AFRB.L Regulatory News (AFRB)

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29 March 2011

AFI DEVELOPMENT PLC

PRELIMINARY STATEMENT OF RESULTS FOR THE YEAR ENDED 31 DECEMBER 2010

AFI Development PLC ("AFI Development" or the "Company"), a leading real estate company focused on developing property in Russia and the CIS, has today announced its preliminary audited financial results for the year ended 31 December 2010.

Financial Highlights: 

·; Adjusted Net Asset Value per share now stands at US$1.65, up by 7.1% from US$1.54 as at 30 June 2010 and 1.4% from US$1.62 as at 31 December 2009.

·; Net Asset Value, based on the valuation of our projects portfolio independently verified by Jones Lang LaSalle LLC and project costs, is US$1.73 billion, up 1.4% from US$1.70 billion as at 31 December 2009.

·; The Company's investment portfolio as at 31 December 2010 is valued at US$2.31 billion, up by 20% since last valuation carried on 31 December 2009 and 31 May 2010 of US$1.92 billion.

·; Profit for the year is US$25.88 million in comparison to a loss of US$2.66 million in 2009.

·; Net Revaluation of our investment portfolio by JLL. In 2010, recognised a US$93.92 million gain from revaluation of our completed projects as opposed to a loss of US$38.92 million in 2009. The major drivers of the revaluations were the revaluation of AFIMALL City, up by US$96.23 million, Ozerkovskaya phase III up by US$66.65 million and W4W up by US$20.01. On the other hand, the Company decided to write-off of the Kuntsevo project, in the amount of US$79.89 million, due to project uncertainties. Strong cash position retained at US$129.84 million and the Company continues to access debt financing for its development projects.

Operational Highlights:

·; Completion of AFIMALL City (formerly Mall of Russia) with approximately 75% of the retail shops in the Mall let to a wide mix of tenants. 

·; The first company focused on Russian real estate to obtain a Premium Listing on the London Stock Exchange with its 'B' shares commencing trading on 5 July 2010 under the ticker AFRB. Greater commitment to corporate governance reiterated through the appointment of a further two independent non-executive directors, Michael Sarris and Panayiotis Demetriou, to the Board of Directors.

·; Acquamarine Hotel on Ozerkovskaya Embankment, which was opened at the end of 2009, started its operation in the beginning of 2010 and achieved high levels of occupancy by year end.

·; Completion of Paveletskaya I office complex with significant progress on preleasing.

·; Significant progress on development at the fully-financed Ozerkovskaya Embankment Phase 3 project which remains on track for completion in 2011.

·; Commencement of development of the Kalinina Hotel in Zheleznovodsk following completion of tender for and appointment of the project's general contractor and approval of the full development budget of US$20 million. Full financing for the project was secured through a Russian rouble loan from Sberbank.

Key highlights since financial year end:

·; Following receipt of the requisite regulatory approvals for the operation of the Mall on 4 March 2011, the Company issued operators of the rented retail units in the Mall a notice requiring them to conclude all fit-out works and prepare for the opening of their shops by March 10, 2011, when AFIMALL City opened to the public.

·; On 26 January 2011, AFI Development's major shareholder, Africa Israel Investments, agreed to purchase approximately 9.7% of the aggregate equity and voting rights in AFI Development from a company wholly-owned by Mr. Alexander Khaldey, the Executive Director of AFI Development. Total consideration is approximately US$129 million or approximately US$1.27 per each share or GDR of AFI Development. Part of the consideration was paid by way of set-off against the existing loan provided by the Company in 2007. Alexander Khaldey continues to serve as the Executive Director on the Board of AFI Development and Chairman of OOO AFI Rus and of ZAO Stroyinkom-K.

·; On 4 March 2011, the Board of AFI Development accepted the resignation of Evgeny Luneev as Chief Financial Officer, who decided to leave the Company in order to pursue other business opportunities. Mr. Luneev will act as the CFO until 29 March 2011. His successor will be announced in due course.

·; On 23 March 2011, AFI Development leased the Paveletskaya office complex to a single tenant ZAO GREENATOM, a subsidiary of the State Atomic Energy Corporation ROSATOM. An 11-month lease agreement was signed with ZAO GREENATOM, which will roll over a 3-year period once the ownership certificate has been obtained, expected before year end. The lease will yield annualized revenue of US$4.7 million, excluding VAT.

·; On March 25 2011, the Company confirmed that it had reached a non-binding understanding with the Moscow City administration regarding the purchase from the City of Moscow of its 25% share in AFIMALL City and 2,700 parking lots adjacent to AFIMALL City, for a total consideration of approximately US$ 310 million.

·; On March 25, 2011, the Company confirmed that it has reached a non-binding understanding with the Moscow City administration to transfer its development rights in the Tverskaya Zastava shopping centre to the City of Moscow in exchange for being fully compensated for its development costs incurred in the project to date. Such compensation may take the form of the City of Moscow granting additional building rights for the Company's other projects. As part of the non-binding understanding reached with the City of Moscow, it is intended that AFI Development will remain the owner of the projects surrounding Tverskaya, equating to nearly 350,000 of commercial and residential space. It is also intended that such projects will retain their key development criteria and it is the Company's understanding that the current planning documentation will remain in place.

Commenting on today's announcement, Lev Leviev, Chairman of AFI Development, said:

"AFI Development has emerged from the crisis in a leading position among Russian developers, well placed to benefit from improving conditions, by completing projects that meet the demand for the quality space that Moscow continues to lack.

The success of our projects has been reflected in our financial performance. The Company returned to profitability in 2010 and maintained a strong cash position with approximately US$130 million at year-end. Reflecting the recovery in the real estate sector, rental income rose by 22% and residential sales rose by 16% to a combined US$75 million.

We look forward to 2011 as another year of growth in the Moscow property sector. We anticipate a significant level of rental revenue this year coming from our newly opened retail project AFIMALL City. We will continue the development of our core projects and selectively activate new projects within our pipeline, ready to meet demand at the right time. We believe we are well positioned within the Moscow real estate sector and on this basis we will create value for all our shareholders. In addition, we remain committed to further strengthening our corporate governance policies and enhancing our internal controls and disclosure procedures."

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For further information, please contact:

AFI Development

Stanislav Joukov +7 495 796 9988

Natalia Ivanova

Citigate Dewe Rogerson, London +44 20 7638 9571

David Westover

Sandra Novakov

Lucie Holloway

About AFI Development

AFI Development is one of the leading real estate development companies operating in Russia. Established in 2001, AFI Development is a publicly traded subsidiary of Africa Israel Investments Ltd.

AFI Development is listed on the Main Market of the London Stock Exchange and aims to deliver shareholder value through a commitment to innovation and continuous project development, coupled with the highest standards of design, construction, and quality and customer service.

AFI Development focuses on developing and redeveloping high quality commercial and residential real estate assets in Moscow, the Moscow Region, and other major cities in Russia and the CIS. The Company's existing portfolio of 30 development projects comprises commercial projects focused on offices, shopping centers, hotels and mixed-use properties, and residential projects. AFI Development's strategy is to sell the residential properties it develops and to either lease the commercial properties or sell them for a favorable return.

AFI Development is a leading force in urban regeneration, breathing new life into city squares and neighborhoods and transforming congested and underdeveloped areas into thriving new communities. The Company's long-term, large-scale regeneration and city infrastructure projects establish the necessary groundwork for the successful launch of commercial and residential properties, providing a strong base for future.

Forward-looking Statements

This document and the documents following may contain certain "forward-looking statements" with respect to the Company's financial condition, results of operations and business, and certain of the Company's plans and objectives with respect to these items.

Forward-looking statements are sometimes, but not always, identified by their use of a date in the future or such words as "anticipates", "aims", "due", "could", "may", "should", "expects", "believes", "intends", "plans", "targets", "goal" or "estimates." By their very nature forward-looking statements are inherently unpredictable, speculative and involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future.

There are a number of factors that could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements. These factors include, but are not limited to, changes in the economies and markets in which the Company operates; changes in the regulatory and competition frameworks in which the Company operates; changes in the markets from which the Company raises finance; the impact of legal or other proceedings against or which affect the Company; and changes in interest and exchange rates.

Any written or verbal forward-looking statements, made in this document or made subsequently, which are attributable to the Company or persons acting on their behalf are expressly qualified in their entirety by the factors referred to above. The Company does not intend to update any forward-looking statements.

Chairman and Executive Director's Joint Statement

2010 was a year of significant achievements for AFI Development. Against the background of an improving real estate sector in Russia, we demonstrated our position as one of the strongest operators in the Russian property development sector through our ability to complete and progress projects across the breadth of our portfolio. In addition to bringing projects to completion, including our major AFIMALL City development, and advancing other developments to their final stages, we continued residential sales and opened a four star hotel.

After two difficult years when Moscow property markets felt the impact of the global financial crisis, the market recovery gathered pace in 2010. The recovery of the Russian economy has directly influenced the Moscow property market as rental levels have started to rise again, increasing by up to 15% for retail properties in 2010. The vacancy rate for Moscow shopping centres averaged 7% through 2010. The office segment slowed considerably during the crisis, but we now see high demand for quality Class A space and office rental levels have also returned to growth. Base rates in Moscow continue to be among the highest in Europe. At the same time, we have observed increased interest in Moscow among domestic and international real estate investors.

As our progress in 2010 and strong market position demonstrate, only developers with high quality projects in good locations and good relationships with lenders have been able to come through the last few years able to advance their developments effectively.

The success of our projects has been reflected in our financial performance. The Company returned to profitability in 2010 and maintained a strong cash position with approximately US$130 million at year-end. Reflecting the recovery in the real estate sector, during 2010, Net Asset Value grew by 1.4% and total revenues by 19% to US$75 million.

Our projects are strongly positioned within the Moscow market, as quality developments in well-chosen locations and thus benefit from the high levels of demand for such properties, which remain in short supply. On this basis, we are implementing our long-term strategy, focused on Moscow and differentiating between completed developments to hold and to sell. We intend to retain our high quality commercial properties, growing our commercial portfolio and generating cash flow, while we will sell our residential developments.

In 2010, we completed work on AFIMALL City, a major new retail centre in Moscow, which is one of the largest new retail developments in Europe to open in 2011, with a total Gross Building Area (GBA) of nearly 180,000 sqm and Gross Leasable Area (GLA) of nearly 107,000 sqm, containing nearly 400 stores and a range of entertainment facilities. Approximately 75% of the retail shops in the Mall have been let and tenants are currently progressing with fit outs. AFIMALL City has an outstanding tenant mix, with a wide range of high quality brands. Key tenants at AFIMALL City include Formula Kino Cinema, Marks & Spencer, H&M, L&G Department Store, UNIQLO, Snezhnaya Koroleva, Zara, Green Perekrestok Supermarket, Holding Centre, GAP, New Yorker, Sportmaster, as well as X5, Russia's largest retail company, and Eldorado Electronics, the country's leading consumer electronics retailing group. For a number of the international brands, including Banana Republic and American Eagle, their AFIMALL City outlets will represent their first stores in Russia, whilst certain retailers, such as Eldorado Electronics, have chosen the Mall as their flagship location. The range of high quality brands and the rental levels demonstrate that our tenants believe in the future of the Mall and recognise it as an essential location for any retailer active in the Moscow market.

AFI Development is well placed among Russian developers, with its ability to realise major projects in the heart of Moscow. In 2010, we obtained a Premium Listing for the Company on the London Stock Exchange, becoming the only company focused on Russian real estate development to have such a listing.

As part of our commitment to strengthen our corporate governance, we have appointed further two independent directors, Michael Sarris and Panayiotis Demetriou. Michael and Panayiotis bring to the Board high-level experience from their backgrounds at the World Bank and the European Parliament, respectively.

These appointments increase the number of independent directors on the Company's Board to five and in consequence the majority of the members of the Board of Directors are independent non-executive directors. On behalf of the Board, we welcome their appointments and also wish to record the thanks of the Board to Nadav Grinshpon and Avraham Barzilay, who resigned as directors in 2010, having made a significant contribution to the growth of the Company in recent years.

Following the debt restructuring performed by our parent company, Africa-Israel Investments Ltd. and its bondholders, the free float of the Company has increased to approximately 36%, which is expected to benefit all our shareholders through the potential increased liquidity in our stock.

AFI Development retains the financial strength and flexibility to adapt to market conditions as they evolve. Its leverage remains relatively low, with a debt to equity ratio of 25%. All of its current projects are fully-funded to completion through secured credit facilities from a diverse range of Russian and international banks, while it retains strong liquidity with cash holdings of approximately US$130 million. Our ability to secure credit financing even in recent uncertain conditions is testimony to the degree of trust AFI Development has built up within the banking sector.

Strategic Update

Management's priority is to generate a return for shareholders through the development of Moscow real estate projects. In 2010, we continued to focus on developing our fully-funded core projects including AFIMALL City, Ozerkovskaya Embankment (Phase III), Paveletskaya Office Complex and Kalinina Hotel.

Our success at bringing projects to completion in 2010 means that we have been able to realise value through sales, especially of residential properties. Sales of residential property continued, with 7 apartments sold at the Four Winds and 18 at the Ozerkovskaya Embankment Phase 2 developments.

Our expectation in the medium-term is that the Moscow real estate market will continue to offer the highest development potential due to its size, position as the largest financial centre in Russia and one of the largest capital centres in Europe, and high volume of business activity. As such, we plan to maintain our development focus on this market until market conditions improve further. At the same time, we will continue to review our land bank outside of Moscow and reactivate select projects based on availability of financing and strength of demand.

Valuation

As at 31 December 2010, Jones Lang LaSalle LLC ("JLL"), our independent appraisers, valued our portfolio of yielding properties at US$161.65 million, our portfolio of commercial and residential projects under development at US$1,605.20 million, our portfolio of residential properties at US$58.10 million, our hotel portfolio at $US97.90 million and our land bank portfolio at US$385.85.

Consequently, the total value of our [investment] portfolio, as valued by JLL, as at 31 December 2010, is US$2.31 billion. This figure represents a 20% increase in the value of our portfolio since the last valuation by JLL as at 31 December 2009 and 31 May 2010.

Major drivers of the reevaluation were positive progress achieved on our major project AFIMALL City, which was fully constructed by the end of 2010 and preleased by 75%, on Ozerkovskaya and Paveletskaya projects as well as increased prices for our residential space for sale left at 4 Winds and Ozerkovskaya II. Improving market conditions that we observed in Russia in 2010 also had a positive influence on our appraisers' views of rent levels and property yields in Moscow. The aforementioned increase of the total value of our portfolio takes into account the write-off of the Kuntsevo project, along with several additional smaller projects.

For additional information, please refer to the "Valuation" section in the MD&A.

Liquidity

We completed 2010 with a strong liquidity position comprising approximately US$130 million cash and cash equivalents on our balance sheet as at 31 December 2010 and low debt to equity level of 25%. This is due to the Company's ability to balance liquidity from a number of sources, including cash proceeds from the IPO and sales of completed projects, as well as bank loans with an outstanding balance of approximately US$453 million (at the exchange rate as at 31 December 2010).

Our financing strategy is to maximize the amount of debt financing for projects under construction while maintaining healthy loan-to-value levels. After delivery and commissioning, we refinance the properties at more favourable terms, including longer amortization periods, lower interest rates and higher principal balloon payments. In general, collateral for the debt are property rights and shares of property holding companies.

For additional information, please refer to the "Liquidity" section in the MD&A.

Portfolio Update

Current projects

AFIMALL City

Our major accomplishment in 2010 was the completion of construction of the AFIMALL City. With a total GBA of nearly 180,000 sqm, and GLA of nearly 107,000 sqm, occupied by a shopping gallery of nearly 400 shops and a 11-screen movie theatre and with a number of additional outstanding leisure facilities, AFIMALL City is one of Europe's largest and most ambitious retail developments in recent years. The Mall introduces a new standard of quality to the Russian retailing sector and will offer visitors a combined shopping, food and entertainment experience unmatched by any one location in Moscow.

The shopping and entertainment centre is strategically located at the heart of the Moscow City development project, the Russian capital's newest business district, which is the first of its kind in Russia and a unique project comprising innovative architectural approaches and multi-functional infrastructure. Moscow City forms part of an evolving upscale district, with a concentration of consumer spending power.

As well as being a one-stop shopping destination for Muscovites, AFIMALL City is expected to attract customers from the City's Central, South Western, Western, North Western and Northern administrative districts.

On March 25 2011, the Company announced that it had reached a non-binding understanding with the Moscow City administration regarding the purchase from the City of Moscow of its 25% share in AFIMALL City and 2,700 parking lots adjacent to AFIMALL City, for a total consideration of approximately US$ 310 million.

Ozerkovskaya Embankment

Ozerkovskaya Embankment Phase 3 is a high quality canal-side development in the centre of the city. Occupying a total area of nearly 79,000 sqm, it consists of 4 class A office buildings.

The Aquamarine Hotel officially opened on Ozerkovskaya Embankment in 2010. As a four star hotel in a key location, it has seen occupancy levels of up to 70% for its 159 rooms and is positioned in the upper mid-scale segment, the fastest growing sector of the Moscow hotel market.

The Ozerkovskaya Embankment Phase 3 project is advancing on track and is expected to be completed this year on schedule. During 2010, the Company secured financing for the final stages of the project in the form of a loan from Sberbank of US$74 million. Consequently, negotiations with potential tenants are now intensively underway.

Tverskaya Zastava Shopping Centre

Tverskaya Zastava Shopping Centre is located in the very centre of Moscow and forms part of the reconstruction of Tverskaya Zastava Square, a complex multi-phase project of AFI Development.

The Shopping Centre is designed include a retail gallery, which will cater to a wide range of consumers, and up to 1,000 parking lots. In addition to the main entrance, there will be direct access to the Mall from metro stations, the train terminal and pedestrian underground passes currently being constructed.

During 2010, construction of the Tverskaya Zastava Shopping Centre continued with focus on external walls and relocation of utility lines along with the City's general contractor.

On March 25, 2011, the Company announced that it has reached a non-binding understanding with the Moscow City administration to transfer its development rights in theTverskaya Zastava Shopping Centre to the City of Moscow in exchange for being fully compensated for its development costs incurred in the project to date. Such compensation may take the form of the City of Moscow granting additional building rights for the Company's other projects. The City of Moscow intends to convert the retail space into an underground parkingfacility at its own expense.

As part of the non-binding understanding reached with the City of Moscow, it is intended that AFI Development will remain the owner of the projects surrounding Tverskaya, equating to nearly 350,000 of commercial and residential space. It is also intended that such projects will retain their key development criteria and it is the Company's understanding that the current planning documentation will remain in place.

Paveletskaya Business Park

Construction at the Paveletskaya Business Park is now completed. The Business Park is expected to shortly open for business. It is located in a fast-growing commercial district in South-Central Moscow.

On March 22, 2011, AFI Development announced having leased the Paveletskaya office complex to a single tenant ZAO GREENATOM, a subsidiary of the State Atomic Energy Corporation ROSATOM. An 11-month lease agreement was signed with ZAO GREENATOM, which will roll over a 3-year period once the ownership certificate has been obtained, expected before year end. The lease will yield annualized revenue of US$4.7 million, excluding VAT.

Kalinina Hotel

Inspired by the success of Plaza Spa in Kislovodsk, the Company started the development of another similar project in the Russia's southern region in the city of Zheleznovodsk. The project envisages a renovation of an existing building to a 3-star hotel with sanatorium facilities. The hotel is envisaged to occupy a site of approximately 0.1 hectares and will include 175 guest rooms, of which 14% are expected to be suites. A spa area will occupy approximately c. 1,100 sqm, which will include 45 treatment rooms, two saunas, a jacuzzi, an indoor swimming pool and extensive medical and diagnostic facilities.

In 2010, AFI Development completed a tender for and appointed the project's general contractor and approved the full development budget of US$ 20 million. Full financing for the project was secured through a Russian rouble loan from Sberbank.

Completed projects

Kossinskaya

In August 2009, this completed project was sold to a third party for US$ 195 million, with the Company receiving approximately US$70 million by 31 December 2009. During 2010, the buyer served AFI Development a warrant for indictment, submitted in the District Court of Nicosia, Cyprus, whereby the buyer has demanded, inter alia, repayment of approximately US$25 million and approximately US$47 million out of the purchase price, reimbursement in the amount of approximately US$17 million for damages and additional reimbursement of US$2.5 million per each month of delay in the aforementioned payments. As of the date of this statement, the buyer has not yet submitted any supporting allegations or documentation in relation to these claims. AFI Development intends to serve its response within the time frames set forth under the applicable law. According to the legal advisors of the Company, the chances of defending the claim are more than 50%. Nonetheless, AFI Development is currently negotiating with the buyer regarding possible settlement options.

Land bank

In addition to yielding assets and projects under development, AFI Development has an extensive land bank, or projects that the Company is currently not developing.

Whilst retaining full flexibility regarding future development of these projects, the Company remains well placed to benefit from further recovery in the regional real estate markets. Given its strong track record in bringing projects to completion, this represents a significant competitive advantage for AFI Development.

The Company's strategy with respect to its land bank is to activate projects upon securing necessary financing and gaining full confidence in the levels of demand from prospective tenants or buyers.

For detailed information on our portfolio updates, please refer to the "Key Portfolio Updates" and "Results of Operations" section in the MD&A.

Market Update

In the commercial real estate sector, 2010 represented a turning point in the market, across all segments, including hotels and warehouses. Investor interest is strongly focused on Moscow, our core market, which represents 94% of current Russian real estate investment. With the total volume of investment transactions standing at US$3.5 billion, Moscow is the third largest real estate market in Europe, after London and Paris. The large majority of these transactions (more than 85%) took place within the office sector.

However, the majority of international investors remained cautious in 2010 and, as a result, FDI rates remained well below those seen in 2008. Nevertheless, the return of foreign capital to the market is expected in 2011, driven by rising rental rates, shrinking vacancies and increasing availability of quality premises for sale.

Throughout 2010, as activity grew, the estimated average capitalisation rates fell from 13% across the sector at the beginning of the year to 9% for offices, 10% for retail and 10.5% for the warehouse and industrial segment. This trend is expected to continue in 2011. Given its position as the country's financial and commercial centre, Moscow in particular is expected to benefit from the overall improvement in market conditions going forward, with higher growth in all real estate segments expected compared to other parts of the country.

The fundamentals of supply and demand in the Moscow real estate market are expected to continue driving its long-term expansion. Economic growth is creating demand for quality space that is currently lacking and supply is not yet coming forward in order to rebalance the market in the coming years. If recent positive economic trends are sustained, demand will expand at an even faster rate, leading to further upward pressure on values.

Source: Rosstat preliminary estimates, EIU and JLL

Retail Real Estate

During 2010, the retail market in Moscow stabilised with increased activity returning to the market during the second half of the year. Total shopping centre completions for 2010 were equivalent to 391,000 sqm.

Prime rents in Moscow remained among the highest in Europe with a 5% increase registered over the course of the year. Following constant levels during the financial crisis, rental rates in the most successful shopping centres in Moscow started to increase again. Prime base rates are now the most expensive in Europe, standing at US$4,000 per sqm per year (around 10% higher than London) and are expected to increase by up to 7% in 2011. Average rents in high-quality shopping centres are estimated at US$1,200 per sqm per year.

Russian consumer spending has been sustained at high levels relative to total income for several years, even through the crisis period, and is expected to increase in real terms as the middle class grows. The catch-up of Russian living standards to those in Western Europe creates demand across all retail segments and increasingly for durable goods and other "big ticket" items, where Russian households are relatively under-equipped.

Consequently, Moscow retail spending is growing faster than the increase in GDP for the economy and growing faster than retail spending in the rest of the economy. Despite the significant growth of recent years, the supply of retail space in Moscow remains modest relative to the size of the city. Vacancy rates at Moscow's shopping centres averaged around 7% at the end of 2010 and are expected to decline further in 2011 as a result of improving retailer demand and lack of new projects coming to the market. The global crisis created difficulties for many developers operating in the market, meaning that they lack the financing to complete or initiate retail projects, further constraining supply, while demand is bolstered by new international retailers looking to enter the market.

In 2011, based on the macroeconomic forecasts, this segment should see continued stable market conditions with no deterioration in consumer demand.

Source: Moscow Retail Market Q4 2010, Jones Lang LaSalle. Marketbeat: An overview of the Russian property market: Q4 2010, Cushman &Wakefield

Office Real Estate

2010 saw a recovery in the office market which registered the highest number of all investment transactions in the market. With the return of business confidence, average rental rates saw a positive trend whilst vacancy rates decreased further and the practice of pre-leasing returned. A significant change took place in the character in the market, as office tenants once more upgraded their quality requirements. Whereas in 2009, at the lowest point of the crisis, tenants were seeking low-cost above all other considerations, 2010 saw the revival of demand for quality space, from both Russian and international companies. Larger companies, in particular, have been seeking premises and this has been reflected in the shortage of large space (i.e. above 10,000 sqm).

Total Class A office completions in 2010 represented 295,630 sqm, while vacancy rates for Moscow stood at 15.2%. Nevertheless, the effective vacancy rate for the highest quality space in Central Moscow is very low at an estimated level of 5% and take-up rates for all Class A and B space in 2010 were very high. A total of 1,463,530 sqm of modern office space was taken up in 2010, the second largest amount in Europe, after Paris. This level of take-up was an increase of 82% over 2009 and approached the pre-crisis record volume of over 1,400,000 sqm in 2007. Despite recent dynamic growth, however, the overall stock level remains relatively moderate compared to other major European cities. Taking Class A and B space together, on a per capita basis, the supply of modern office stock in Moscow is one of the lowest in Europe, behind not only Western European capitals, but also Warsaw, Prague and Budapest. The level of prime base rents is thus one of the highest in Europe, at US$ 900 per sqm per year, only exceeded by Paris and London, increasing by 29% in 2010.

As the positive economic growth continues to drive demand for quality office space, the supply of which is not expected to increase in the short-term due to a continued lack of financing, rent levels are expected to rise further over the course of 2011. The total volume of new modern office space created by project completions in 2010 was 45% lower than the volume of completions in 2009, as new projects failed to start or conclude, constrained by more difficult financial conditions.

Source: Moscow Office Market Q4 2010, Jones Lang LaSalle. Marketbeat: An overview of the Russian property market: Q4 2010, Cushman & Wakefield

Residential Real Estate

Residential real estate remains in high demand which is reflected in the return of elite residential segment volumes to pre-crisis levels (430 apartments per annum) and prices to 25% below pre-crisis levels.

At the same time, business class volumes in 2010 were 18% higher than in 2009 and prices in U.S. dollar terms were up by 8% year-on-year.

Residential real estate has recovered strongly as consumer confidence returns and mortgage finance becomes more easily available. As in other property sectors, the financial crisis reduced the financing available to developers and the effects of this are now apparent in the reduced supply of new residential projects. Although new residential building grew rapidly in the pre-crisis period, Russia's average living space remains 20-30% below the European average and requires significant refurbishment. An estimated additional 2 billion sqm of housing stock is required to meet the population's needs.

With limited supply of high- and mid-end properties, low per capital footage and favourable macroeconomic conditions, a positive price trend is expected in 2011.

Source: Moscow Residential Market H2 2010, Miel. Moscow Residential Real Estate Overview, Q4 2010: IntermarkSavills

Outlook

We expect continued positive market trends throughout 2011 with Moscow, in particular, expected to benefit from further improvement in market conditions, resulting in higher growth in all real estate segments compared to other parts of Russia.

In this context, we plan to capitalise on opportunities created by increased demand in the market and a limited pipeline of supply of quality developments, through continued focus on our projects under development in Moscow. At the same time, we will continue to review our land bank outside of Moscow and reactivate selected projects based on availability of financing and strength of demand.

Board

The Directors of AFI Development as at the date of this announcement are as set out below:

Mr. Lev Leviev, Chairman of the Board

Mr. Alexander Khaldey, Executive Director

Mr. Izzy Cohen, Non-Executive Director

Mr. Christakis Klerides, Independent Director; Head of the Audit Committee

Mr. Moshe Amit, Independent Director; Head of Remuneration Committee

Mr. John Porter, Independent Director

Mr. Michael Sarris, Independent Director

Mr. Panayiotis Demetriou, Independent Director

29 March 2011

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Overview

As at 31 December 2010, we had a portfolio of 4 yielding properties, 9 active investment projects under development, 2 completed residential projects, 2 residential projects under development, 8 land bank projects and 5 hotel projects at various stages of development in Russia and Ukraine. These comprise commercial projects focused on offices, shopping centres, hotels and mixed-use properties, residential projects in prime locations in Moscow focused on upscale apartment buildings and residential districts in the Moscow Region aimed at the upper middle class segment of the market. As at 31 December 2010, JLL valued our beneficial interest in the projects in our current portfolio in their existing state of development, at approximately US$2.31 billion.

In 2010, we had a profit of US$25.88 million, in comparison to a loss of US$2.66 million in 2009. Our profit derived primarily from the revaluation of our investment portfolio by JLL. In 2010, we recognised a US$93.92 million gain from revaluation of our completed projects as opposed to a loss of US$38.92 million in 2009. At the same time, our revenue from rental activity increased from US$36.15 million in 2009 to US$43.95 million in 2010. We also realised profits from sales of residential premises at Four Winds and Ozerkovskaya Embankment Phase II projects for a total amount of US$30.17 million as well as income from construction consulting and management services income of US$0.88 million.

Key Factors Affecting our Financial Results

Our results have been affected, and are expected to be affected in the future, by a variety of factors, including, but not limited to, the following:

Macroeconomic Factors

Our properties and projects are mainly located in Russia. As a result, Russian macroeconomic trends and country-specific risks significantly influence our performance.

The following table sets out certain macroeconomic information for Russia as of and for the dates indicated:

Source: International Monetary Fund

Company Specific Factors

The following factors affected our performance in 2010:

·; The Company completed AFIMALL City with approximately 75% of the retail shops in the Mall let to a wide mix of tenants.

·; The Company obtained a Premium Listing on the London Stock Exchange with its 'B' shares commencing trading on 5 July 2010 under the ticker AFRB.

·; Aquamarine Hotel on Ozerkovskaya Embankment, which was opened at the end of 2009, started its operation at the beginning of 2010 and achieved high levels of occupancy by year end.

·; Paveletskaya I office complex was completed with significant progress on preleasing.

·; Significant progress on development at the fully-financed Ozerkovskaya Embankment Phase 3 project was achieved which remains on track for completion in 2011.

·; Commencement of development of the Kalinina Hotel in Zheleznovodsk.

Key Portfolio Updates

The Company had the following updates at its portfolio:

Current projects

AFIMALL City

The Company completed AFIMALL City with approximately 75% of the retail shops in the Mall let to a wide mix of tenants.

Ozerkovskaya Embankment

The Aquamarine Hotel officially opened on Ozerkovskaya Embankment in 2010. As a four star hotel in a central location, it has seen occupancy levels of up to 70% for its 159 rooms and is positioned in the upper mid-scale segment, the fastest growing sector of the Moscow hotel market.

The Ozerkovskaya Embankment Phase 3 project[1] is advancing as planned and is expected to be completed this year on schedule. During 2010, the Company secured financing for the final stages of the project in the form of a loan from Sberbank of US$74 million. Consequently, negotiations with potential tenants are now intensively underway.[2]

Tverskaya Zastava Shopping Centre[3]

During 2010, construction of the Tverskaya Zastava Shopping Centre continued with focus on external walls and relocation of utility lines.[4] 

Paveletskaya Business Park

Construction at the Paveletskaya Business Park continued to progress during 2010.

On March 22, 2011, AFI Development announced having leased the Paveletskaya office complex to a single tenant ZAO GREENATOM, a subsidiary of the State Atomic Energy Corporation, ROSATOM. An 11-month lease agreement was signed with ZAO GREENATOM, which will roll over a 3-year period once the ownership certificate has been obtained, which is expected before the end of 2011. The lease will yield annualized revenue of US$4.7 million, excluding VAT.

Kalinina Hotel

In 2010, the Company started the development of the Kalinina hotel project in the Russia's southern region in the city of Zheleznovodsk.

In 2010, AFI Development completed a tender for and appointed the project's general contractor and approved the full development budget of US$ 20 million. Full financing for the project was secured through a Russian rouble loan from Sberbank.

Kossinskaya

In August 2009, this completed project was sold to a third party for US$ 195 million, with the Company receiving approximately US$70 million by 31 December 2009. During 2010, the buyer served AFI Development a warrant for indictment, submitted in the District Court of Nicosia, Cyprus, whereby the buyer has demanded, inter alia, repayment of approximately US$25 million and approximately US$47 million out of the purchase price, reimbursement in the amount of approximately US$17 million for damages and additional reimbursement of US$2.5 million per each month of delay in the aforementioned payments. As of the date of this statement, the buyer has not yet submitted any supporting allegations or documentation in relation to these claims. AFI Development intends to serve its response within the time frames set forth under the applicable law. According to the legal advisors of the Company the chances of defending the claim are more than 50%. Nonetheless, AFI Development is currently negotiating with the buyer regarding possible settlement options.

Land bank

Due to risks of not being able to obtain and renew a full set of project documentation for the Kuntsevo project and therefore eliminate uncertainty over the project start date, the Company made a decision to write down the values of Kuntsevo to zero[5]. Due to uncertainty in demand levels and therefore absence of economic rationale to start the developments, the Company decided to also write-off the values of Volgograd, Zaporozhie and Old Lake projects.

Key Events Subsequent to 31 December 2010

Following the year-end, the following key events occurred:

·; Following receipt of the requisite regulatory approvals for the operation of the Mall on 4 March 2011, the Company issued a notice to operators of the rented retail units in the Mall requiring them to conclude all fit-out works and prepare for the opening of their shops by March 10, 2011, when AFIMALL City opened to the public.

·; On 26 January 2011, AFI Development's major shareholder, Africa Israel Investments, agreed to purchase approximately 9.7% of the aggregate equity and voting rights in AFI Development from a company wholly-owned by Mr. Alexander Khaldey, the Executive Director of AFI Development. Total consideration is approximately US$ 129 million or approximately US$ 1.27 per each share or GDR of AFI Development. Alexander Khaldey will continue to serve as the Executive Director on the Board of AFI Development and Chairman of OOO AFI Rus and of ZAO Stroyinkom-K.

·; On 4 March 2011, the Board of AFI Development accepted the resignation of Evgeny Luneev as Chief Financial Officer, who decided to leave the Company in order to pursue other business opportunities. Mr. Luneev will act as the CFO until 29 March 2011. His successor will be announced in due course.

·; On 23 March 2011, AFI Development leased the Paveletskaya office complex to a single tenant ZAO GREENATOM, a subsidiary of the State Atomic Energy Corporation, ROSATOM. An 11-month lease agreement was signed with ZAO GREENATOM, which will roll over a 3-year period once the ownership certificate has been obtained, expected before year end. The lease will yield annualized revenue of US$4.7 million, excluding VAT.

·; On 25 March 2011, the Company announced that it had reached a non-binding understanding with the Moscow City administration regarding the purchase from the City of Moscow of its 25% share in AFIMALL City and 2,700 parking lots adjacent to AFIMALL City, for a total consideration of approximately US$ 310 million.

·; On 25 March 2011, the Company announced that it has reached a non-binding understanding with the Moscow City administration to transfer its development rights in the Tverskaya Zastava Shopping Centre to the City of Moscow in exchange for being fully compensated for its development costs incurred in the project to date. Such compensation may take the form of the City of Moscow granting additional building rights for the Company's other projects. As part of the non-binding understanding reached with the City of Moscow, it is intended that AFI Development will remain the owner of the projects surrounding Tverskaya, equating to nearly 350,000 sqm of commercial and residential space. It is also intended that such projects will retain their key development criteria and it is the Company's understanding that the current planning documentation will remain in place.

Disposals and Acquisitions

There were no disposals or acquisitions made by the Company in 2010.

Presentation of Financial Information

Our consolidated financial statements were prepared in accordance with International Financial Reporting Standards ("IFRS"), as adopted by the European Union ("EU"), which were in effect at the time of preparing our consolidated financial statements. IFRS differs in various material respects from US GAAP and UK GAAP.

Financial policies and practices

Revenue Recognition

The key elements of our revenue recognition policies are as follows:

·; Rental income. We recognise rental income from investment properties leased out under operating leases in our income statement on a straight line basis over the term of the lease.

·; Construction consulting and construction management fees. We recognise revenues from construction consulting and construction management services in our income statement, in proportion to the stage of the project as at the relevant reporting date. We assess the stage of completion by reference to the amount of work performed.

·; Sales of trading properties. We recognise revenue from the sale of trading properties in our income statement when the risks and rewards of ownership of the property are transferred to the buyer. When we receive down payments in connection with the sale of trading property that is under construction, we record this figure in the current liabilities on our balance sheet at the time of sale.

Operating expenses

Operating expenses consist mainly of employee wages, social benefits and property operating expenses, which are directly attributable to revenues. As substantially all of our activities to date have involved real estate development projects that are still in the pre-construction or construction phase, we have historically capitalized the great majority of our overall costs. We recognise as expenses in our income statement the costs of those employees who have provided construction consulting and construction management services to third parties or, with respect to a portion of such costs, to our 50-50 joint ventures. We also recognise property operating costs (including outsourced building maintenance), utilities, security and other tenant services related to our properties that generate rental income, as expenses on our income statement.

Administrative expenses

Our administrative expenses comprise primarily of general and administrative expenses such as office rental costs, audit, marketing costs, travelling and entertainment, office equipment as well as depreciation expenses related to our office use motor vehicles.

Profit on disposal of investment in subsidiaries

We recognise profit or loss from the sale of interests in our subsidiaries when the risks and rewards of ownership are transferred to the buyer in the transaction.

Revaluation of investment property

An external, independent valuation company, having appropriate recognised professional qualifications and recent experience in the location and categories of properties being valued, values the Company's investment property portfolio every six months. The fair values are based on market values, being the estimated amount for which a property could be exchanged on the date of the valuation in a transaction between a willing buyer and a willing seller after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion. The difference between revalued fair value of investment property and its book value is recognised as revenue in the income statement.

Operating profit before net finance costs

Operating profit before net finance costs is calculated by adding revenue, other income, profit on disposal of investment in subsidiaries and valuation gains on investment property, and subtracting operating expenses, administrative expenses and other expenses.

Finance income

Our finance income comprises net foreign exchange gain, if any, and interest income. We recognise foreign exchange gains and losses, principally in connection with US Dollar denominated payables and receivables of our Russian subsidiaries, whose functional currency is the Rouble. Our interest income is derived primarily from interest on our bank deposits which primarily include proceeds from our May 2007 IPO and interest on loans to our joint ventures, including Westec and Krown Investments.

Finance expenses

Our finance expense comprises net foreign exchange loss, if any, and interest expense on outstanding loans less interest capitalised. We recognise foreign exchange gains and losses principally in connection with US Dollar denominated payables and receivables of our Russian subsidiaries, whose functional currency is the Rouble. We capitalise our interest expense with respect to our development projects that are under construction, for which amounts are not reflected as expenses in our income statement. When funds are borrowed specifically for a particular project, we capitalize all actual borrowing costs related to the project less income earned on the temporary investment of such borrowings and when funding for a project is obtained from our general funds, we capitalise only funding costs related to the particular project based on the weighted average of the borrowing costs applicable to our general funds.

Income tax expense

Income taxes are calculated based on tax legislation applicable to the country of residence of each of our subsidiaries and, as a company based and organised in Cyprus, we are subject to income tax in Cyprus. We and our Cypriot subsidiaries are currently subject to a statutory corporate income tax rate of 10% in Cyprus. Our Russian subsidiaries were subject to corporate income tax at a rate of 20%. Profits on revaluation gains of investment property in companies based in Russia, from which we have derived the vast majority of our profits to date, are subject to deferred income tax at a rate of 20%.

Capitalisation of Costs for Properties under Development 

We capitalise all costs directly related to the purchase and construction of properties being developed as both investment properties and trading properties, including costs to acquire land rights and premises, design costs, permit costs, costs of general contractors, costs relating to the lease of the underlying land and the majority of our employee costs related to such projects.

In addition, we capitalise financing costs related to development projects only during the period of construction of the projects. We do not, however, commence the capitalising of financing costs related to expenditures on a project until construction on each project begins. As the majority of our development projects are still in the pre-construction or construction phases, to date we have capitalised the great majority of the overall costs related to our business activities. In our consolidated financial statements, we capitalised expenses related to the development of our investment and trading properties in aggregate amounts of US$200.16 million and US$160.01 million in the years ended 2009 and 2010, respectively. Since the Company's adoption of IAS 40 from 1 January 2009, upon completion of construction works, property classified as investment property under development (which are those properties that are being constructed or developed for future use to earn rental income or for capital appreciation) is appraised to market value and reclassified as an investment property and any gain or loss on appraisal is recognised in our income statement. Trading properties, which include those projects where we intend to sell the entire project as a whole or in part (this principally includes our residential development projects), are represented on our balance sheet at the lower of cost and net realizable value, which is the estimated selling price in the ordinary course of business, less the estimated costs of completion and sale.

Exchange Rates

Our consolidated financial statements are presented in US Dollars, which is our functional currency. The functional currency of our Russian subsidiaries and joint ventures is the Rouble. The balance sheets of our Russian subsidiaries are translated into US Dollars in accordance with IAS 21, whereby assets and liabilities are translated into US Dollars at the rate of exchange prevailing at the balance sheet date and income and expense items are translated into US Dollars at the average exchange rate for the period. All resulting foreign currency exchange rate differences are recognised directly in our shareholders' equity under the line item "translation reserve." When a foreign operation is sold, the cumulative amount of the exchange differences deferred in the separate component of equity relating to that foreign operation is recognised in our income statement when the gain or loss on disposal of the foreign operation is recognised. The monetary assets and liabilities of our Russian subsidiaries that are denominated in currencies other than Roubles are initially recorded by our subsidiaries at the exchange rate between the Rouble and such foreign currency prevailing at such date. Such monetary assets and liabilities are then retranslated into Roubles at the exchange rate prevailing at each subsequent balance sheet date. We recognise the resulting exchange rate differences between the dates at which such assets or liabilities were originally recorded and at subsequent balance sheet dates as foreign exchange losses and gains in our income statement. In particular, during the period under review, we have recognised foreign exchange rate gains and losses in connection with US Dollar denominated payables and receivables of our Russian subsidiaries. As most of our projects are still in the preyield stage, our Russian subsidiaries have historically had higher levels of US Dollar denominated payables, including interest on loans and general contractor fees, than US Dollar denominated receivables, such as rental payments, with the result that we have historically recorded foreign exchange gains when the Rouble appreciates against the US Dollar, thus reducing the US Dollar denominated liabilities of our Russian subsidiaries when translated into Roubles and foreign exchange losses when the US Dollar appreciates against the Rouble.

Recovery of VAT

We pay VAT to the Russian authorities with respect to construction costs and expenses incurred in connection with our projects, which, according to Russian tax law, can be recovered upon completion of construction. We have accordingly included recoverable VAT as an asset on our balance sheet, the size of which we expect will increase as the development of our projects advances.

Deferred Taxation

As we continue to advance the development of our projects, we also expect to record higher deferred tax liabilities and assets. Under Russian tax law, we are not allowed to capitalise certain of the costs in relation to the design, construction and financing of projects that we capitalise for the purposes of our consolidated financial statements under IFRS. As a result, our tax bases in the related assets may be lower than our accounting bases for IFRS purposes, which would result in deferred tax liabilities. However, the recognition of such costs as expenses may result in accumulated tax losses for Russian tax purposes that we may be able to carry forward against estimated future profits, resulting in deferred tax assets. We expect these deferred tax liabilities and assets to grow as our major projects reach more advanced stages. However, such tax losses may only be carried forward to offset gains for a ten-year period under Russian tax law and they may only be utilised in the Russian subsidiary in which such tax losses were generated.

Fair Value Calculation

Our future results of operations may be affected by our measurement of the fair value of our investment properties and changes in the fair value of such properties. Upon completion of construction, the projects that we have classified as investment property under development are reassessed at fair value and reclassified asinvestment property, and any gain or loss as a result of reassessment is recognised in our income statement.

Any change in fair value of the investment property under development is thereafter recognised as a gain or loss in the income statement. Accordingly, fair value measurements of investment properties under development may significantly affect results of operations even if the Company does not dispose of such assets. Specifically, in May 2008 the International Accounting Standards Board issued its latest standard, titled 'Improvements to International Financial Reporting Standards, 2008.' Amendments to IAS 40 'Investment property' under this standard had a significant impact on the Company's financial statements in 2009 and will continue to do so in 2010.

Results of Operations

Description of Income Statement Line Items

Summary of income statement for 2010 and 2009

Revenue - General Overview

To date, we have derived revenues from three sources: construction consulting and construction management fees, rental income and sale of residential properties. During the period under review, we derived considerable amounts of revenue from such rental income and sale of residential properties, unlike in the previous reporting period. We expect that our revenue from rental income will increase further in the future once we have completed the construction of the commercial properties we are currently developing for lease. As we no longer provide construction consulting and construction management services to third parties, other than our joint ventures, we do not expect construction consulting and construction management fees to contribute a significant amount to our revenue in the future.

Construction consulting and construction management fees

We derive construction consulting and construction management fees from project management services we provide to our joint ventures. We typically charge a fixed percentage of the total costs related to the projects for which we provide such services. We provide such services to (i) our 50% owned joint venture Westec Four Winds Ltd., ("Westec"), which owns the Four Winds project; and (ii) our 50% owned joint venture Krown Investments, which is developing the Ozerkovskaya Phase II and Phase III projects.

Rental income

We derive rental income from our core assets that we acquired or developed in the past and from non-core assets, i.e. existing real estate on land sites where we plan to develop new projects.

Sale of residential properties

Revenue. Our revenue increased by US$12.03 million or 19%, from US$62.96 million in 2009 to US$74.99 million in 2010. This increase resulted mainly from an increase in rental income due to improving rent levels and occupancies, putting in operation of the Aquamarine hotel in February 2010 and higher sale prices for our remaining apartments in 4 Winds and Ozerkovskaya II residential complexes.

Operating expenses. Our operating expenses increased by US$9.23 million, or 98%, from US$9.43 million in 2009 to US$18.66 million in 2010. This increase was primarily due to the following:

·; Higher expenses resulting from an increase in the number of revenue producing properties we operated. In 2010, Aquamarine hotel operating costs were US$4.40 million.

·; At Four Winds, new premises were opened (fitness and retail) resulting in additional US$1.51 million utility costs.

·; Following a more conservative approach to financial reporting, expenses incurred in projects where development is not actively on-going were expensed rather than capitalized. This includes costs of land leases and costs of obtaining project documentation.

Administrative expenses. Our administrative expenses increased by US$2.23 million, or 20%, from US$10.94 million in 2009 to US$13.18 million in 2010. This is due to an increase in audit costs and legal costs to support the Company's day-to-day activities.

Other expenses. Other expenses increased by US$17.19 million, or 1036%, from US$0.69

million in 2009 to US$7.88 million in 2010. This increase primarily relates to costs incurred in obtaining Premium listing on LSE of US$2.19 million, writing off non-recoverable VAT (older than 3 years) of US$3.34 million.

Net valuation gain/(losses) on investment property. Net result of investment property valuation increased by US$47.37 million, or 122%, from a gain of US$38.92 million in 2009 to a gain of US$93.92 million in 2010 mainly due to improved market conditions and capital expenditures spent on development projects during the year. In accordance with the revised IAS 40, which became effective on 1 January 2009, we disclosed investment property under development on a fair value basis.

Net finance costs. Net finance costs are finance income less finance expense. Our net finance costs decreased by US$1.30 million, or 29%, from a US$4.44 million cost in 2009 to cost of US$3.14 million in 2010.

Finance income

Our finance income increased by US$2.94 million, or 27%, from US$10.72 million in 2009 to US$13.66 million in 2010. This increase was primarily due to higher interest income received from funds held on bank deposits.

Net foreign exchange loss

We recorded a net foreign exchange loss of US$7.98 million in 2010 compared to a net foreign exchange gain of US$6.98 million in 2009. Our foreign exchange loss in 2010 was primarily due to the weakening of the Rouble against the US Dollar in 2009 which resulted in US Dollar denominated bank loans payable by our Russian subsidiaries being increased when translated into Rouble and transferring from depreciating against US Dollar Eurobonds to USD based instruments.

Finance expenses

Finance expenses increased from US$3.73 million in 2009 to US$8.83 million in 2010. The increase in finance expenses from 2009 to 2010 primarily resulted from higher interest expenses accrued (rather than capitalised) on the loan granted by MDM Bank to Westec (Four Winds office), which increased from US$2.05 million to US$6.67 million.

Current tax expense. Our current tax expense decreased in 2010 by US$2.74 million or by 6%, from US$47.2 million in 2009 to US$44.4 million in 2010. The reason for this increase is the higher levels of income generated from rental activity of income producing assets. The Cypriot rate of corporate income tax remained unchanged during 2009 and 2010 and profit on the disposal of investments in subsidiaries is not subject to income tax in Cyprus.

Profit/Loss for the year. Due to the factors described above, we recorded a US$25.88 million profit for 2010 compared to a loss of US$2.66 million for 2009.

Liquidity and Capital Resources

Cash flows

Summary of cash flows for 2010 and 2009

Net cash used in operating activities

Net cash from operating activities increased from a negative US$15.12 million in 2009 to a positive US$22.97 million in 2010. This increase was primarily attributable to an increase in profit after adding back all non-cash items in the amount of US$7.55 million, an increase in working capital changes of US$33.48 million from a negative US$14.92 million in 2009 to a positive US$18.56 million in 2010 less additional taxes paid in the amount of US$2.94 million. The increase in working capital changes was mainly due to an increase in cash receipts from the residential sales of Ozerkovskaya II residential complex. In addition, in 2009, a $23.48 million decrease in payables to the JV partner in Krown Investments was recorded as compared to a decrease of only US$5.64 million in 2010.

Net cash used in investing activities

Net cash used in operating activities increased from a negative US$81.54 million in 2009 to a negative US$148.08 million 2010. This increase was primarily attributable to advances received for the sale of the Kossinskaya project of US$70 million in 2009 whereas only US$3 million in 2010.

Net cash used in financing activities

Net cash used in financing activities decreased from US$76.52 million in 2009 to US$2.85 million in 2010. The Company borrowed US$130.82 million in 2010 as opposed to US$187.99 million in 2009. Of US$130.82 million, US$117.15 was used to finance AFIMALL City, US$10.40 million for Ozerkovskaya III project (through Krown Investments, the Company's 50% subsidiary) and US$2.50 million for the Kalinina hotel project.

Capital Resources

Capital Requirements.

We require capital to finance capital expenditures, consisting of cash outlays for capital investments in active real estate development projects; repayment of debt; changes in working capital; and general corporate activities. 

Real estate development is a capital-intensive business, and we expect to have significant ongoing liquidity and capital requirements in order to finance our active development projects.

For the foreseeable future, we expect that we will continue to rely on our financing activities to support our investing and operating activities. We also expect that our capital expenditures in connection with the development of real estate properties will comprise the majority of our cash outflows for the foreseeable future.

We completed 2010 with a strong liquidity position comprising US$129.84 million cash and cash equivalents on our balance sheet as at 31 December 2010. This is due to the Company's ability to balance liquidity from a number of sources, including cash proceeds from the IPO and sales of residential projects, as well as use project fenced debt financing to fund our projects.

Our financing strategy is to maximize the amount of debt financing for projects under construction while maintaining healthy loan-to-value levels. After delivery and commissioning, we refinance the properties at more favourable terms including longer amortization periods, lower interest rates and higher principal balloon payments.

In general, collateral for this debt are property rights and shares of property holding companies.

As of December 31, 2010 our debt portfolio was as follows:

*recoded value on the balance sheet, Borrower is Krown Invesments, in which the Company owns 50%.

Accrued Interest expenses of the total amount of loans outstanding are US$ 2.3 million. In addition, there are loans received by subsidiaries before being acquired by the Company in the amount of US$14.5 million.

For more detail, see notes 5 and 25 to our consolidated financial statements.

As at 31 December 2010, our loans and borrowings were payable as follows:

Portfolio Valuation

As at 31 December 2010, JLL, our independent appraisers, valued our portfolio of yielding properties at US$161.65 million, our portfolio of commercial and residential projects under development at US$1,605.20 million, our portfolio of residential properties at US$58.10 million, our hotel portfolio at US$97.90 million and our land bank portfolio at US$385.85.

Consequently, the total value of our [investment] portfolio, as valued by JLL, is US$2.31 billion. This figure represents a 20% increase since last valuations carried on 31 December 2009 and 31 May 2010 of US$1.92 billion.

Major drivers of the portfolio reevaluation were the following:

·; Progressed construction works in the Company's projects which are currently under development. The progress had a positive effect on the valuations through a decrease in development risks.

·; Due to improving macroeconomic conditions in Russia in general and in real estate market in particular, yield compression and rent increases are observed due to which JLL concluded higher values for many of the Company's projects.

·; In December 2010, we managed to complete AFIMALL City and achieve a rate of occupancy of 75%. Due to this progress in construction, capitalization of expenses, improvements in yields and letting, JLL appraised the property at 49% more than at 31 December 2009, at approximately US$490 million to US$732 million (in respect of the 75% of the project belonging to the Company). It should be noted that, out of the total value increase, the Company has recorded a revaluation gain of $US96.12 million.

·; Four Winds residential complex includes commercial premises. Accordingly, despite selling 7 apartments in 2010, resulting in a decrease of balance sheet value of 24%, JLL concluded a 25% increase in the overall value of the property.

·; Plaza IIa was revalued up by 86% to US$12,200,000 due to a decreased development budget and improved market conditions, resulting from removal of demolishing costs on the site, an expense now to be incurred by the municipal authorities.

·; Ozerkovskaya Phase III value has increased by 81% due to significant progress achieved in construction and improving yields for quality offices in Moscow's central business district.

·; Ukraine was treated as a single project in the last valuation and as two separate projects being Borysol and Zaporozhie in the December 31, 2010 valuation.

·; Despite positive values for Kuntsevo, Volgograd, Zaporozhie and Old Lake, the Company made a decision to write down their values to zero. For Kuntsevo, this is due to risks of not being able to obtain and renew a full set of project documentation and therefore eliminate uncertainty over the project start date.[6] 

·; For the other projects - this is due to uncertainty in demand levels given which there was no economic rationale for starting the developments.

·; Other changes in JLL valuation and balance sheet values of properties are due to different valuation dates. The last valuation was carried out for some properties as at May 31, 2010 and June 20, 2010 while the comparable balance sheet values are as at December 31, 2009.

Principal Risks and Uncertainties Affecting the Company

This section presents information about the Company's exposure to each of the risks listed below, the Group's objectives, policies and processes for measuring and managing risks.

Risk management framework

The Board of Directors has overall responsibility for the establishment and oversight of the Company's risk management framework and is responsible for developing and monitoring the Company's risk management policies.

The Company's risk management policies are established to identify and analyse the risks faced by the Company, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Company's activities. The Company, through its training and management standards and procedures, aims to develop a disciplined and constructive control environment in which all employees understand their roles and obligations.

The Company's Audit Committee overseas how management monitors compliance with the Company's risk management policies and procedures, and reviews the adequacy of the risk management framework in relation to the risks faced by the Group. The Company's Audit Committee is assisted in its oversight role by Internal Audit. Internal Audit undertakes both regular and ad hoc reviews of risk management controls and procedures, the results of which are reported to the Audit Committee.

Credit risk

Credit risk is the risk of financial loss to AFI Development if a customer or counterparty to a financial instrument fails to meet its contractual obligations and arises principally from the Company's receivables from customers and investment securities.

Trade and other receivables

Financial assets that are potentially subject to credit risk consist principally of trade and other receivables. The carrying amount of trade and other receivables represents the maximum amount exposed to credit risk. Credit risk arises from cash and cash equivalents as well as credit exposures with respect to rental customers, including outstanding receivables. The Company has policies in place to ensure that, where possible, rental contracts are made with customers with an appropriate credit history. Cash transactions are limited to high-credit-quality financial institutions. The utilisation of credit limits is regularly monitored.

AFI Development has no other significant concentrations of credit risk. Although collection of receivables could be influenced by economic factors, the management team believes that there is no significant risk of loss to the Company.

Investments

The Company limits its exposure to credit risk by investing only in liquid securities and only with counterparties that have a high credit rating. Management actively monitors credit ratings and given that the Group only has invested in securities with high credit ratings, management does not expect any existing counterparty to fail to meet its obligations, except as disclosed in note 33 to the Company's Audited Financial Statements for year 2010.

Guarantees

The Company's policy is to provide financial guarantees only to wholly-owned subsidiaries. As at 31 December 2010, there was one guarantee outstanding under the non-revolving credit line from VTB Bank for RUR 8,488 million and one under the Joint Stock Commercial Savings Bank of the Russian Federation ("Sberbank") loan for US$20 million. As at 31 December 2009, there was only one guarantee outstanding under the non-revolving credit line from VTB Bank for RUR 8,488 million.

Liquidity risk

Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. AFI Development's approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Company's reputation. Prudent liquidity risk management implies maintaining sufficient cash, the availability of funding through an adequate amount of committed credit facilities and the ability to close out market positions. Due to the dynamic nature of the underlying businesses, the Company aims to maintain flexibility in its funding requirements by keeping cash and committed credit lines available.

AFI Development's liquidity position is monitored on a daily basis by the management, which takes necessary actions if required. The Company structures its assets and liabilities in such a way that liquidity risk is minimised.

Market risk

Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates and equity prices will affect the Company's income or the value of its holdings of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimising the available returns for shareholders. We are exposed to market risks from changes in both foreign currency exchange rates and interest rates. We do not use financial instruments, such as foreign exchange forward contracts, foreign currency options and forward rate agreements, to manage these market risks. To date, we have not utilised any derivative or other financial instruments for trading purposes.

Interest rate risk

We are subject to market risk deriving from changes in interest rates, which may affect the cost of our current floating rate indebtedness and future financing. As of 31 December 2010, 80% of our indebtedness was fixed rate. For more detail see note 23 to our consolidated financial statements.

Currency risk

The Company is exposed to currency risk on future commercial transactions, recognized monetary assets and liabilities and net investments in foreign operations that are denominated in a currency other than the respective functional currencies of AFI Development's entities, primarily the US Dollar and Russian Rouble. The currency in which these transactions are primarily denominated is the Euro.

Operational risk

Operational risk is the risk of direct or indirect loss arising from a wide variety of causes associated with the Company's processes, personnel, technology and infrastructure, and from external factors other than credit, market and liquidity risks such as those arising from legal and regulatory requirements and generally accepted standards of corporate behaviour. Operational risks arise from all of the Group's operations.

The Company's objective is to manage operational risk so as to balance the need to avoid financial losses and damage to the Group's reputation with overall cost effectiveness.

The primary responsibility for the development and implementation of controls to address operational risk is assigned to senior management within each business unit. This responsibility is supported by the development of overall Company standards for the management of operational risk. Compliance with Company standards is supported by a programme of periodic reviews undertaken by way of internal audits. The results of the internal audit reviews are discussed with the management of the business unit to which they relate, with summaries submitted to the Audit Committee and senior management of the Company.

Critical Accounting Policies

Critical accounting policies are those policies that require the application of our management's most challenging, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Critical accounting policies involve judgments and uncertainties that are sufficiently sensitive to result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies are those described below.

A detailed description of certain of the main accounting policies we use in preparing our consolidated financial statements is set forth in note 3 to our consolidated financial statements.

Estimates regarding fair value

We make estimates and assumptions regarding the fair value of our investment properties that have a significant risk of causing a material adjustment to the amounts of assets and liabilities on our balance sheet. In particular, our investment properties under development (which currently comprise the majority of our projects) are re-measured at fair value upon completion of construction and the gain or loss on re-measurement is recognised in our income statement, as appropriate. In forming an opinion on fair value, we consider information from a variety of sources including, among others, the current prices in an active market, third party valuations and internal management estimates.

The principal assumptions underlying our estimates of fair value are those related to the receipt of contractual rentals, expected future market rentals, void/vacancy periods, maintenance requirements and discount rates that we deem appropriate. We regularly compare these valuations to our actual market yield data and actual transactions and those reported by the market. We determine expected future market rents on the basis of current market rents for similar properties in the same location and condition.

Impairment of financial assets

We recognise impairment losses with respect to financial assets, including loans receivable and trade and other receivables, in our income statement if objective evidence indicates that one or more events have had a negative effect on the estimated future cash flows of that asset. We test significant financial assets for impairment on an individual basis and assess our remaining financial assets collectively in groups that share similar credit characteristics. Impairment losses with respect to financial assets are calculated as the difference between the asset's carrying amount and the present value of the estimated future cash flows of the asset discounted at the original effective interest rate of that asset.

Estimating the discounted present value of the estimated future cash flows of a financial asset is inherently uncertain and requires us both to make an estimate of the expected future cash flows from the asset and also to choose a suitable discount rate in order to calculate the present value of those cash flows. Changes in one or more of these estimates can lead us to either recognizing or avoiding impairment charges.

Impairment of non-financial assets

We recognise impairment loss with respect to non-financial assets, including investment property under development and trading properties under construction, if the carrying amount of the asset exceeds its recoverable amount. The recoverable amount of an asset is the greater of its value in use and its fair value less costs to sell. In assessing value in use, we discount estimated future cash flows of the asset to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. The carrying amounts of impaired non-financial assets are reduced to their estimated recoverable amount either directly or through the use of an allowance account and we include the amount of such loss in our income statement for the period.

We assess at each reporting date whether there is any indication that a non-financial asset may be impaired. If any such indication exists, we then estimate the recoverable amount of the asset. Estimating the value in use requires us to make an estimate of the expected future cash flows from the asset and also to choose a suitable discount rate in order to calculate the present value of those cash flows. The development of the value in use amount requires us to estimate the life of the asset, its expected cash flows over that life and the appropriate discount rate, which is primarily based on our weighted average cost of capital, itself subject to additional estimates and assumptions. Changes in one or all of these assumptions can lead to us either recognizing or avoiding impairment charges.

Deferred income taxes

We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves a jurisdiction-by-jurisdiction estimation of actual current tax exposure and the assessment of the temporary differences resulting from differing treatment of items, such as capitalization of expenses, among others, for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must assess, in the course of our tax planning process, our ability and the ability of our subsidiaries to obtain the benefit of deferred tax assets based on expected future taxable profit and available tax planning strategies. If, in our management's judgment, the deferred tax assets recorded will not be recovered, a valuation allowance is recorded to reduce the deferred tax asset.

Significant management judgment is required in determining our provision for income taxes, deferred tax assets, deferred tax liabilities and valuation allowances to reflect the potential inability to fully recover deferred tax assets. In our consolidated financial statements the analysis is based on the estimates of taxable income in the jurisdictions in which we operate and the period over which the deferred tax assets and liabilities will be recoverable.

If actual results differ from these estimates, or we adjust these estimates in future periods, we may need to establish an additional valuation allowance which could adversely affect our financial position and results of operations.

Share-based payment transactions

The fair value of employee stock options is measured using a binomial lattice model. The fair value of share appreciation rights is measured using the Black-Scholes formula. Measurement inputs include share price on the measurement date, exercise price of the instrument, expected volatility (based on weighted average historic volatility adjusted for changes expected due to publicly available information), weighted average expected life of the instruments (based on historic experience and general option holder behaviour), expected dividends and the risk-free interest rate (based on government bonds). Service and non-market performance conditions attached to the transactions are not taken into account in determining fair value.

Related Party transactions

There were no related party transactions during the financial year 2010.

A. General - the projects the Group plans and constructs in CIS are mostly zoned for mixed uses and/or commercial use, while some also include residential units intended for sale. The following tables present the Group's projects including, among others, construction for residential purposes. During the fourth quarter of 2008, the Company decided to change its strategy in light of the economic situation. The Company is focusing on the construction and completion of a number of projects and it will decide on the construction of additional projects out of its inventory of projects based on the situation prevailing in the market. With respect to these projects, the Company will formulate a business plan including a forecast relating to the project budget and its completion date (and obviously relating to additional project components) when a decision to begin its construction is made. Therefore, the tables do not include any forecasts in connection with these projects.

It is noted that based on Russian law, upon completion of the construction of projects, the owner of the building (the construction of which was completed) is permitted to receive long‑term lease rights for the land on which the said building stands and that is needed for purposes of its use, generally for 49 years. In order to realize the right to the long‑term lease rights as stated, the owner of the building must submit a request to the relevant authority including the required documents, and within about one month from the submission date of the said request, the relevant authority will make a decision regarding provision of the lease rights. It is noted that under the new long‑term lease agreement to be signed between the parties, the lessee of the land (who up until now had been merely the owner of the building) to pay the City lease fees (generally on a quarterly basis)[7].

B. Set forth below are details in connection with the Company's projects in CIS, which include residential areas, the execution of which had not yet been started as at December 31, 2010:

As stated, execution of these projects has been frozen at this stage and, therefore, forecasted data has not been included in the following table, such as, estimated project cost, expected gross profit percentage, expected construction commencement year, expected duration of the construction in years and planned additional number of residential units.

It is noted that the Botanic Gardens project, detailed in the table above, is in concept stage and the Otradnoye project, also described in the table above, is at the design stage of development, that is, after receipt of certain permits relating to their construction and execution agreements have also been signed (in one of the projects, the execution agreement as stated was signed with Danya Cebus). However, following the effects of the financial Crisis the Company's group has decided, at this stage, not to commence execution of these projects, and to continue monitoring, from time to time, the feasibility of their construction. It is further noted that these two projects detailed in the table above are not subject to liens. It is also noted that in the investment contract relating to the Otradnoye project, the holding company is required to construct a school and a kindergarten by mid‑2010; as the project has been suspended, it does not intend to construct these facilities within the time frame originally contemplated and accordingly is in breach of the contract after mid‑2010. The holding company for the Otradnoye project, paid rent for the fourth quarter 2009 and the first quarter of 2010, after the due dates under its land lease contracts. Due to such delay in making lease payments, the Municipal Authority of the Odintsovo District might seek terminating the lease contracts. Termination of the lease agreements will mean that the holding company will not be able to obtain the construction permits required to complete this project. Although the construction deadline under the Botanic Gardens investment contract was extended until December 2010, the holding company is still in breach of certain interim construction deadlines under the Botanic Gardens investment contract and is in breach of the contract.

As at the date of this statement, the Company's group is planning to enter into negotiations with the Municipal Authority of the Odintsovo District regarding the prolongation of the investment contract under the Otradnoye project and is already entered into negotiations with the City of Moscow to postpone the completion date under the Botanic Gardens project until the end of 2014.

C. Set forth below are details in connection with projects the Company has executed in CIS, which include residential areas, and which were completed as at December 31, 2010: [Financial data to be updated to year-end]

(1) As at the date of this statement, the Company's group holds the rights in residential units in projects that have been completed in Moscow - "The Four Winds II" and "Ozerkovskaya Phase II". The residential units as stated are held, partly, through the Company's group's associated companies (which also have activities in the rental properties area) and, partly, through wholly owned companies (indirectly) of AFI Development.

(2) As at December 31, 2010, AFI Development holds (indirectly) all the rights in 5 residential units in "The Four Winds II" project and 5 residential units in "Ozerkovskaya Phase II" project (not including rights in residential units of the associated companies as stated).

In its residential real estate development activities in Russia, the Group's target group is mainly private customers with a high socio‑economic background.

In this area of activities, the Group markets its projects through independent agents as well as by means of Company employees.

General Information regarding the Activity Segment

The Company's group plans, develops and constructs commercial properties held for rent. The group's revenues from its activities in the rental property area in Russia derive mainly from the development, re‑development and sale of commercial properties, alone or together with partners in joint ventures, as well as from rental of the group's rental properties. In addition, in the past the Company's group had insignificant revenues from management of projects not owned by it.

(a) General Parameters Regarding the Russian Market:

Products and Services

The following tables present information in connection with the Group's projects included in its properties' portfolio. Certain information included in the tables includes estimates and forecasts relating to projects in the advanced stages of the development, that is, the concept or design stages. Such information is "forward looking" information based on the existing data and facts in the Company's possession as of the date of this statement. It is hereby clarified that the estimates and forecasts in connection with each of the Group's projects may change in the future.

1. Summary of Aggregate Results of the Investment Properties Activity

(a) Summary of Results

(b) Breakdown of the rental property areas based on regions and uses as at 12.31.10 (sq.m.)

(c) Breakdown of the rental property areas based on regions and uses as at 12.31.09 (sq.m.)

(d) Breakdown of the rental property value based on regions and uses as at 12.31.10

(e) Breakdown of the rental property value based on regions and uses as at 12.31.09

(f) Breakdown of the NOI based on regions and uses for the year ended 12.31.10

(g) Breakdown of the NOI based on regions and uses for the year ended 12.31.09

(h) Breakdown of the revaluation income (losses) based on regions and uses for the year ended 12.31.10

(i) Breakdown of the revaluation income (losses) based on regions and uses for the year ended 12.31.09

(j) Breakdown of the actual average rent per sq.m. per month/year in the functional currency

(k) Breakdown of the actual average rent per sq.m. per month/year in the functional currency

(l) Breakdown of the average occupancy rates

(m) Number of properties based on regions and uses