of two tenants onto long leases. First a 20 year term to Harwoods over its 18,800 sq ft unit incorporating five yearly RPI linked rent reviews capped and collared at 1%–3% p.a. The rent agreed of £288,000 p.a. (equivalent to £15 per sq ft) was 8.5% ahead of the ERV at the time of signing and is now in line with the current ERV. The second, with Snows Business Holdings, was for a new 25 year lease over its 30,000 sq ft unit at a rent of £440,000 p.a., equivalent to £15 per sq ft and in line with ERV. Again this lease incorporates RPI indexation, capped and collared at 1%–3.25% p.a., compounded

with rent reviews every five years. These lettings increase the weighted unexpired lease length at Motor Park, where UKCM owns a total of 160,000 sq ft of commercial space across nine units, from 6.1 years to 12.8 years, as well as maintaining occupancy at 100%.

Industrial/Logistics Distribution – 92% Occupied

XDock 377, Magna Park, Lutterworth

Following the takeover of Argos by Sainsbury’s, the former Argos logistics distribution unit on Magna Park, Lutterworth, fell vacant in December 2017 and accounts for just under half of the Company’s 6.9% void position. During the year the unit was extensively refurbished at a cost of circa £7 million with completion of the work just after the year end. The unit is being marketed for let with good early interest and the Company, as is normal in these circumstances, is pursuing a claim against the previous tenant for the cost of dilapidations.

Ocado, Distribution Facility, Hatfield

A rent review was agreed with Ocado over its distribution facility in Hatfield which secured an annual rent of £3.03 million, 12% ahead of ERV at the review date, an uplift of £322,000 p.a. After the year end Ocado’s news of a distribution arrangement with Marks & Spencer appears to have been positively received by markets, partially offsetting concern over damage to its Andover facility.

Newton’s Court, Dartford

Whilst lagging a little behind other points of the London industrial/distribution compass, rental growth arrived in force during the year at the Company’s Dartford estate. One unit has been let to Millmoll Group Holdings Ltd, an event furniture business, on a 10 year term lease with a tenant only break option in year five at a rent of £240,578 p.a., 8.5% ahead of ERV. Two existing tenants, Wilhelmsen Ship Services Ltd and Baxi Heating UK Limited, signed new ten year leases at a combined rent of £244,779 p.a., 3% ahead of ERV.

Dolphin Trading Estate, Sunbury-on-Thames

With shrinking supply in the market, particularly West London, we agreed a lease renewal 47% ahead of the previous passing rent and 15% ahead of ERV at the time with existing tenant Lubkowski Saunders & Associates Ltd for 10 years with a break at five, securing a new rent of £510,763 p.a.

Emerald Park, Bristol

A new ten year lease renewal took place with Nomenca, a specialist engineering company, at Emerald Park, Bristol at a new rent of £76,000 p.a., 15% ahead of the previous passing rent and 3% ahead of ERV.

Ventura Park, Radlett

A number of leasing transactions took place through the year on this, our largest South East industrial asset and largest asset in the portfolio. In Q2 the Company signed an agreement to lease the largest vacancy (26% of ERV) on the estate to an existing global tenant, at a rent of £1.34 million p.a. with five yearly inflation-linked and upwards only rent reviews; completion of the lease itself is subject to completion of certain landlord’s works, expected in spring 2019. This letting represents an increase of 39% on the previous passing rent and is in line with ERV. On a smaller unit occupied by the same tenant the Company regeared the existing lease providing a 10 year certain term and securing a rent of £330,750 p.a., 3% ahead of ERV and 15% ahead of the previous rent passing. In addition a new 10 year reversionary lease was completed with Rhys Davies & Sons Ltd, incorporating a new rent of £343,485 p.a. 10% ahead of ERV. The new contract will commence upon the expiry of their current lease in 2020 and incorporates a tenant break option in 2025. This asset management activity helped to deliver one of the largest positive contributions to portfolio total return during the year driven by both capital growth and ERV improvement.

Environmental, Social and Governance (ESG)

The Chair has already commented upon the Board’s commitment to ESG as well as the strong GRESB sustainability rating and EPRA award. As the Company’s Investment Manager, Aberdeen Standard Investments views the management of Environmental, Governance and Social issues as a fundamental part of its business. Whilst real estate investment provides valuable economic benefits and returns for investors it has, by its nature, an environmental and societal impact. We have committed to:

·     Identifying, assessing, monitoring and controlling environmental, societal and regulatory risks at key stages of the investment, development and asset management operations;

·     Ensuring effective governance and responding to and complying with regulatory requirements;

·     Sharing our knowledge and engaging with central and local government and with other bodies in order to encourage best practice in the market and to steer government policy;

·     Working in partnership with our key stakeholder groups – our investors, occupiers, employees, suppliers and the communities we serve.

A key element of our policy and approach is the employment of our ESG Impact Dial – a proprietary research framework – in support of investment strategies, underwriting decisions and asset management approach. We have identified a range of major forces for change – Environment & Climate, Governance & Engagement, Demographics and Technology & Infrastructure – which together form the basis of the ESG Impact Dial. These guide the prioritisation and integration of ESG factors within the Company’s portfolio and provide a structure for engagement with, and reporting to, stakeholders. A practical example is our current investigation of the practicality, financing and returns to be generated from the installation of solar photo-voltaic energy generation on select warehouse roofs with clear benefits to both the environment and leasing prospects.

Portfolio Strategy

Your Company aims to deliver an attractive level of income, together with the potential for capital and income growth, through investment in a diversified UK commercial property portfolio. Our strategy to achieve this combines investment, divestment and asset management, including disciplined investment in existing stock where accretive. In order to help meet the Company’s investment objective, which remains unchanged, the Company has widened its investment policy to provide greater flexibility to invest in additional sectors, which have come to be regarded as mainstream and are commonly referred to as “alternative sectors”, and include healthcare, student housing, hotels, car parks, pubs, petroleum and automotive and the commercially-managed private residential rental sector, amongst others. These represent an increasing share of the commercial property investment market and have accounted for 25% of all UK real estate transactions over the last five years. Driven by a combination of favourable structural drivers which we believe are set to continue, including demographic, urbanisation and trends in technology, together with the stability of income returns and diversification benefits that investing in alternatives sectors brings, this investment flexibility is to be welcomed.

Net investment during the year utilised all surplus investment cash which will aid dividend cover going forward but the Company also took advantage of low yields in the debt markets to refinance, extend and increase its gearing capability whilst maintaining its policy of low overall gearing. The result, secured in February 2019, is £100 million of revolving credit available for investment which, currently, is intended to be used tactically where a short term sale is expected to rebalance gearing levels.

When looking at opportunities to deploy these resources our current strategy focuses on two themes; first, long-term secure income, often found in funding the construction of new ‘pre let’ buildings, but with caution around competitive pricing; secondly, sustainable income which exhibits growth potential within the better yielding sub-sectors of the alternative sector, not necessarily through long leases. Straddling these strategies we are alert to investments in vibrant economies with strong demographics which have opportunistic pricing through potential vendor distress; with uncertainty continuing in politics as the path to Brexit evolves, feeding into the economy and property market, we believe interesting opportunities may be available if, for example, owners require to increase liquidity quickly.

With income important to the Company, and likely to drive total return in the current market, we have successfully worked through a period of spikes in lease expiry profile which are due to enhance income in 2019. Our portfolio focus remains firmly on leasing vacant properties to generate income, and with over 50% of our vacancy in the industrial/ logistics sector the outlook is positive. Meanwhile we are keeping a close eye on those assets with a weaker prognosis and strategic opportunities to disinvest. Recent examples are the sale of our Shrewsbury shopping centres to Shropshire Council in January 2018 and, as announced at the start of this year, the re-letting of our Wembley logistics warehouse for 10 years crystallising growth in rental values in that location and removing the risk of a future vacancy.

We enter 2019 ready to meet political uncertainty with a diversified portfolio biased towards favourable sectors of the market, a strong opportunity to generate additional income from our industrial-logistics portfolio, a refreshed investment policy providing greater flexibility to invest, and a strong balance sheet.

Will Fulton
Fund Manager
Aberdeen Standard Fund Managers Limited
25 April 2019

Strategic Overview

Investment Strategy

The Group’s investment strategy is set out in its investment objective and policy below. It should be considered in conjunction with the Chair’s Statement and the Investment Manager’s Review which both give a more in depth review of performance and future strategy.

The Group’s investment objective is to provide ordinary shareholders with an attractive level of income together with the potential for capital and income growth from investing in a diversified UK commercial property portfolio. In order to achieve this objective the Group has an investment strategy that focuses on identifying and acquiring institutional grade, secure income producing assets in favoured sectors as well as identifying assets that benefit from wider infrastructure improvements delivered by others where possible. In addition the Group will look to sell assets that have limited future return prospects or where there are significant risks to achieving future acceptable returns. As part of this investment strategy, the Group also recognizes that tenants are a key stakeholder and aims to foster a culture whereby the experience of tenants is seen as paramount to the future success of the Group. The Investment Manager works closely with tenants to understand their needs through regular communication and visits to properties. Where required, and in consultation with tenants, the Group refurbishes and manages the owned assets to improve the tenants’ experience, including consideration of health and safety and environmental factors, with the aim being to generate greater tenant satisfaction and retention and hence lower voids, higher rental values and stronger returns. In addition to the above, members of the Board also visit properties and where appropriate engage with tenants directly which enables the Board to have an enhanced understanding of each property and the tenants’ requirements.

On 18 April 2019, the Investment policy was amended to provide the Investment Manager with the flexibility to invest across a wider spectrum of commercial property assets such as healthcare, car parks and the commercially-managed private rental sector. The Investment Policy now reads as follows: Investment risks to the Group are managed by investing in a diversified portfolio of freehold and long leasehold UK commercial properties. The Group invests in income producing assets across the four commercial property sectors: industrial, office, retail and other alternative commercial property sector assets.  The Group has not set any maximum geographic exposures within the UK nor any maximum weighting limits in any of the principal property sectors. No single property shall, however, exceed at the time of acquisition 15 per cent of the gross assets of the Group.

The Group is currently permitted to invest up to 15 per cent of its total assets in indirect property funds including in other listed investment companies. The Group is permitted to invest cash, held by it for working capital purposes and awaiting investment, in cash deposits, gilts and money market funds.

Although not part of the Company's formal investment policy, the Board intends to limit the Company's investment into alternative sectors to 35 per cent of the gross assets of the Group at the time of acquisition.

At an EGM of the Company on 28 April 2011 the shareholders of the Company approved a revised gearing policy of the Group amended to read as follows: “Gearing, calculated as borrowings as a percentage of the Group’s gross assets, may not exceed 65 per cent. The Board intends that borrowings of the Group at the time of draw down will not exceed 25 per cent. of the Total Assets of the Group. The Board receives recommendations on gearing levels from the Investment Manager and is responsible for setting the gearing range within which the Investment Manager may operate. As mentioned in the Chair’s statement the Group restructured its debt facilities in February 2019 which increased the weighted average maturity of the Group’s debt profile, lowered the cost and increased the debt available while still maintaining the 25% debt cap referred to above.

The Group’s performance in meeting its objective is measured against key performance indicators as set out below. A review of the Group’s returns during the year, the position of the Group at the end of the year, and the outlook for the coming year is contained in the Chair’s Statement and the Investment Manager Review.

The Board of Directors is responsible for the overall stewardship of the Company, including investment and dividend policies, corporate strategy, corporate governance, and risk management. The Company has no executive Directors or employees.

Management of Assets and Shareholder Value

The Board contractually delegated the management of the investment portfolio and other services to Aberdeen Standard Fund Managers Limited from 10 December 2018 (prior to this Standard Life (Corporate) Funds Limited).

The Group invests in properties which the Investment Manager believes will generate a combination of long-term growth in income and capital for shareholders. Investment decisions are based on analysis of, amongst other things, prospects for future capital growth, sector and geographic prospects, tenant covenant strength, lease length and initial yield. In the year to 31 December 2018, the Group generated operating cash flows of £46.9m (2017: £42.4m) and a net profit for the year of £53.0m (2017: £131.6m). The fall in profits in 2018 was attributable to the slowing rate of growth in the UK commercial real estate sector with gains on investments of £18.9 million being generated in 2018 compared to £90.4 million in 2017.

Investment risks are spread through investing in a range of geographical areas and sectors, and through letting properties to low risk tenants. Further analysis can be found in the Investment Manager Review. At each Board meeting, the Board receives a detailed portfolio, financial, risk and shareholder presentation from the Investment Manager together with a comprehensive analysis of the performance of the portfolio during the reporting period.

The Board and the Investment Manager recognise the importance of managing the premium/discount of share price to net asset value in enhancing shareholder value. One aspect of this involves appropriate communication to gauge investor sentiment. The Investment Manager meets with current and potential new shareholders, and with stockbroking analysts who cover the investment company sector, on a regular basis. In addition, communication of quarterly portfolio information is provided through the Company’s website, www.ukcpreit.co.uk, and the Company also utilizes a public relations agency to enhance its profile among investors. In addition the Chair of the Board meets key shareholders on an annual basis.

Key Performance Indicators / Alternative Performance Measures

The Company’s benchmark is the MSCI Investment Property Databank (IPD) Balanced Monthly and Quarterly Index. This benchmark incorporates all monthly and quarterly valued property funds and the Board believes this is the most appropriate measure to compare against the performance of a quarterly valued property investment company with a balanced portfolio.

The Board uses a number of performance measures to assess the Company’s success in meeting its objectives. The key performance indicators/alternative performance measures are as follows:

-      Net asset value and share price total return against a peer group of similar companies.

-      Portfolio performance against the IPD benchmark and other selected comparators.

-      Premium/(Discount) of share price to net asset value.

-      Dividend per share and dividend yield.

-      Ongoing charges

Given the structure of the Company and the Company’s knowledge of its underlying shareholder base, it is believed the above measures are the most appropriate for shareholders to determine the performance of the Company. These indicators for the year ended 31 December 2018 are set out above. In addition the Board considers specific property KPIs such as void rates, rent collection levels and weighted average lease length on a regular basis.

Risk management

In accordance with the UK Corporate Governance Code and FRC Guidance, the Board has established procedures to identify and manage risk, to oversee the internal control framework and to determine the nature and extent of the principal risks the company is willing to take in order to achieve its long-term strategic objectives.

The Board recognises its responsibility to carry out a robust assessment of the company’s principal risks and emerging risks. Principal risks are defined as those that could result in events or circumstances that might threaten the company’s business model, future performance, solvency or liquidity and reputation. Emerging risks are those that have not yet occurred but are at an early stage of development or are current risks that are expected to increase in significance and become more fundamental in the future.

The Board has appointed a Risk Committee to ensure that proper consideration of risk is undertaken in all aspects of the company’s business on a regular basis. The Risk Committee meets quarterly and comprises all members of the Board and is chaired by Margaret Littlejohns (previously by John Robertson until 31 March 2018). Its duties include the assessment of the Company’s risk appetite and the regular review of principal and emerging risks, seeking assurance that these risks are appropriately rated and that effective mitigating controls are in place, where possible.

Risks are identified and weighted according to their potential impact on the Company and to their likelihood of occurrence. The impact is evaluated in terms of the effect on the Company’s business, finances and reputation, the three of which are usually interlinked. Each identified risk is assessed twice: first as a “gross risk” before taking into consideration any mitigating controls and secondly as a residual or “net risk” after reviewing the safeguards in place to manage and reduce either the severity of its impact or the probability of its event. The Risk Committee uses a detailed Risk Matrix to prioritise the individual risks, allocating scores of 1 to 5 to each risk for both the likelihood of its occurrence (ranging from very unlikely to almost certain) and the severity of its impact (ranging from minimal to highly significant). The combined scores for both the gross risks and net risks are then colour coded, applying a traffic light system of green, amber and red to emphasise those posing the greatest threats to the Company. Those with the highest gross rating in terms of impact are highlighted as top risks within the matrix and are defined here as principal risks.

The Risk Committee, with the help of the Investment Manager’s extensive research resources and market intelligence, surveys the full risk landscape of the Company in order to identify increasing and emerging risks to which the Company may be exposed in the future. In particular, the Risk Committee questions which parts of the Company’s business may be vulnerable to disruption, including but not limited to the business models of its key tenants and its outsourced third party suppliers. The Risk Committee not only reviews the existing portfolio of investments but also ensures that risk is considered in the case of each property acquisition and disposal.

The Risk Committee works closely with the Audit Committee to examine the effectiveness of the risk management systems and internal control systems upon which the Company relies to reduce risk. This monitoring covers all material controls, including financial, operational and compliance controls. All risks and mitigating controls are reviewed by the Risk Committee on a quarterly basis, and any significant changes to the Risk Matrix are presented to the Board.

Principal Risks

The Company’s assets consist of direct investments in UK commercial property. Its risks are therefore principally related to the commercial property market in general and also to each specific property in the portfolio. Risks to the Company fall broadly under the following six categories:

Strategy (Risk A)

Management may fail to execute a clear corporate strategy successfully and the strategic objectives and performance of the fund, both absolute and relative, may become unattractive or irrelevant to its investors.

Investment and Asset Management (Risk B & C)

Ill-judged property investment decisions and associated redevelopment and refurbishment may lead to health and safety dangers and environmental issues and ultimately to poor investment returns.

Financial (Risk D, E & F)

Macro-economic changes (e.g. levels of GDP, employment, inflation and interest rate movements) political changes (e.g. new legislation and regulation) and structural changes (e.g. disruptive technology, demographics) can all impact the commercial property market, both its capital value and income generation, its access to finance and the underlying businesses of its tenants. This risk encompasses real estate market risk, liquidity risk, interest rate risk and credit risk, all of which are covered in more detail in note 18 to the accounts.

Operations (Risk G & H)

Poor service and inadequate control processes at the Company’s outsourced suppliers may lead to disruption, error and fraud, and increasingly cyberattacks. The company’s key service providers are the Investment Manager, the Company Secretary, the Managing Agent and the Registrar and are assessed annually through the Management Engagement Committee.

Regulation (Risk I)

Failure to comply with applicable regulation and legislation could lead to financial penalties and withdrawal of necessary permissions by governing authorities. Changes to existing regulations could also result in suboptimal performance of the Company.

Stakeholder Engagement (Risk J)

Failure to communicate effectively and consistently with the Company’s key stakeholders, in particular shareholders and tenants, could prevent the Company from understanding and responding to their needs and concerns.

Emerging Risks

Emerging risks have been identified by the Risk Committee through a process of evaluating which of the principal risks have increased materially in the year and/or through market intelligence are expected to grow significantly. Any such emerging risks are likely to cause disruption to the business model. If ignored, they could impact the Company’s financial performance and future prospects. Alternatively, if recognised, they could provide opportunities for transformation. In the current year three significant

emerging risks have been highlighted:

1.    The Company’s strategic objectives, linked to a widening of the discount and a continuation vote (Risk A).

2.    Macroeconomic changes particularly associated with the uncertainty surrounding Brexit and its political impact on the UK economy and the resultant effect on the UK commercial property market (Risk D).

3.    Credit risk, in particular the weakness in the retail sector and its impact on the Group’s tenants, affecting both capital values and income generation of the investment portfolio (Risk F).

The principal and emerging risks, including their impact and the actions taken by the Company to mitigate them, are provided in more detail below:

Risk A – Strategic Risks: Widening Discount and Continuation Vote
Risks & Impact	The Company’s strategic objectives and performance, both absolute and relative, could become unattractive to investors leading to a widening of the share price’s discount to net asset value, and potentially a continuation vote.
Mitigation	·     The Company’s strategy and objectives are regularly reviewed by the Board to ensure they remain appropriate and effective. ·     The Board receives regular presentations from research analysts on both the general economy but also the property market in particular to identify structural shifts and threats, so the Board can adapt the Company’s strategy if necessary. ·     The NAV and share price are constantly monitored and regular analyses of the Company’s performance are reviewed by the Board and compared with the Company’s benchmark and its peer group. ·     Cash flow projections are prepared by the Investment Manager and reviewed quarterly by the Board. ·     Regular contact is maintained with shareholders and the Company’s broker.
Commentary	·     The Company’s discount has increased in the year from 4.5% at the end of 2017 to 10.8% at the end of 2018. This compares to the peer group which moved from an average premium of 0.1% to a discount of 6.4%. ·     As at 15 April 2019, the discount (adjusted for the shares going ex-dividend) was 3.7%. ·     The Company is due to hold a periodic continuation vote in 2020.
Change	INCREASED AND EMERGING RISK - The Company’s rating, like that of the wider peer group, has fallen to a wider discount during the year.
	See the annual report for details of the current discount control policy.

   

Risk B – Investment and Asset Management Risks: Health & Safety
Risks & Impact	The Company could fail to identify, mitigate or manage major Health & Safety issues potentially leading to injury, loss of life, litigation and the ensuing financial & reputational damage.
Mitigation	·     Health and safety checks are included as a key part of due diligence for any new property acquisition. ·     For existing multi-tenancy properties the Group’s Managing Agent (Jones Lang LaSalle) are responsible for managing and monitoring health and safety matters of each building. ·     The Investment Manager monitors on an ongoing basis all identified Health and Safety issues with strict deadlines for resolution by the Managing Agent. ·     The Investment Manager also engages S2 Partnership Limited who provide an independent health & safety review of all properties. ·     The Risk Committee reviews the Company’s Health & Safety performance quarterly.
Commentary	·     A wider fire safety review of buildings with any type of cladding has been conducted. This has resulted in work being undertaken beyond the minimum legal requirements to ensure the highest standards of health and safety in the Company’s portfolio of properties.
Change	No significant change in risk.
	See the annual report for further information on the Group’s Health & Safety policy.

   

Risk C – Investment and Asset Management Risks: Environmental
Risks & Impact	Properties could be negatively impacted by an extreme environmental event (e.g. flooding) or the Company’s own asset management activities could create environmental damage. Failure to achieve environmental targets could adversely affect the Company’s reputation and result in penalties and increased costs. Legislative changes relating to sustainability could affect the viability of asset management initiatives.
Mitigation	·     The Company considers its impact on the environment and its local communities in all its activities. ·     In-depth research is undertaken on each property at acquisition with a detailed environmental survey. ·     Experienced advisers on environmental, social and governance matters are consulted both internally at the Investment Manager and externally where required. ·     The Investment Manager has adopted a thorough environmental policy which is applied to all properties within the portfolio. ·     EPC rating benchmarks have been set to ensure compliance with Minimum Energy Efficiency Standards (MEES).
Commentary	·     The Company has achieved Sector Leader status in the Global Real Estate Sustainability Benchmark (“GRESB”) as a top performer in ESG (environmental, social and governance). It was awarded an ‘A’ score for Public Disclosure; EPRA “Gold” rating for European Sustainability Best Practice Recommendations in September 2018. ·     A full review of EPC ratings across the Group’s portfolio has been undertaken with now only 2 units rated as below standard. A strategy has been put in place to improve these sub-par ratings before any new lease is granted.
Change	DECREASED RISK - Given the work undertaken by the Group across the portfolio, the Board considers environmental risk has decreased in the year.
	See the annual report for further information on the Groups ESG policy.

   

Risk D – Financial Risks: Macroeconomic
Risks & Impact	Macroeconomic changes (e.g. levels of GDP, employment, inflation, interest rate & FX movements), political changes (e.g. Brexit, new legislation) or structural changes (e.g. new technology, demographics) could negatively impact commercial property values and the underlying businesses of tenants (market risk and credit risk). Falls in the value of investments could result in breaches of loan covenants and solvency issues.
Mitigation	·     The Aberdeen Standard Investments Research team takes into account macroeconomic conditions when collating property forecasts. This research is fed into the Investment Manager’s decisions on purchases and sales and sector allocations. ·     The portfolio is UK based and diversified across a number of different sectors and regions of the UK and also has a wide and diverse tenant base to minimize any risk concentration. ·     There is a wide range of lease expiry dates within the portfolio in order to minimise concentrated re-letting risk. ·     The Company is lowly geared with 25% limit on overall gearing. ·     The Company has limited exposure to speculative development and is only undertaken on a pre-let basis. ·     Rigorous portfolio reviews are undertaken by the Investment Manager and presented to the Board on a regular basis. ·     Annual asset plans are developed for each property and every building has comprehensive insurance to cover both the property itself and injury to associated third parties. ·     Individual investment decisions are subject to robust risk versus return evaluation and approval.
Commentary	·     Portfolio continues to be diversified and balanced with investments across the four main commercial property sectors and across a number of geographical regions. ·     267 tenancies at the year end with top ten tenants accounting for only 34.2% of annualised rental income. ·     Net gearing of 14.6% at year end. ·     Occupancy rate of 93.1% at year end.
Change	INCREASED AND EMERGING RISK - The ongoing uncertainty surrounding the negotiations of Great Britain’s withdrawal from the EU and the ensuing political instability makes economic forecasting difficult. This uncertainty has undoubtedly impacted business investment, consumer sentiment and hence GDP growth. This in turn is likely to impact the demand for commercial property and some tenants’ business prospects and their financial strength.
	See further details on risk in note 18 to the accounts set out below.

   

Risk E – Financial Risks: Gearing
Risks & Impact	An inappropriate level of gearing, magnifying investment losses in a declining market, could result in breaches of loan covenants and threaten the Company’s liquidity and solvency. An inability to secure adequate borrowing with appropriate tenor and competitive rates could also negatively impact the Company.
Mitigation	·     Gearing is restricted to a maximum of 25% of gross assets. This low gearing limit means that the Company should, barring unforeseen circumstances, have adequate resources to service and repay its debt. ·     The Company’s diversified, prime UK commercial property portfolio, underpinned by its strong tenant base, should provide sufficient value and income in a challenging market to meet the Company’s future liabilities. ·     The Company’s relatively modest level of gearing attracts competitive terms and interest rates from lenders for the Company’s loan facilities. ·     The Investment Manager has relationships with multiple funders and wide access to different sources of funding on both a fixed and variable basis. ·     Financial modelling is undertaken and stress tested annually as part of Company’s viability assessment and whenever new debt facilities are being considered. ·     Loan covenants are continually monitored and reported to the Board on a quarterly basis and also reviewed as part of the disposal process of any secured property.
Commentary	·     The Group increased and extended its loan facilities in February 2019. ·     57% are fixed rate and 43% are variable with a spread of repayment dates. ·     The increased revolving credit facility will provide the Company with the flexibility to make timely acquisitions when opportunities arise. ·     Following this refinancing, the weighted maturity profile of the Group’s fixed rate debt stood at 10.0 years with an overall blended rate of interest of 2.79% and net gearing of 14.7%. ·     There is considerable headroom before any loan covenants would be breached.
Change	DECREASED RISK Refinancing completed in February 2019 has reduced this risk.
	See further details on risk in note 18 to the accounts set out below.

   

Risk F – Financial Risks: Credit Risk of Tenants
Risks & Impact	Income might be adversely affected by macroeconomic factors. Financial difficulties could cause tenants to default on their rents and could lead to vacant properties. This might result in falling dividend cover for the Company and potential dividend cuts.
Mitigation	·     Dividend cover is forecast and considered at each Board meeting. ·     The property portfolio has a balanced mix of tenants and reflects diversity across business sectors. ·     Rigorous due diligence is performed on all prospective tenants and their financial performance continues to be monitored during their lease. ·     Rent collection from tenants is closely monitored so that early warning signs can be detected. ·     Contingency plans are put in place where tenants with financial difficulties have been identified. ·     Board approval is necessary for any material lettings.
Commentary	·     Dividend cover of 82% in 2018 but annualised rental income has increased to £69.0 per annum as at 31 December. ·     Key focus on ongoing voids particularly at XDock 377 at Lutterworth. ·     Retail sector continues to be of a concern with number of administrations in this sector in the last 12 months which has resulted in lost income of 1.5% of total income in the Group’s portfolio.
Change	INCREASED AND EMERGING RISK - The continued weakness of the retail sector has increased this risk in 2018.
	See further details on risk in note 18 to the accounts set out below.

   

Risk G – Operational Risks: Service Providers
Risks & Impact	Poor performance and/ or inadequate procedures at key service providers i.e. Investment Manager, Company Secretary, Managing Agent, Registrar, could lead to errors, fraud, non-compliance with their contractual agreements and/or with relevant legislation. Failings in their data management processes and disaster recovery plans, including cyber security safeguards, could lead to financial loss and business disruption for the Company.
Mitigation	·     UKCM has a strong control culture that is also reflected in its partnerships with suppliers. ·     All investment decisions are subject to a formal approval process with specified authority limits. ·     All third party service providers are carefully selected for their expertise, reputation and financial standing. Service level agreements are negotiated with all material suppliers and regularly monitored to ensure that pre-agreed standards are met. ·     Suppliers’ business continuity and disaster recovery plans, including safeguards against cyber-crime, are also regularly examined. ·     The Management Engagement Committee (“MEC”) formally reviews all key service providers once a year.
Commentary	·     Key service providers have not changed during 2018. No material issues noted from the reviews of service providers in the year.
Change	No significant change in risk.

   

Risk H – Operational Risks: Accounting and Valuation
Risks & Impact	Accounting records and financial statements could be incorrect or incomplete or fail to comply with current accounting standards. In particular property valuations, income and expenses could be calculated and recorded inaccurately.
Mitigation	·     All properties within the portfolio are independently valued by CBRE Ltd on a quarterly basis and their year-end valuations recorded in the Company’s accounts. ·     A rigorous valuation process is undertaken each quarter by the Company’s Investment Manager to ensure fair and complete property valuations that are then reviewed, challenged and verified by CBRE. ·     The Property Valuation Committee reviews thoroughly each quarter this independent valuation process. ·     Accounting control and reconciliation processes are in place at the Investment Manager. These are subject to regular independent assessment for their suitability and operating effectiveness by an external auditor. ·     Financial statements are subject to a year-end audit by Deloitte LLP.
Commentary	·     No material accounting/valuation issues recorded in the year.
Change	No significant change in risk.

   

Risk I – Regulatory Risks: Compliance
Risks & Impact	The Company could fail to comply with existing legislation or adapt to new or future regulation. In particular, the Company could fail to comply with REIT legislation and ultimately lose its REIT status, thereby incurring substantial tax penalties.
Mitigation	·     The Board receives regular updates on relevant regulatory changes from its professional advisors. ·     The highest corporate governance standards are required from all key service providers and their reputation and performance are reviewed annually by the Management Engagement Committee. ·     The Board reviews quarterly a REIT dashboard confirming compliance with REIT regulations.
Commentary	·     Board has reviewed and taken action to ensure compliance with new UK Code of Corporate Governance. ·     The Management Engagement Committee has ensured all key suppliers and contracts are GDPR compliant. ·     Processes have been put in place to ensure ongoing compliance with REIT rules following conversion to a REIT on 1 July 2018.
Change	No significant change in risk.

   

Risk J – Stakeholder Engagement Risks: Communication
Risks & Impact	A communication breakdown with key stakeholders, particularly shareholders and tenants, could prevent the Company from understanding and responding to their needs and concerns. When required to fulfil certain reporting requirements, the Company could fail to communicate with regulatory authorities about its major shareholders. As a result the Company could potentially suffer financial penalties and reputational damage.
Mitigation	·     A high degree of engagement is maintained with both shareholders and tenants. ·     The Investment Manager regularly meets with shareholders and periodically, the Chair of the Board, also meets shareholders. ·     Quarterly Board reports include detailed shareholder analysis, written and verbal reports from JP Morgan, the Company’s Corporate Broker and feedback from shareholder and analyst meetings where appropriate. ·     The Investment Manager works closely with tenants to understand better their needs and to remodel and refurbish buildings to fit their evolving requirements. This helps to reduce the risk of vacant properties. ·     The Company receives professional advice on its reporting obligations regarding major shareholders to ensure that it complies with regulations.
Commentary	·     The Company has held two shareholder and analyst presentations in the year and the Investment Manager has met multiple shareholders. ·     Chair of the Board has also met with several institutional shareholders. ·     Investment Managers have visited all properties held at least once in 2018. ·     Board of Directors have continued to visit properties during the year as part of a rolling programme to visit all properties over a three year period.
Change	No significant change in risk.

Viability Statement

The Board considers viability as part of its ongoing programme of monitoring risk. The Board considers five years to be a reasonable time horizon over which to review the continuing viability of the Company. The Board also considers viability over the longer term, in particular to key points outside this time frame, such as the due dates for the repayment of long-term debt. In addition, the Board considers viability in relation to continuation votes. These are held periodically with the next one scheduled for 2020 and every seven years thereafter. In addition a continuation vote may be required if the Company’s shares trade at a discount of over 5% for a continuous period of 90 dealing days or more.

The Board has considered the nature of the Company’s assets and liabilities and associated cash flows. The Board has determined that five years is a reasonable timescale over which the performance of the Company can be forecast with a material degree of accuracy and so is an appropriate period over which to consider the Company’s viability.

The Board has also carried out a robust assessment of the principal risks faced by the Group, as detailed earlier. The main risks which the Board considers will affect the business model, future performance, solvency, and liquidity are ongoing discounts leading to continuation votes, tenant failure leading to a fall in dividend cover and macroeconomic uncertainty. The Board takes any potential risks to the ongoing success of the Group, and its ability to perform, very seriously and works hard to ensure that risks are consistent with the Group’s risk appetite at all times.

In assessing the Group’s viability, the Board has carried out thorough reviews of the following:

·     Detailed NAV, cash resources and income forecasts, prepared by the Company’s Investment Manager, for a five year period under both normal and stressed conditions;

·     The Group’s ability to pay its operational expenses, bank interest, tax and dividends over a five year period;

·     Future debt repayment dates and debt covenants, in particular those in relation to LTV and interest

·     Demand for the Company’s shares and levels of premium or discount at which the shares trade to NAV;

·     Views of shareholders on the ongoing continuation of the Company; and

·     The valuation and liquidity of the Group’s property portfolio, the Investment Manager’s portfolio strategy for the future and the market outlook.

Despite the uncertainty in the UK regarding Brexit, the Board has a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the next five years. This assessment is based on the results of the analysis outlined above and on the assumption that the periodic continuation vote to be held in 2020 is passed.

Sustainable Real Estate Investment Policy

The Investment Manager acquires, develops and manages properties on behalf of the Company. It is recognised that these activities have both direct and indirect environmental and social impacts. The Board has adopted the Investment Manager’s own Environmental, Social and Governance Policy (ESG) and associated operational procedures and is committed to environmental management in all phases of the investment process.

The Manager has identified four ESG megatrends that are highly relevant for real estate investment now and in the future: Environment & Climate Change, Governance & Engagement, Population & Urban Living and Technology & Connectivity. The identification of risks and opportunities for the Company in relation to each of the megatrends is embedded throughout the investment process and at all levels, from Company-level strategic planning to asset underwriting and individual asset ESG action plans.

To facilitate this, the Manager works in partnership with contractors, suppliers, occupiers and consultants, seeking continuous improvements in ESG performance and conducting regular reviews.

The Company was awarded a Green Star ranking from the Global Real Estate Sustainability Benchmark 2018 and improved its score by 9% compared with 2017. A Green Star is awarded to entities that perform well in both categories of the GRESB assessment: Management & Policies and Implementation & Measurement. The Company also received a European Sector Leader award as the top performer in its peer group.

Following the disclosure of ESG performance against the EPRA Sustainability Best Practice Reporting guidelines in the 2018 report, the Company received both Gold and Most Improved awards from EPRA. These awards recognise the Company’s strong commitment to ESG and transparency.

The full ESG disclosures for the Company, including energy, water and emissions performance for 2018 are included in the annual report.

Health & Safety Policy

Alongside these environmental principles the Company has a health and safety policy which demonstrates commitment to providing safe and secure buildings that promote a healthy working environment and a customer experience that supports a healthy lifestyle. The Company, through the Investment Manager, manages and controls health and safety risks systematically as any other critical business activity using technologically advanced systems and environmentally protective materials and equipment. By achieving a high standard of health and safety performance, the Company aims to earn the confidence and trust of tenants, customers, employees, shareholders and society at large.

Bribery & Ethical Policy

It is the Company’s Policy to prohibit and expressly forbid the offering, giving or receiving of a bribe in any circumstances. This includes those instances where it may be perceived that a payment, given or received, may be a bribe. The Company has adopted this Anti-Bribery and Corruption Policy to ensure robust compliance with The UK Bribery Act 2010. The Company has made relevant enquiries of its Investment Manager and has received assurances that appropriate anti-bribery and corruption policies have been formulated and communicated to its employees. In addition the Board has adopted an ethical policy which highlights the need for ethical considerations to be considered in the acquisition and management of both new and existing properties.

Approval of Strategic Report

The Strategic Report of the Company comprises the Financial and Property Highlights, Performance Summary, Chair’s Statement, Investment Manager Review, Portfolio Information and Strategic Overview incorporating the risk management section.

The Strategic Report was approved by the Board on 25 April 2019.

Andrew Wilson                   Ken McCullagh

Director                                 Director

Extract from Report of Directors

Annual General Meeting

Among the resolutions being put at the Annual General Meeting of the Company to be held on 17 June 2019, the following resolutions will be proposed.

Dividend policy

It is the Directors’ intention in line with the Company’s investment objective to pay an attractive level of dividend income to shareholders on a quarterly basis. The Directors intend to set the level of dividend after taking into account the long term income return of the Property Portfolio, the diversity and covenant strength of the tenants and the length of the leases of the Properties.

Dividends on the ordinary shares are expected to be paid in four instalments quarterly in respect of each financial year in February, May, August and November. All dividends will be in the form of property income distribution, ordinary dividends or a mixture of both and paid as interim dividends.

As a result of the timing of the payment of the Company’s quarterly dividends, the Company’s shareholders are unable to approve a final dividend each year. As an alternative the Board will put the Company’s dividend policy to Shareholders for  approval on an annual basis.

Resolution 2, which is an ordinary resolution, relates to the approval of the Company’s dividend policy to continue to pay four interim dividends quarterly.

Directors Fees

At the December 2018 Board Meeting, the Board carried out a review of the level of directors’ fees. The resulting increases, which took effect from 1 January 2019, are detailed in the Directors’ Remuneration Report.

As a result of these increases in fees, and in order to ensure that the Board has ongoing flexibility to be able to appoint additional directors, Resolution 5, an ordinary resolution, will be put to shareholders at the 2019 AGM seeking approval to increase, the maximum aggregate limit of remuneration of the directors each year in respect of their ordinary services as directors from £300,000 to £400,000. Since the maximum fee level was last increased in 2010 the number of Directors has increased from 5 to 6.

Disapplication of Pre-emption Rights

Resolution 14 gives the Directors, for the period until the conclusion of the Annual General Meeting in 2020 or, if earlier, on the expiry of 15 months from the passing of resolution 14, the necessary authority either to allot securities or sell shares held in treasury, otherwise than to existing shareholders on a pro-rata basis, up to an aggregate nominal amount of £32,485,312. This is equivalent to approximately 10 per cent of the issued ordinary share capital of the Company as at 25 April 2019. There are no shares currently held in treasury. The Directors will allot new shares pursuant to this authority only if they believe it is advantageous to the Company’s shareholders to do so and the issue price of new shares will be at a premium to the latest published net asset value per share.

Directors’ Authority to Buy Back Shares

The current authority of the Board granted to it by shareholders at the 2018 AGM to buy back shares in the Company expires at the end of AGM to be held in 2019. The Board intends to renew such authority to buy back shares up to 14.99 per cent of the number of ordinary shares in issue. This special resolution (resolution 15), if approved, will enable the Company to buy back up to 194,781,928 shares based on the current number of shares in issue (excluding any treasury shares). Any buy back of ordinary shares will be made subject to Guernsey law and within guidelines established from time to time by the Board, which will take into account the income and cashflow requirements of the Company, and the making and timing of any buy backs will be at the absolute discretion of the Board.

Purchases of ordinary shares will only be made through the market for cash at prices below the prevailing published net asset value of an ordinary share (as last calculated, adjusted downwards for the amount of any dividend declared by the Company upon the shares going ex-dividend), where the Directors believe such purchases will enhance shareholder value. Such purchases will also only be made in accordance with the rules of the UK Listing Authority which provide that the price to be paid must not be more than the higher of (i) five per cent. above the average of the middle market quotations for the ordinary shares for the five business days before the purchase is made and (ii) the higher of the last independent trade and the highest current independent bid on the London Stock Exchange. The minimum price (exclusive of expenses) that may be paid is 25 pence a share.

The Company may retain any shares bought back as treasury shares for future re-issue, or transfer, or may cancel any such shares. During the period when the Company holds shares as treasury shares, the rights and obligations in respect of those shares may not be exercised or enforced by or against the Company. The maximum number of shares that can be held as treasury shares by the Company is 10 per cent of the aggregate nominal value of all issued ordinary shares. Ordinary shares held as treasury shares will only be re-issued, or transferred at prices which are not less than the published net asset value of an ordinary share.

Prior to the publication of this report, the share buyback policy included an intention by the Directors that they may buyback ordinary shares if the share price is more than 5 per cent below the published net asset value. However the Board are modifying this policy in the paragraph below to focus on long term risk adjusted returns for shareholders as it weighs up buybacks versus real estate opportunities, be it new assets or capital expenditure in the existing portfolio. The Directors believe that this policy is better suited to an illiquid asset class.

It is the intention of Directors that the share buy back authority may be used to purchase ordinary shares in the Company, (subject to the income and cash flow requirements of the Company) if the level of discount represents an opportunity that will generate risk adjusted returns in excess of that which could be achieved by investing in real estate opportunities at a particular time.

The discount control policy of the Company provides that in the event that the share price discount to prevailing published NAV (as last calculated, adjusted downwards for the amount of any dividend declared by the Company upon the shares going ex-dividend) is more than 5 per cent for 90 dealing days or more, following the second anniversary of the Company’s most recent continuation vote, the Directors will convene an Extraordinary General Meeting (“EGM”) to be held within three months to consider an ordinary resolution for the continuation of the Company. If this continuation resolution is not passed, the Directors will convene a further extraordinary general meeting to be held within six months of the first EGM to consider the winding up of the Company or a reconstruction of the Company which offers all shareholders the opportunity to realise their investment. If any such continuation resolution is passed, this discount policy, save in respect of share buy backs, would not apply for a period of two years thereafter. The last continuation vote was held on 9 November 2016. As at 15 April 2019, the discount, adjusted for the shares going ex-dividend, was 3.7%.

Directors’ Responsibility Statement

The Directors are responsible for preparing the Annual Report and the Group financial statements in accordance with applicable Guernsey law and those International Financial Reporting Standards (“IFRS”) as have been adopted by the European Union. They are also responsible for ensuring that the Annual Report includes information required by the Rules of the UK Listing Authority.

The Directors are required to prepare Group financial statements for each financial year which give a true and fair view of the financial position of the Group and the financial performance and cash flows of the Group for that period. In preparing those Group financial statements the Directors are required to:

·     select suitable accounting policies in accordance with IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors and then apply them consistently;

·     present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;

·     provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the Group’s financial position and financial performance;

·     state that the Group has complied with IFRS, subject to any material departures disclosed and explained in the financial statements; and

·     prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Group will continue in business.

The Directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Group and enable them to ensure that the Group financial statements comply with the Companies (Guernsey) Law 2008. They are also responsible for safeguarding the assets of the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are also responsible for ensuring that the Group complies with the provisions of the Listing Rules and the Disclosure Rules and Transparency Rules of the UK Listing Authority which, with regard to corporate governance, require the Group to disclose how it has applied the principles, and complied with the provisions, of the UK Corporate Governance Code applicable to the Group.

We confirm that to the best of our knowledge:

·     the Group financial statements, prepared in accordance with the IFRS, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Group and comply with the Companies Law;

·     that in the opinion of the Board, the Annual Report and Accounts taken as a whole, is fair, balanced and understandable and it provides the information necessary to assess the Group’s position, performance, business model and strategy; and

·     the Strategic Report includes a fair review of the progression and performance of the business and the position of the Group together with a description of the principal risks and uncertainties that it faces.

On behalf of the Board
Andrew Wilson
Director
25 April 2019

Consolidated Statement of Comprehensive Income
For the year ended 31 december 2018

		Year Ended 31 December 2018	Year Ended 31 December 2017
	Notes	£’000	£’000
Revenue
Rental income	2	65,936	69,826
Service charge income	3	5,950	-
Gains/(Losses) on investment properties	10	18,947	90,416
Interest income		510	295
Total income		91,343	160,537
Expenditure
Investment management fee	4	(9,567)	(9,215)
Direct property expenses	5	(3,569)	(4,444)
Service charge expenses	5	(5,950)
Other expenses	5	(5,446)	(3,565)
Total expenditure		(24,532)	(17,224)
Operating profit before finance costs		66,811	143,313
Finance costs
Finance costs	6	(7,976)	(8,143)
		(7,976)	(8,143)
Net profit from ordinary activities before taxation		58,835	135,170
Taxation on profit on ordinary activities	7	(5,830)	(3,608)
Net profit for the year		53,005	131,562
Other comprehensive income to be reclassified to Profit or Loss
Gain arising on effective portion of interest rate swap	14	1,388	1,664
Other comprehensive income		1,388	1,664
Total comprehensive income for the year		54,393	133,226
Basic and diluted earnings per share	9	4.08p	10.12p
EPRA earnings per share (excluding non-recurring tax items)		3.03p	3.42p

All of the profit and total comprehensive income for the year is attributable to the owners of the Company. All items in the above statement derive from continuing operations. The accompanying notes are an integral part of this statement. The accompanying notes are an integral part of this statement.

Consolidated Balance Sheet
As at 31 December 2018

	Notes	2018 £’000	2017 £’000
Non-current assets
Investment properties	10	1,430,851	1,332,923
Deferred tax asset	7	-	3,271
Interest rate swap	14	166	-
		1,431,017	1,336,194
Current assets
Investment properties held for sale	10	-	47,600
Trade and other receivables	12	23,765	23,433
Cash and cash equivalents		43,505	72,443
		67,270	143,476
Total assets		1,498,287	1,479,670
Current liabilities
Trade and other payables	13	(35,139)	(22,408)
Interest rate swap	14	(868)	(1,130)
		(36,007)	(23,538)
Non-current Liabilities
Bank Loan	14	(249,661)	(249,126)
Interest rate swap	14	-	(960)
		(249,661)	(250,086)
Total liabilities		(285,668)	(273,624)
Net assets		1,212,619	1,206,046
Represented by:
Share capital	15	539,872	539,872
Special distributable reserve		570,158	583,920
Capital reserve		103,291	84,344
Revenue reserve		-	-
Interest rate swap reserve		(702)	(2,090)
Equity shareholders’ funds		1,212,619	1,206,046
Net asset value per share	16	93.3p	92.8p
EPRA Net asset value per share		93.4p	93.0p

The accounts were approved and authorised for issue by the Board of Directors on 25 April 2019 and signed on its behalf by:

Andrew Wilson                    Ken McCullagh

Director                                 Director

The accompanying notes are an integral part of this statement.

Consolidated Statement of Changes in Equity
For the year ended 31 December 2018

	Notes	Share Capital £’000		Special Distributable Reserve £’000		Capital Reserve £’000		Revenue Reserve £’000		Interest Rate Swap Reserve £’000		Equity Shareholders’ funds £’000
At 1 January 2018		539,872		583,920		84,344		-		(2,090)		1,206,046
Net profit for the year		-		-		-		53,005		-		53,005
Other comprehensive income		-		-		-		-		1,388		1,388
Total comprehensive income		-		-		-		53,005		1,388		54,393
Dividends paid	8	-		-		-		(47,820)		-		(47,820)
Transfer in respect of gains on investment property	10	-		-		18,947		(18,947)		-		-
Transfer from special distributable reserve		-		(13,762)		-		13,762		-		-
At 31 December 2018		539,872		570,158		103,291		-		(702)		1,212,619
FOR THE YEAR ENDED 31 DECEMBER 2017
	Notes	Share Capital £'000		Special Distributable Reserve £'000		Capital Reserve £'000		Revenue Reserve £'000		Interest Rate Swap Reserve £'000		Equity Shareholders’ funds £’000
At 1 January 2017		539,872		590,594		(6,072)		-		(3,754)		1,120,640
Net profit for the year		-		-		-		131,562		-		131,562
Other comprehensive income		-		-		-		-		1,664		1,664
Total comprehensive income		-		-		-		131,562		1,664		133,226
Dividends paid	8	-		-		-		(47,820)		-		(47,820)
Transfer in respect of gains on investment property	10	-		-		90,416		(90,416)		-		-
Transfer from special distributable reserve		-		(6,674)		-		6,674		-		-
At 31 December 2017		539,872		583,920		84,344		-		(2,090)		1,206,046

The accompanying notes are an integral part of this statement.

Consolidated Cash Flow Statement
For the year ended 31 December 2018

	Notes	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Cash flows from operating activities
Net profit for the year before taxation		58,835	135,170
Adjustments for:
Gains on investment properties	10	(18,947)	(90,416)
Movement in lease incentives	10	2,408	(6,597)
Movement in provision for bad debts	12	71	(130)
Increase in operating trade and other receivables		(7,996)	(672)
(Decrease)/Increase in operating trade and other payables		4,571	(3,094)
Finance costs	6	7,976	8,131
Cash generated by operations		46,918	42,392
Tax paid		(1,010)	-
Net cash inflow from operating activities		45,908	42,392
Cash flows from investing activities
Purchase of investment properties	10	(156,030)	(52,016)
Sale of investment properties	10	171,928	41,513
Capital expenditure	10	(40,490)	(8,981)
Net cash outflow from investing activities		(24,592)	(19,484)
Cash flows from financing activities
Dividends paid		(43,008)	(47,820)
Bank loan interest paid		(6,215)	(6,114)
Payments under interest rate swap arrangement		(1,031)	(1,424)
Net cash outflow from financing activities		(50,254)	(55,358)
Net decrease in cash and cash equivalents		(28,938)	(32,450)
Opening cash and cash equivalents		72,443	104,893
Closing cash and cash equivalents		43,505	72,443
Represented by:
Cash at bank		16,363	27,735
Money market funds		27,142	44,708
		43,505	72,443

The accompanying notes are an integral part of this statement.

Notes to the Accounts

1. Accounting Policies

A summary of the principal accounting policies, all of which have been applied consistently throughout the year, is set out below.

(a)  Basis of Accounting

The consolidated accounts have been prepared in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (the IASB), interpretations issued by the IFRS Interpretations Committee that remain in effect, and to the extent that they have been adopted by the European Union, applicable legal and regulatory requirements of Guernsey law and the Listing Rules of the UK Listing Authority. The audited Consolidated Financial Statements of the Group have been prepared under the historical cost convention as modified by the measurement of investment property and derivative financial instruments at fair value. The consolidated financial statements are presented in pound sterling.

New and amended standards and interpretations

The accounting policies adopted are consistent with those of the previous financial year. There have been other new and amended standards issued or have come into effect in the European Union from 1 January 2018 but either these were not applicable or did not have a material impact on the annual consolidated financial statements of the Group and hence not discussed and are detailed below:

Annual Improvements to IFRSs 2015–2017 Cycle

(b)  Significant accounting judgements, estimates and assumptions

The preparation of the Group’s financial statements requires management to make judgements, estimates and assumptions that affect the amounts recognised in the financial statements. However, uncertainty about these judgements, assumptions and estimates could result in outcomes that could require a material adjustment to the carrying amount of the asset or liability affected in the future. In applying the Group’s accounting policies, there were no critical accounting judgements.

Key estimation uncertainties

Fair value of investment properties: Investment property is stated at fair value as at the balance sheet date as set out in note 1(h) and note 10 to these accounts.

The determination of the fair value of investment properties requires the use of estimates such as future cash flows from the assets and unobservable inputs such as capitalisation rates. The estimate of future cash flows includes consideration of the repair and condition of the property, lease terms, future lease events, as well as other relevant factors for the particular asset.

These estimates are based on local market conditions existing at the balance sheet date.

(c)  Basis of Consolidation

The consolidated accounts comprise the accounts of the Company and its subsidiaries drawn up to 31 December each year. Subsidiaries are consolidated from the date on which control is transferred to the Group and cease to be consolidated from the date on which control is transferred out of the Group.

The Jersey Property Unit Trusts (“JPUTS”) are all controlled via voting rights and hence those entities are consolidated.

(d)  Functional and Presentation currency

Items included in the financial statements of the Group are measured using the currency of the primary economic environment in which the Company and its subsidiaries operate (“the functional currency”) which is Pounds Sterling. The financial statements are also presented in Pounds Sterling. All figures in the financial statements are rounded to the nearest thousand unless otherwise stated.

(e)  Revenue Recognition

Rental income, excluding VAT, arising from operating leases (including those containing stepped and fixed rent increases) is accounted for in the Statement of Comprehensive Income on a straight line basis over the lease term. Lease premiums paid and rent free periods granted, are recognised as assets and are amortised over the non-cancellable lease term.

Non-rental service charge income is recognised in the period where the non-rental service charge income is received.

Interest income is accounted on an accruals basis and included in operating profit.

(f)  Expenses

Expenses are accounted for on an accruals basis. The Group’s investment management and administration fees, finance costs and all other expenses are charged through the Statement of Comprehensive Income.

(g)  Taxation

Current income tax assets and liabilities are measured at the amount expected to be recovered from or paid to taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted by the reporting date. Current income tax relating to items recognised directly in equity is recognised in equity and not in profit or loss. Positions taken in tax returns with respect to situations in which applicable tax regulations are subject to interpretation are periodically evaluated and provisions established where appropriate.

Deferred income tax is provided using the liability method on all temporary differences at the reporting date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred income tax assets are recognised only to the extent that it is probable that taxable profit will be available against which deductible temporary differences, carried forward tax credits or tax losses can be utilised.

The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities. In determining the expected manner of realization of an asset the directors consider that the Group will recover the value of investment property through sale. Deferred income tax relating to items recognised directly in equity is recognised in equity and not in profit or loss.

(h) Investment Properties

Investment properties are initially recognised at cost, being the fair value of consideration given, including transaction costs associated with the investment property. Any subsequent capital expenditure incurred in improving investment properties is capitalised in the period during which the expenditure is incurred and included within the book cost of the property.

After initial recognition, investment properties are measured at fair value, with the movement in fair value recognised in the Statement of Comprehensive Income and transferred to the Capital Reserve. Fair value is based on the external valuation provided by CBRE Limited, chartered surveyors, at the Balance Sheet date. The assessed fair value is reduced by the carrying amount of any accrued income resulting from the spreading of lease incentives and/or minimum lease payments.

On derecognition, gains and losses on disposals of investment properties are recognised in the Statement of Comprehensive Income and transferred to the Capital Reserve.

Recognition and derecognition occurs when the risks and rewards of ownership of the properties have transferred between a willing buyer and a willing seller.

Investment property is transferred to current assets held for sale when it is expected that the carrying amount will be recovered principally through sale rather than from continuing use. For this to be the case, the property must be available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of such property and its sale must be highly probable.

The Group has entered into forward funding agreements with third party developers in respect of certain properties. Under these agreements the Group will make payments to the developer as construction progresses. The value of these payments is assessed and certified by an expert.

Investment properties are recognised for accounting purposes upon completion of contract. Properties purchased under forward funding contracts are recognised at certified value to date.

Investment properties acquired through the purchase of a company or other form of special purpose vehicle are treated as asset acquisitions if the vehicle is deemed to be a corporate wrapper.  If the vehicle is not deemed to be a corporate wrapper then the acquisition would be treated as business combination. 

(i)  Operating Lease Contracts – the Group  as Lessor

The Group has entered into commercial property leases on its investment property portfolio. The Group has determined, based on an evaluation of the terms and conditions of the arrangements that it retains all the significant risks and rewards of ownership of these properties and so accounts for leases as operating leases. Initial direct costs incurred in negotiating and arranging an operating lease are added to the carrying amount of the leased asset and recognised as an expense on a straight-line basis over the lease term.

(j)  Share Issue Expenses

Incremental external costs directly attributable to the issue of shares that would otherwise have been avoided are written off to capital reserves.

(k)  Segmental Reporting

The Directors are of the opinion that the Group is engaged in a single segment of business being property investment in the United Kingdom. The directors are of the opinion that the four property sectors analysed throughout the financial statements constitute this single segment, and are not separate operating segments as defined by IFRS 8 Operating Segments.

(l)  Cash and Cash Equivalents

Cash and cash equivalents are defined as cash in hand, demand deposits, and other short-term highly liquid investments readily convertible within three months or less to known amounts of cash and subject to insignificant risk of changes in value.

(m) Trade and Other Receivables

Trade receivables are recognised initially at their transaction price unless they contain a significant financing component, when they are recognised at fair value. Trade receivables are subsequently measured at amortised cost using the effective interest method.

Other receivables are initially recognised at fair value plus any directly attributable transaction costs and subsequently measured at amortised cost using the effective interest method.

The Group applies the IFRS 9 simplified approach to measuring expected credit losses which uses a lifetime expected loss allowance for all trade receivables and contract assets.

(n)  Trade and Other Payables

Rental income received in advance represents the pro-rated rental income invoiced before the year end that relates to the period post the year end. VAT payable is the difference between output and input VAT at the year end. Other payables are accounted for on an accruals basis and include amounts which are due for settlement by the Group as at the year end and are generally carried at the original invoice amount. An estimate is made for any services incurred at the year end but for which no invoice has been received.

(o)  Reserves

Share Capital

This represents the proceeds from issuing ordinary shares.

Special Distributable Reserve

The special reserve is a distributable reserve to be used for all purposes permitted under Guernsey law, including the buyback of shares and the payment of dividends. Dividends can be paid from all of the below listed reserves.

Capital Reserve

The following are accounted for in this reserve:

– gains and losses on the disposal of investment properties;

– increases and decreases in the fair value of investment properties held at the year end.

Revenue Reserve

Any surplus arising from the net profit on ordinary activities after taxation and payment of dividends is taken to this reserve, with any deficit charged to the special distributable reserve.

Interest Rate Swap Reserve

Any surplus/deficit arising from the marked to market valuation of the swap instrument is credited/charged to this account.

Treasury Share Reserve

This represents the cost of shares bought back by the Company and held in Treasury. The balance within this reserve is currently nil.

(p)  Interest-bearing borrowings

All bank loans and borrowings are initially recognised at cost, being the fair value of the consideration received net of arrangement costs associated with the borrowing. After initial recognition, all interest bearing loans and borrowings are subsequently measured at amortised cost. Amortised cost is calculated by taking into account any loan arrangement costs and any discount or premium on settlement.

On maturity, bank loans are recognised at par, which is equivalent to amortised cost. Bank loans redeemed before maturity are recognised at amortised cost with any charges associated with early redemptions being taken to the Statement of Comprehensive Income.

(q)  Derivative financial instruments

The Group uses derivative financial instruments to hedge its risk associated with interest rate fluctuations.

Derivative instruments are initially recognised in the Balance Sheet at their fair value split between current and non-current. Fair value is determined by reference to market values for similar instruments. Transaction costs are expensed immediately.

Gains or losses arising on the fair value of cash flow hedges in the form of derivative instruments are taken directly to Other Comprehensive Income. Such gains and losses are taken to a reserve created specifically for that purpose, described as the Interest Rate Swap Reserve in the Balance Sheet.

On termination the unrealised gains or losses arising from cash flow hedges in the form of derivative instruments, initially recognised in Other Comprehensive Income, are transferred to profit or loss.

The Group considers its interest rate swap qualifies for hedge accounting when the following criteria are satisfied:

– The instrument must be related to an asset or liability

– It must change the character of the interest rate by converting a variable rate to a fixed rate or vice versa;

– It must match the principal amounts and maturity date of the hedged item; and

– As a cash flow hedge the forecast transaction (incurring interest payable on the bank loan) that is subject to the hedge must be highly probable and must present an exposure to variations in cash flows that could ultimately affect the profit or loss. The effectiveness of the hedge must be capable of reliable measurement and must be assessed as highly effective on an ongoing basis throughout the financial reporting periods for which the hedge was designated.

If a derivative instrument does not satisfy the Group’s criteria to qualify for hedge accounting that instrument will be deemed as an ineffective hedge.

Should any portion of an ineffective hedge be directly related to an underlying asset or liability, that portion of the derivative instrument should be assessed against the Group’s effective hedge criteria to establish if that portion qualifies to be recognised as an effective hedge.

Where a portion of an ineffective hedge qualifies against the Group’s criteria to be classified as an effective hedge that portion of the derivative instrument shall be accounted for as a separate and effective hedge instrument and treated as other comprehensive income.

Gains or losses arising on any derivative instrument or portion of a derivative instrument which is deemed to be ineffective will be recognised in profit or loss. Gains and losses, regardless of whether related to effective or ineffective hedges, are taken to a reserve created specifically for that purpose described in the balance sheet as the Interest Rate Swap Reserve.

(r)  New standards, amendments and interpretation not yet effective

There are a number of new standards, amendments and interpretations that have been issued for this accounting year. The standards, amendments and interpretations which have been adopted by the Group on 1 January 2018 are listed below.

IFRS 9 — Financial Instruments

The final version of IFRS 9 Financial Instruments (“IFRS 9”) was published in July 2014 by the IASB. IFRS 9 replaces IAS 39 Financial Instruments and is effective for annual periods beginning on or after 1 January 2018.

The IASB split the changes into 3 main phases; classification and measurement of financial assets and financial liabilities, hedge accounting and impairment requirements relating to the expected credit losses. The Group elected not to restate comparative on adoption of IFRS 9.

Classification and Measurement

The Group has assessed the changes of the classification of financial assets and financial liabilities under IFRS 9 and concludes that there are no changes to the classification of the Group’s financial assets and financial liabilities on adoption of IFRS 9.

The Group has assessed the changes of measurement of financial assets and financial liabilities under IFRS 9 and the Group will continue to initially recognize financial assets and financial liabilities at fair value plus, any directly attributable transactions costs, with subsequent measurement at amortised cost using the effective interest method, with exception to trade receivables. Trade receivables will now be measured in accordance with IFRS 15. The Group has updated the accounting policy for trade receivables, 1 (m), but has made no adjustments to the Group’s financial statements following the adoption of IFRS 9.

Hedge Accounting

The Group concludes that there are no changes on adoption of IFRS 9 on accounting for the Group’s interest rate swap. The Group has updated the hedge documentation, so that it is compliant under IFRS 9.

Impairment

The Group has identified trade receivables being subject to the new expected credit loss model on adoption to IFRS 9. The Group shall apply the simplified approach to measure the loss allowance at an amount equal to lifetime expected credit losses for trade receivables, as outlined in the updated accounting policy, 1 (m). The Group applies a loss rate to trade receivables of more than 90 days past due where, the full net amount is charged as a provision for bad debt to the profit and loss account. The Group continues to monitor the loss rate and adjusts for any forward-looking estimates. There is no material impact on the Group’s bad debt provision on adoption to IFRS 9, when compared to the bad debt provision under IAS 39.

Refinance

IFRS 9 brings changes to the accounting for modified debt terms, in which a 10% test is applied to assess if the modifications of debt terms are substantial. This will have no impact to the Group’s refinance, in 2019 detailed in Note 21, as the changes to the Groups’ modified debt terms are considered substantial

IFRS 15 — Revenue from Contracts

IFRS 15 Revenue from Contractors with Customers (“IFRS 15”) was issued in 2014 by the IASB. IFRS 15 replaces IAS 18 Revenue and IAS 11 Construction Contracts and is effective for annual periods beginning on or after 1 January 2018. The Group has assessed its revenue streams on adoption of IFRS 15 and has identified the following:

Rental Income

The Group’s rental income, which is derived from operating leases, is out with the scope of IFRS 15, as

the Group’s leases contracts are within scope of IAS 17.

Non-rental Income

The Group has identified a non-rental revenue stream of service charge income, which is within scope of the standard. The new financial statement line “Non-rental service charge income” and accompanying note have been included as a result of implementing the standard. Comparative figures have been included accordingly. There has been no financial impact of the new standard to the Group.

IAS 7 – Statement of Cash Flows

In January 2016, the IASB amended IAS 7 Statement of Cash Flows (“IAS 7”) to require entities to provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities. The new movements table in Note 14 is included as a result of implementing the amended standard.

(s) New standards, amendments and interpretation not yet effective

IFRS 16 — Leases

IFRS 16 Leases (“IFRS 16”) replaces IAS 17 Leases (“IAS 17”) and is effective for annual periods beginning on or after 1 January 2019. The key changes are the lessee and lessor accounting models are no longer symmetrical.

For lessees, the accounting for leases will change to a new single lessee accounting model, requiring recognition of a right-of-use asset (right to use underlying leased asset) and a lease liability (obligation to make lease payments) for a lease with a term greater than 12 months, exclusion to recognition is if the underlying asset is of a low value when new.

For lessors, this remains relatively unchanged – IFRS 16 retains IAS 17’s distinction of finance and operating lease however, IFRS 16 has introduced changes for the lessor where the lessor acts as an intermediate lessor in the lease contract. The Group has made an assessment of the leases, where the Group acts as intermediate lessor in the lease agreement, and has identified that the Group has five investment properties held on leased land. The rent per annum ranges from one peppercorn to £5 per annum. The classification of the head leases will change from operating lease to financial lease on transition to IFRS 16.

The Group currently does not anticipate that the standard will have any material impact on the Group’s financial statements as presented for the current year.

Annual Improvements to IFRS

In addition to the above, Annual Improvements to IFRS 2015–2017 Cycle (effective 1 January 2019) have not been adopted early.

2. Rental Income

	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Rental Income	65,936	69,826

Included within rental income is amortisation of lease premiums and rent free periods granted.

2. Service Charge Income

	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Non-rental service charge income	5,950	5,896

The Group’s managing agents Jones Lang LaSalle manage service charge accounts for all the Group’s properties. Service charges on rented properties are detailed in note 5. Service charge expenses, are recharged to tenants. The service charge paid by the Group in respect of void units was £0.6 million (2017: £1.4 million) and is included within note 5 Direct Property Expenses.

4. Investment Management Fees

	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Investment management fee	9,567	9,215

The Group’s Investment Manager up to 10 December 2018 was Standard Life Investments (Corporate Funds) Limited and after this was Aberdeen Standard Fund Managers Limited. The Investment Manager received an aggregate annual fee from the Group at an annual rate of 0.65 per cent of the Total Assets. The Investment Manager is also entitled to an administration fee of £100,000 per annum. The total paid in relation to this fee in the year was £100,000 (2017: £100,000). The Investment Management agreement is terminable by either of the parties to it on 12 months’ notice. From 1 January 2019, the fee will be 0.60% on total assets up to £1.75 billion and 0.475% on total assets over £1.75 billion. There will be no administration fee.

5. Expenses

	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Direct Property Expenses	3,569	4,444
Service charge expenses	5,950	5,896

   

Other Expenses	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Professional fees (including valuation fees)	4,739	2,744
Movement in bad debt provision	(71)	130
Directors’ fees	282	222
Administration fee	100	100
Administration and company secretarial fees	85	85
Regulatory fees	230	212
Auditor’s remuneration for:
Statutory audit	81	68
Non audit services	-	4
	5,446	3,565

6. Finance costs

	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Interest on principal loan amount	6,352	5,794
Amounts payable in respect of interest rate swap arrangement	894	1,435
Facility fees	332	321
Amortisation of loan set up fees	398	593
	7,976	8,143

7. Deferred and Current Taxation

The Company owns five Guernsey tax exempt subsidiaries, UK Finance Holdings Limited (UKFH), UK Commercial Property GP Limited (GP), UK Commercial Property Holdings Limited (UKCPH), UK Commercial Property Estates Limited (UKCPEL) and UK Commercial Property Estates Holdings Limited (UKCPEH). GP and UKCPH are partners in a Guernsey Limited Partnership (“the Partnership”). UKFH and UKCPH own two JPUTS. UKCPEL and UKCPEH also own two JPUTS. Up to REIT conversion on 1 July, The Partnership, UKCPH and UKCPEL owned a portfolio of UK properties and derived rental income from those properties. As the Partnership and the unit trusts are income transparent for UK tax purposes, the partners and unit holders were liable to UK income tax on their share of the net rental profits of the Partnership and unit trusts respectively. The entities directly owning UK property were also liable to UK income tax on their own net UK rental profits. All entities subject to UK income tax elected to receive rental income gross under HMRC’s non-resident landlord scheme.

UK REIT Status

The Group migrated tax residence to the UK and elected to be treated as a UK REIT with effect from 1 July 2018. As a UK REIT, the income profits of the Group’s UK property rental business are exempt from corporation tax as are any gains it makes from the disposal of its properties, provided they are not held for trading or sold within three years of completion of development. The Group is otherwise subject

to UK corporation tax at the prevailing rate.

As the principal company of the REIT, the Company is required to distribute at least 90% of the income profits of the Group’s UK property rental business. There are a number of other conditions that also are required to be met by the Company and the Group to maintain REIT tax status. These conditions were met in the period and the Board intends to conduct the Group’s affairs such that these conditions continue to be met for the foreseeable future. Accordingly, deferred tax is no longer recognised on temporary differences relating to the property rental business or income tax losses previously built up.

The Company and its Guernsey subsidiaries have obtained exempt company status in Guernsey so that they are exempt from Guernsey taxation on income arising outside Guernsey and bank interest receivable in Guernsey.

 A reconciliation between the tax charge and the product of accounting profit multiplied by the applicable tax rate for the year ended 31 December 2018 and 2017 is prepared below.

	Year ended	Year ended
	31 December  2018	31 December  2017
	£’000	£’000
Net profit before tax	58,835	135,170
UK corporation tax at a rate of 19 percent (2017: Income tax – 20%)	11,178	27,034
Effect of:
Capital gains on Investment properties not taxable	(3,600)	(18,084)
UK REIT exemption on net income	(3,963)	-
Income not taxable	(50)	(59)
Intercompany loan interest	(3,478)	(7,099)
Expenditure not allowed for income tax purposes	415	(1,428)
Total current tax charge	502	364
Net Movement in deferred tax asset	3,271	3,244
Corporation tax charge on acquisition of White Building, Reading	2,057
Total tax charge/(credit)	5,830	3,608

The components of the tax charge in the consolidated income statement are as follows:

Reconciliation of current corporation and income tax in the consolidated income statement	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Income tax charge in the year	502	481
Adjustment in respect of prior year over provision	-	(117)
Corporation tax charge in the year	2,057	-
At 31 December 2018	2,559	364

The Company owns two UK Limited Companies, Brixton Radlett Property Limited (“BRPL”) and UK Commercial Property Estates (Reading) Limited. In terms of BRPL, prior to REIT conversion, the losses of the Group could not be used to offset the profits of BRPL, hence the profits of BRPL were subject to corporation tax in the UK, at a rate of 19%. As the inter-company debt in BRPL was payable to a Guernsey entity, withholding tax was suffered on payment of this interest. During 2016, this debt was listed as a eurobond on the Guernsey Stock Exchange, resulting in withholding tax no longer being payable. This listing was cancelled post REIT conversion. For the year ended 31 December 2018 & 2017 the total amount payable in corporation tax was nil and withholding tax was nil.

The White Building, Reading was acquired in June 2018 via the purchase of the share capital of UK Commercial Property Estates (Reading) Limited. The purchase, and subsequent allocation of the property as an investment property, triggered a corporation tax charge of £2,057,000 which was deducted from the purchase price.

Reconciliation of deferred tax in the consolidated income statement	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Movement in deferred tax asset on tax losses	5,635	2,793
Movement in deferred tax asset in respect of capital allowance timing differences	481	(144)
Movement in deferred tax liability in respect of capital allowance timing differences	(2,845)	595
	3,271	3,244

The Components of the deferred tax asset in the consolidated balance sheet are as follows:

Reconciliation of deferred tax in the consolidated balance sheet	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Deferred tax asset on tax losses	-	5,635
Deferred tax asset in respect of capital allowance timing differences	-	481
Deferred tax liability on temporary timing differences	-	(2,845)
	-	3,271

Deferred tax asset

Pre REIT conversion the Group has unused income tax losses carried forward of £40,186,000 (2016/2017: £49,537,000) based on the 2017/2018 tax returns to 5 April 2018. Post REIT conversion the Group is now part of the UK corporation tax regime and hence it is not anticipated that these losses will be utilised. As a result both the deferred tax asset and liability balance, which netted off to £3,271,000 has been written off in 2018.

8. Dividends

Dividends on Ordinary Shares: 2017 Fourth interim of 0.92p per share paid	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
28 February 2018 (2016 Fourth interim:0.92p)	11,955	11,955
2018 First interim of 0.92p per share paid
31 May 2018 (2016 First interim: 0.92p)	11,955	11,955
2018 Second interim of 0.92p per share paid
31 August 2018 (2016 First interim: 0.92p)	11,955	11,955
2018 Third interim of 0.92p per share(split between property income distribution of 0.643p per ordinary share and ordinary dividend of 0.277p per ordinary share) paid 30 November 2018 (2017 Third interim: 0.92p)
	11,955	11,955
	47,820	47,820

A fourth interim dividend of 0.92p was paid on 28 February 2019 to shareholders on the register on 15 February 2019. This dividend was split between a property income distribution of 0.775p per ordinary share and an ordinary dividend of 0.145p per ordinary share. Although this payment relates to the year ended 31 December 2018, under International Financial Reporting Standards it will be accounted for in the year ending 31 December 2019.

9. Basic and diluted Earnings per Share

	Year ended 31 December 2018	Year ended 31 December 2017
Number of Shares	1,299,412,465	1,299,412,465
Net Profit (£)	53,005,000	131,562,000
	4.08	10.12

As there are no dilutive instruments outstanding, basic and diluted earnings per share are identical.

10. Investment Properties

Freehold and Leasehold properties	Year ended 31 December 2018 £’000	Year ended 31 December 2017 £’000
Opening valuation	1,380,523	1,270,624
Purchases at cost	156,030	52,016
Capital expenditure	40,490	8,981
Gain on revaluation to fair value	14,650	94,994
Disposals at prior year valuation	(163,250)	(39,495)
Lease incentive movement	2,408	(6,597)
Total fair value at 31 December	1,430,851	1,380,523
Less: reclassified as held for sale	-	(47,600)
Fair value as at 31 December	1,430,851	1,332,923
Gains on investment properties at fair value comprise
Valuation gains	14,649	94,994
Movement in provision for lease incentives	2,408	(6,597)
Gain on disposal	1,890	2,019
	18,947	90,416
Gains on investment properties sold
Original cost of investment properties sold	(168,188)	(28,293)
Sale proceeds less sales costs	171,928	41,513
Profit on investment properties sold	3,740	13,220
Recognised in previous periods	(4,938)	11,201
Recognised in current period	8,678	2,019
	3,740	13,220

Given the objectives of the Group and the nature of its investments, the Directors believe that the Group has only one asset class, that of Commercial Property. CBRE Limited, (the “Property Valuer”) completed a valuation of Group investment properties as at 31 December 2018 on the basis of fair value in accordance with the requirements of the Royal Institution of Chartered Surveyors (RICS) ‘RICS Valuation — Global Standards 2017 (the ‘Red Book’). For most practical purposes there would be no difference between Fair Value (as defined in IFRS 13) and Market Value. The Property Valuer, in valuing the portfolio, is acting as an ‘External Valuer’, as defined in the Red Book, exercising independence and objectivity. The Property Valuer’s opinion of Fair Value has been primarily derived using comparable recent market transactions in order to determine the price that would be received to sell an asset in an orderly transaction between market participants at the valuation date. The fair value of these investment properties amounted to £1,445,170,000 (2017: £1,397,250,000). The difference between the fair value and the value per the consolidated balance sheet at 31 December 2018 consists of accrued income relating to the pre-payment for rent-free periods recognised over the life of the lease totalling £14,319,000 (2017: £16,727,000) which is separately recorded in the accounts as a current asset.

The Group has entered into leases on its property portfolio as lessor (See note 19 for further information).

·     No one property accounts for more than 15 per cent of the gross assets of the Group.

·     All leasehold properties have more than 60 years remaining on the lease term.

·     There are no restrictions on the realisability of the Group’s investment properties or on the remittance of income or proceeds of disposal.

However, the Group’s investments comprise UK commercial property, which may be difficult to realise.

The property portfolio’s fair value as at 31 December 2018 has been prepared adopting the following assumptions:

·     That, where let, the Estimated Net Annual Rent (after void and rent free period assumptions) for each property, or part of a property, reflects the terms of the leases as at the date of valuation. If the property, or parts thereof, are vacant at the date of valuation, the rental value reflects the rent the Property Valuer considers would be obtainable on an open market letting as at the date of valuation.

·     The Property Valuer has assumed that, where let, all rent reviews are to be assessed by reference to the estimated rental value calculated in accordance with the terms of the lease. Also there is the assumption that all tenants will meet their obligations under their leases and are responsible for insurance, payment of business rates, and all repairs, whether directly or by means of a service charge.

·     The Property Valuer has not made any adjustments to reflect any liability to taxation that may arise on disposal, nor any costs associated with disposals incurred by the owner.

·     The Property Valuer assumes an initial yield in the region of 3 to 7.25 per cent, based on market evidence. For the majority of properties, the Property Valuer assumes a reversionary yield in the region of 3.25 to 9 per cent.

·     The Property Valuer takes account of deleterious materials included in the construction of the investment properties in arriving at its estimate of Fair Value when the Investment Manager advises of the presence of such materials.

The majority of the leases are on a full repairing basis and as such the Group is not liable for costs in respect of repairs or maintenance to its investment properties.

The following disclosure is provided in relation to the adoption of IFRS 13 Fair Value Measurement. All properties are deemed Level 3 for the purposes of fair value measurement and the current use of each property is considered the highest and best use. There have been no transfers from Level 3 in the year. The fair value of completed investment property is determined using a yield methodology.

Under this method, a property’s fair value is estimated using explicit assumptions regarding the benefits and liabilities of ownership over the asset’s life including an exit or terminal value. As an accepted method within the income approach to valuation, this method involves the projection of a series of cash flows on a real property interest. To this projected cash flow series, an appropriate, market derived discount rate (capitalisation rate) is applied to establish the present value of the cash inflows associated with the real property.

The duration of the cash flow and the specific timing of inflows and outflows are determined by events such as rent reviews, lease renewal and related void or rent free periods, re-letting, redevelopment, or refurbishment. The appropriate duration is typically driven by market behaviour that is a characteristic of the class of property. In the case of investment properties, periodic cash flow is typically estimated as gross income less vacancy, non-recoverable expenses, collection losses, lease incentives, maintenance cost, agent and commission costs and other operating and management expenses. The series of periodic net cash inflows, along with an estimate of the terminal value anticipated at the end of the projection period, is then discounted. Set out below are the valuation techniques used for each property sector plus a description and quantification of the key unobservable inputs relating to each sector. There has been no change in valuation technique in the year.

Sector	Fair Value at	Valuation Techniques techniques	Unobservable inputs	Range
	31/12/18 (£m)			(weighted average)
Industrial	670.5	Yield methodology	Annual rent per sq ft	£0-£17 (£7)
			Capitalisation rate	4.1%-6.8% (4.8%)
Office	231.9	Yield methodology	Annual rent per sq ft	£15-£57 (£27)
			Capitalisation rate	3.3%-7.2% (5.4%)
Retail	384.9	Yield methodology	Annual rent per sq ft		£18-£305 (£60)
			Capitalisation rate		3.3%-8.7% (5.5%)
Alternatives	157.9	Yield methodology	Annual rent per sq ft		£0-£21 (£14)
			Capitalisation rate		5.1%-6.1% (5.6%)

Sensitivity analysis

The table below presents the sensitivity of the valuation to changes in the most significant assumptions underlying the valuation of investment property.

Sector	Assumption	Movement	Effect on valuation
Industrial	Capitalisation rate	+50 basis points	Decrease £69.3m
		-50 basis points	Increase £86.0m
Office	Capitalisation rate	+50 basis points	Decrease £22.3m
		-50 basis points	Increase £27.4m
Retail	Capitalisation rate	+50 basis points	Decrease £35.0m
		-50 basis points	Increase £42.9m
Alternatives	Capitalisation rate	+50 basis points	Decrease £13.9m
		-50 basis points	Increase £16.5m

Investment property valuation process

The valuations of investment properties are performed quarterly on the basis of valuation reports prepared by independent and qualified valuers and reviewed by the Property Valuation Committee of the Company.

These reports are based on both:

·     Information provided by the Investment Manager such as current rents, terms and conditions of lease  agreements, service charges and capital expenditure. This information is derived from the Investment Manager’s financial and property management systems and is subject to the Investment Manager’s overall control environment.

·     Assumptions and valuation models used by the valuers — the assumptions are typically market  related, such as yields. These are based on their professional judgment and market observation.

The information provided to the valuers and the assumptions and valuation models used by the valuers are reviewed by the Investment Manager. This includes a review of fair value movements over the period.

Asset held for sale

There are no assets held for sale as at 31 December 2018. At the prior year end the assets held for sale were the three Shrewsbury shopping centres, Charles Darwin, Pride Hill and Riverside. The assets were shown at fair value in the Balance Sheet as a held for sale asset and included within the investment property table shown in this note. The assets were sold by the Group on 24 January 2018 for approximately £51 million and the losses on these assets are shown in investment property table and included within the consolidated statement of comprehensive income as losses on investment properties.

11. Subsidiary Undertakings

The Company owns 100 per cent of the issued ordinary share capital of UK Commercial Property Finance Holdings Limited (UKCFH), a company incorporated in Guernsey whose principal business pre REIT conversion was that of a holding company.

The Company owns 100 per cent of the issued share capital of UK Commercial Property Estates Holdings Limited (UKCPEH), a company incorporated in Guernsey whose principal business pre REIT conversion was that of a holding company. UKCPEH Limited owns 100 per cent of the issued share capital of UK Commercial Property Estates Limited, a company incorporated in Guernsey whose principal business is that of an investment and property company. UKCPEH also owns 100% of Brixton Radlett Property Limited, a UK company, whose principal business is that of an investment and property company.

UKCFH owns 100 per cent of the issued ordinary share capital of UK Commercial Property Holdings Limited (UKCPH), a company incorporated in Guernsey whose principal business is that of an investment and property company.

UKCFH owns 100 per cent of the issued share capital of UK Commercial Property GP Limited, (GP), a company incorporated in Guernsey whose principal business is that of an investment and property company.

UKCPT Limited Partnership, (GLP), is a Guernsey limited partnership, and it holds a portfolio of properties. UKCPH and GP, have a partnership interest of 99 and 1 per cent respectively in the GLP. The GP is the general partner and UKCPH is a limited partner of the GLP.

UKCFH owns 100 per cent of the issued share capital of UK Commercial Property Nominee Limited, a company incorporated in Guernsey whose principal business is that of a nominee company.

In addition the Group controls four JPUTS namely Junction 27 Retail Unit Trust, St George’s Leicester Unit Trust, Kew Retail Park Unit Trust and Rotunda Kingston Property Unit Trust. The principal business of the Unit Trusts is that of investment in property.

Following REIT conversion all direct properties held by UKCPH, UKCPEL and the Limited Partnership were transferred to UKCPFH and UKCPEH.

12. Trade and Other receivables

	2018 £’000	2017 £’000
Rents receivable	4,067	2,995
Lease Incentive	14,319	16,727
Other debtors and prepayments	5,379	3,711
	23,765	23,433

   

Provision for bad debts as at 31 December 2017/20156	790	660
Movement in the year	(71)	130
Provision for bad debts as at 31 December 2018/2017	719	790

The ageing of these receivables is as follows:

	2018 £’000	2017 £’000
Less than 6 months	566	374
Between 6 and 12 months	124	290
Over 12 months	29	126
	719	790

Other debtors include tenant deposits of £2,618,000 (2017: £3,070,000)

All other debtors are due within one year. No other debts past due are impaired in either year.

13. Trade and Other payables

	2018 £’000	2017 £’000
Rental income received in advance	13,308	14,334
Investment Manager fee payable	2,381	2,370
VAT payable	-	641
Income tax payable	2,030
Withholding tax payable*	608	481
Other payables	16,812	4,582
	35,139	22,408

* Tax withheld on PIDs at the basic rate of income tax, currently 20%.

Other payables include tenant deposits of £2,618,000 (2017: £3,070,000), bank loan and interest rate swap payments of £1,429,000 (2017: £1,430,000), dilapidation settlement of £3,500,000 (2017: £0), acquisition costs of £830,000 (2017: £0) and dividend payable of £4,182,000 (2017: £0). As at the payment date of the third interim dividend (30 November 2018), Phoenix Life Limited were deemed to be a substantial shareholder under the REIT regulations. PLL notified the Company they were no longer a substantial shareholder in January 2019 and the dividend was subsequently paid. The Group’s payment policy is to ensure settlement of supplier invoices in accordance with stated terms.

14. Bank Loan and Interest rate swaps

	2018	2017
	£’000	£’000
Total Facilities available	300,000	300,000
Drawn down:
Barclays facility	150,000	150,000
Cornerstone facility	100,000	100,000
Set up costs incurred	(4,536)	(4,536)
Accumulated amortisation of set up costs	3,465	3,067
Accrued variable rate interest on bank loan	732	595
Total due	249,661	249,126

(i) Barclays Facility

The Group has a five year £150 million facility, maturing in April 2020, with Barclays Bank plc initially taken out in May 2011 and extended in April 2015. As at 31 December 2018 this entire loan was drawn down. The bank loan is secured on the property portfolio held by UKCPEL. Under bank covenants related to the loan UKCPEL is to ensure that at all times:

·     The loan to value percentage does not exceed 60 per cent.

·     Interest cover at the relevant payment date is not less than 160 per cent.

 UKCPEL met all covenant tests during the year.

Interest rate exposure is hedged by the purchase of an interest rate swap contract. The notional amount of the swap and the swap term matches the loan principal and the loan term. As at 31 December 2018 the Group had in place one interest rate swap totaling £150 million with Barclays Bank plc (2017: £150 million). The interest rate swap effectively hedges the current drawn down loan with Barclays Bank plc.

Interest on the swap is receivable at a variable rate calculated on the same LIBOR basis as for the bank loan (as detailed below but excluding margins) and payable at a fixed rate of 1.30 per cent per annum on the £150 million swap. The fair value of the liability in respect of the interest rate swap contract at 31 December 2018 is £702,000 (2017: liability of £2,090,000) which is based on the marked to market value.

Interest is payable by UKCPEL at a rate equal to the aggregate of LIBOR, mandatory costs of the Bank and a margin. The applicable margin is fixed at 1.50 per cent per annum and this was the applicable margin as at 31 December 2018 (2017: 1.50 per cent).

In addition to the above UKPCPEL has a £50 million revolving credit facility (“RCF”) with Barclays Bank plc at a margin of 1.50 per cent above LIBOR available for four years but cancellable at any time. The RCF has a non-utilisation fee of 0.6 per cent per annum charged on the proportion of the RCF not utilised on a pro-rata basis. At 31 December 2018 the RCF remained unutilised.

(ii) Barings Facility

The Group has a twelve year £100 million loan which is due to mature in April 2027 with Barings Real Estate Advisers LLP (previously Cornerstone Real Estate Advisers LLP), a member of the MassMutual Financial Services Group. The loan was taken out by UK Commercial Property Finance Holdings Limited (UKCFH). As at 31 December 2018 this entire loan was drawn down. The bank loan is secured on the portfolio of eight properties held within the wider Group. Under bank covenants related to the loan UKCFH is to ensure that at all times:

·     The loan to value percentage does not exceed 75 per cent.

·     Interest cover at the relevant payment date and also projected over the course of the proceeding 12 months is not less than 200 per cent.

UKCFH met all covenant tests during the year.

Interest is payable by UKCFH at a fixed rate equal to the aggregate of the equivalent 12 year gilt yield, fixed at the time of drawdown and a margin. This resulted in a fixed rate of interest payable of 3.03 per cent per annum. There are no interest rate swaps in place relating to this facility.

Swap Instruments

As at 31 December 2018 the Group had in place an interest rate swap instrument totalling £150 million which was deemed to be an effective hedge as per note 1(q).

The revaluation of this swap at the year end resulted in a gain on interest rate swaps of £1.4 million (2017: gain of £1.7 million). Of the total loss arising on interest rate swaps, £1.4 million related to effective hedge instruments (2017: gain £1.7 million) which is credited through Other Comprehensive Income in the Statement of Comprehensive Income.

The valuation techniques applied to fair value the derivatives include the swap models including the CVA/DVA swap models, using present value calculations. The model incorporates various inputs including the credit quality of counterparties and forward rates.

The fair value of the interest rate swaps as at 31 December 2018 amounted to a liability of £702,000 (2017: Liability of £2,090,000). Based on current yield curves and non-performance risk, £868,000 (2017: £1.1 million) of this value is a liability which relates to the next 12 months and is therefore classified as a current liability. The remainder is classified as a long term liability.

15. Share capital accounts

			2018	2017
			£’000	£’000
Share capital
Opening balance			539,872	539,872
Share Capital as at 31 December			539,872	539,872
(number of shares in issue at the year end being 1,299,412,465 (2017: 1,299,412,465) of 25p each.

Ordinary shareholders participate in all general meetings of the Company on the basis of one vote for each share held. The Articles of Association of the Company allow for an unlimited number of shares to be issued, subject to restrictions placed by AGM resolutions. There are no restrictions on the shares in issue.

16. Net Asset Value per Share

The net asset value per ordinary share is based on net assets of £1,212,619,000 (2017: £1,206,046,000) and 1,299,412,465 (2017: 1,299,412,465) ordinary shares, being the number of ordinary shares in issue at the year end.

17. Related Party Transactions

No Director has an interest in any transactions which are or were unusual in their nature or significant to the nature of the Group. Standard Life Investments (Corporate Funds) Limited, as the Manager of the Group up until 10 December 2018 and Aberdeen Standard Fund Managers Limited after this date, received fees for their services as investment managers. Further details are provided in note 3. The total management fee charged to the Statement of Comprehensive Income during the year was £9,567,000 (2017: £9,215,000) of which £2,381,000 (2017: £2,370,000) remained payable at the year end. The Investment Manager also received an administration fee of £100,000 (2017: £100,000), of which £25,000 (2017: £25,000) remained payable at the year end.

The Directors of the Company are deemed as key management personnel and received fees for their services. Further details are provided in the Directors’ Remuneration Report (unaudited). Total fees for the year were £282,443 (2017: £222,000) none of which remained payable at the year end (2017: nil).

The Group invests in the Aberdeen Standard Investments Liquidity Fund which is managed by Aberdeen Standard Investments Limited. As at 31 December 2018 the Group had invested £27.1 million in the Fund (2017: £44.7 million). No additional fees are payable to Aberdeen Standard Investments as a result of this investment.

18. Financial Instruments and Investment Properties

The Group’s investment objective is to provide ordinary shareholders with an attractive level of income together with the potential for income and capital growth from investing in a diversified UK commercial property portfolio.

Consistent with that objective, the Group holds UK commercial property investments. The Group’s financial instruments consist of cash, receivables and payables that arise directly from its operations and loan facilities and swap instruments.

The main risks arising from the Group’s financial instruments are credit risk, liquidity risk, market risk and interest rate risk. The Board reviews and agrees policies for managing its risk exposure. These policies are summarised below and remained unchanged during the year.

Fair value hierarchy

The following table shows an analysis of the fair values of investment properties recognized in the balance sheet by level of the fair value hierarchy:

Explanation of the fair value hierarchy:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date.

Level 2 – Use of a model with inputs (other than quoted prices included in level 1) that are directly or indirectly observable market data.

Level 3 – Use of a model with inputs that are not based on observable market data.

Investment Properties

31 December 2018	Level 1	Level 2	Level 3	Total fair value
	£'000	£'000	£'000	£'000
Investment properties	-	-	1,445,170	1,445,170
31 December 2017	Level 1	Level 2	Level 3	Total fair value
	£'000	£'000	£'000	£'000
Investment properties	-	-	1,397,250	1,397,250

The lowest level of input is the underlying yield on each property which is an input not based on observable market data.

The following table shows an analysis of the fair values of loans recognised in the balance sheet by level of the fair value hierarchy:

Bank Loans
31 December 2018	Level 1	Level 2	Level 3	Total fair value
	£'000	£'000	£'000	£'000
Bank loans	-	253,950	-	253,950
31 December 2017	Level 1	Level 2	Level 3	Total fair value
	£'000	£'000	£'000	£'000
Bank loans	-	264,720	-	264,720

The lowest level of input is the interest rate payable on each borrowing which is a directly observable input.

The following table shows an analysis of the fair values of financial instruments and trade receivables and payables recognised at amortised cost in the balance sheet by level of the fair value hierarchy:

31 December 2018	Level 1	Level 2	Level 3	Total fair value
	£’000	£’000	£’000	£’000
Interest rate swap	-	(702)	-	(702)
Trade and other receivables	-	23,765	-	23,765
Trade and other payables	-	35,139	-	35,139
31 December 2017	Level 1	Level 2	Level 3	Total fair value
	£’000	£’000	£’000	£’000
Interest rate swap	-	(2,090)	-	(2,090)
Trade and other receivables	-	23,433	-	23,433
Trade and other payables	-	22,408	-	22,408

The lowest level of input is the three month LIBOR yield curve which is a directly observable input.

The carrying amount of trade and other receivables and payables is equal to their fair value, due to the short term maturities of these instruments. Expected maturities are estimated to be the same as contractual maturities.

The fair value of investment properties is calculated using unobservable inputs as described in note 10.

The fair value of the derivative interest rate swap contract is estimated by discounting expected future cash flows using current market interest rates and yield curves over the remaining term of the instrument.

The fair value of the bank loans are estimated by discounting expected future cash flows using the current interest rates applicable to each loan.

There have been no transfers between levels in the year for items held at fair value.

Real Estate Risk

The Group has identified the following risks associated with the real estate portfolio:

•             The cost of any development schemes may increase if there are delays in the planning process. The Group uses advisers who are experts in the specific planning requirements in the scheme’s location in order to reduce the risks that may arise in the planning process;

•             A major tenant may become insolvent causing a significant loss of rental income and a reduction in the value of the associated property (see also credit risk below). To reduce this risk, the Group reviews the financial status of all prospective tenants and decides on the appropriate level of security required via rental deposits or guarantees;

•              The exposure of the fair values of the portfolio to market and occupier fundamentals such as tenants financial position.

Credit risk

Credit risk is the risk that an issuer or counterparty will be unable or unwilling to meet a commitment that it has entered into with the Group.

At the reporting date, the maturity of the Group’s financial assets was:

Financial Assets 2018
	3 months or less	More than 3 months but less than one year	More than one year	Total
	£’000	£’000	£’000	£’000
Cash	43,505	-	-	43,505
Rent receivable	4,067	-	-	4,067
Other debtors	5,379	-	-	5,379
	52,951	-	-	52,951
Financial Assets 2017
	3 months or less	More than 3 months but less than one year	More than one year	Total
	£’000	£’000	£’000	£’000
Cash	72,443	-	-	72,443
Rent receivable	2,995	-	-	2,995
Other debtors	3,711	-	-	3,711
	79,149	-	-	79,149

In the event of default by a tenant, the Group will suffer a rental shortfall and incur additional costs, including legal expenses, in maintaining, insuring and re-letting the property until it is re-let. The Board receives regular reports on concentrations of risk and any tenants in arrears. The Investment Manager monitors such reports in order to anticipate and minimise the impact of defaults by tenants.

The Company has a diversified tenant portfolio. The maximum credit risk from the rent receivables of the Group at 31 December 2018 is £6,710,000 (2017: £6,065,000). The Group holds rental deposits of £2,618,000 (2017: £3,070,000) as collateral against tenant arrears/defaults. All tenant deposits are in line with market practice. There is no residual credit risk associated with the financial assets of the Group. Other than those included in the provision for bad debts, no financial assets past due are impaired.

All of the cash is placed with financial institutions with a credit rating of A or above. £27.1 million (2017: £44.7 million) of the year end cash balance is held in the Aberdeen Standard Investments Liquidity Fund, which is a money market fund and has a triple A rating. Bankruptcy or insolvency of a financial institution may cause the Group’s ability to access cash placed on deposit to be delayed or limited. Should the credit quality or the financial position of the banks currently employed significantly deteriorate, the Investment Manager would move the cash holdings to another financial institution subject to restrictions under the loan facilities.

Liquidity Risk

Liquidity risk is the risk that the Group will encounter difficulty in realising assets or otherwise raising funds to meet financial commitments. While commercial properties are not immediately realisable, the Group has sufficient cash resources to meet liabilities.

The Group’s liquidity risk is managed on an ongoing basis by the Investment Manager investing in a diversified portfolio of prime real estate and placing cash in liquid deposits and accounts. This is monitored on a quarterly basis by the Board. In certain circumstances, the terms of the Group’s bank loan entitles the lender to require early repayment, and in such circumstances the Group’s ability to maintain dividend levels and the net asset value attributable to the ordinary shares could be adversely affected.

As at 31 December 2018 the cash balance was £43,505,000 (2017: £72,443,000).

At the reporting date, the contractual maturity of the Group’s liabilities, which are considered to be the same as expected maturities, was:

Financial Liabilities 2018	3 months or less £’000	More than 3 months but less than one year £’000	More than one year £’000	Total £’000
Bank loan	1,783	5,447	272,167	279,397
Other creditors	33,800	-	-	33,800
	35,583	5,447	272,167	313,197
Financial Liabilities 2017	3 months or less £’000	More than 3 months but less than one year £’000	More than one year £’000	Total £’000
Bank loan	1,783	5,447	279,028	286,258
Other creditors	21,207	-	-	21,207
	22,990	5,447	279,028	307,465

The amounts in the table are based on contractual undiscounted payments.

Interest rate risk

The cash balance as shown in the Balance Sheet, is its carrying amount and has a maturity of less than one year. Interest is receivable on cash at a variable rate ranging from 0.2 per cent to 0.6 per cent at the year end and deposits are re-priced at intervals of less than one year.

An increase of 1 per cent in interest rates as at the reporting date would have increased the reported profit by £435,000 (2017: increased the reported profit by £774,000). A decrease of 1 per cent would have reduced the reported profit £435,000 (2017: decreased the reported profit by £774,000). The effect

on equity is nil (excluding the impact of a change in retained earnings as a result of a change in net profit).

As the Group’s bank loans have been hedged by interest rate swaps or are at fixed rates, these loans are not subject to interest rate risk.

As at 31 December 2018 the Group had in place a total of £150 million of interest rate swap instruments (2017: £150 million). The values of these instruments are marked to market and will change if interest

rates change. It is estimated that an increase of 1 per cent in interest rates would result in the swap liability decreasing by £1.8 million (2017: £3.3 million) which would increase the reported other comprehensive income by the same amount. A decrease of 1 per cent in interest rates would result in the swap liability increasing by £1.8 million (2017: £3.3 million) which would decrease the reported other comprehensive income by the same amount.

The other financial assets and liabilities of Group are non-interest bearing and are therefore not subject to interest rate risk.

Foreign Currency Risk

There was no foreign currency risk as at 31 December 2018 or 31 December 2017 as assets and liabilities of the Group are maintained in pounds Sterling.

Capital Management Policies

The Group considers that capital comprises issued ordinary shares, net of shares held in treasury, and long-term borrowings. The Group’s capital is deployed in the acquisition and management of property assets meeting the Group’s investment criteria with a view to earning returns for shareholders which are typically made by way of payment of regular dividends. The Group also has a policy on the buyback of shares which it sets out in the Directors’ Authority to Buy Back Shares section of the Directors’ Report.

The Group’s capital is managed in accordance with investment policy which is to hold a diversified property portfolio of freehold and long leasehold UK commercial properties. The Group invests in income producing properties. The Group will principally invest in four commercial property sectors: office, retail, industrial and leisure. The Group is permitted to invest up to 15 per cent of its Total Assets in indirect property funds and other listed investment companies. The Group is permitted to invest cash, held by it for working capital purposes and awaiting investments, in cash deposits, gilts and money market funds.

The Group monitors capital primarily through regular financial reporting and also through a gearing policy. Gearing is defined as gross borrowings divided by total assets less current liabilities. The Group’s gearing policy is set out in the Investment Policy section of the Report of the Directors. The Group is not subject to externally imposed regulatory capital requirements but does have banking covenants on which it monitors and reports on a quarterly basis. Included in these covenants are requirements to monitor loan to value ratios which is calculated as the amount of outstanding debt divided by the market value of the properties secured. The Group’s Loan to value ratio is shown below.

The Group did not breach any of its loan covenants, nor did it default on any other of its obligations under its loan arrangements in the year to 31 December 2018.

	2018	2017
	£’000	£’000
Carrying amount of interest-bearing loans and borrowings	249,661	249,126
External valuation of completed investment property (excluding lease incentive adjustments)	1,445,170	1,397,250
Loan to value ratio	17.3%	17.8%

The Group’s capital balances are set out in the Consolidated Statement of Changes in Equity and are regarded as the Group’s equity and net debt.

19. Capital Commitments

The Group had contracted capital commitments as at 31 December 2018 of £11.5 million (31 December 2017 – £44.4 million), which included:

·     £1 million capital works refurbishment of Magna Park, Lutterworth.

·     £2.5 million capital works building pre-let additional units at St George’s Retail Park, Leicester.

·     £2.3 million for capital works across Cineworld Complex Glasgow, Motor Park Portsmouth, Ventura Park Radlett and M8 Interlink.

·     £5.7 million forward funding of the pre-let Maldron Hotel, Newcastle.

20. Lease Analysis

The Group leases out its investment properties under operating leases.

The future income under non-cancellable operating leases, based on the unexpired lease length at the year end was as follows (based on total rentals):

	2018 £000	2017 £000
Less than one year	65,487	65,675
Between one and five years	218,547	200,249
Over five years	355,523	307,618
Total	639,557	573,542

The largest single tenant at the year end accounted for 5.9 per cent (2017: 5.8 per cent) of the current annual rental income.

The unoccupied property expressed as a percentage of annualised total rental value was 6.9 per cent (2017: 7.6 per cent) at the year end.

The Group has entered into commercial property leases on its investment property portfolio. These properties, held under operating leases, are measured under the fair value model as the properties are held to earn rentals. The majority of these non-cancellable leases have remaining non-cancellable lease terms of between 5 and 15 years.

21. Events After the Balance Sheet Date

On 21 February 2019 the Company announced it had refinanced its

debt facilities as follows:

Barclays Facility

·     The £150 million Barclays term loan facility due to expire in April 2020 has been repaid along with the associated interest rate swap. The cost of closing out the swap was £703,000. There were no repayment fees on the term loan facility.

·     The current £50 million Barclays RCF has been increased to £150 million and extended to February 2024. £55 million of this RCF has been utilised to repay the term loan.

Barings Real Estate (“Barings”) Facility

·     A new £100 million 2.72% fixed rate facility has been taken out with Barings Real Estate, part of Barings LLC, one of the world’s largest diversified real estate investment managers, maturing in February 2031, which has been used to repay the balance of the Barclays term loan facility. The Group now has £200 million of debt in two equal tranches with Barings with £100 million expiring in April 2027 and £100 million in February 2031.

This Annual Financial Report announcement is not the Company's statutory accounts for the year ended 31 December 2018. The statutory accounts for the year ended 31 December 2018 received an audit report which was unqualified.

The Annual Report will be posted to shareholders in May 2018 and additional copies will be available from the Manager (Tel. [phone]) or by download from the Company's webpage (www.ukcpreit.co.uk).

Please note that past performance is not necessarily a guide to the future and that the value of investments and the income from them may fall as well as rise. Investors may not get back the amount they originally invested.

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