BREI.L Regulatory News (BREI)

BMO Real Estate Investments Ltd - BREI - Annual Results Announcement

PR Newswire

London, September 19

To RNSDate 20 September 2019From BMO Real Estate Investments LimitedLEI 231801XRCB89W6XTR23 

* See Alternative Performance Measures

Chairman’s Statement

The Group’s net asset value (‘NAV’) total return for the year was 1.3 per cent. The NAV per share as at 30 June 2019 was 104.8 pence, down from 108.5 pence per share at the prior year-end, after dividends of 5.0 pence per share.

The share price total return for the year was -15.2 per cent with the shares trading at 80.0 pence per share at the year-end, a discount of 23.7 per cent to the NAV. It is disappointing that the share price has fallen, which is largely attributable to a lack of demand for the Company’s shares in a market which has been impacted by the political and economic uncertainties surrounding Brexit as well as sector specific concerns linked to challenges faced by the retail market in particular. The Company’s shares traded at a discount to NAV for most of the year with some noticeable weakness over the latter half of the year resulting in a widening of the discount by the year end and significant volatility in the share price over the period.

Property Market

The UK commercial property market delivered a total return of 3.3 per cent as measured by the MSCI UK Quarterly Property Universe (‘MSCI’) for all assets in the year to 30 June 2019. Total return performance was positive throughout the year, but the pace slowed when compared with the previous year. The annual all-property income return was 4.4 per cent and capital values fell by 1.1 per cent in the year, hit by weakness in the retail segment.

Performance was again driven by Industrial and Distribution property with south east industrials out-performing within that sector. Although the all-property return was depressed by the negative performance from retail, all sectors recorded a slowing in total returns compared with the previous year. In the year to 30 June 2019, open market rental value growth at the all-property level was -0.1 per cent, with falls in the retail sector offsetting a positive performance elsewhere in the market. Investment activity was lower, and that trend intensified in the latter part of the year, moving beyond retail to affect all sectors. Initial yields edged slightly higher over the year as higher retail yields were counterbalanced by yield compression in parts of the office and industrial markets.

Portfolio

The Group’s property portfolio produced an ungeared total return of 2.9 per cent over the year to June 2019, a significant slowdown from 2018 when the portfolio delivered 11.7 per cent and below MSCI which recorded 3.3 per cent over the same period.

In an environment of valuation falls, both at the market and portfolio level, performance was income driven. Capital falls for the portfolio of 2.2 per cent were offset by a 5.3 per cent income return. The portfolio continues to deliver an above market income yield, with the void rate reducing to 0.1 per cent at year end following the successful completion of leasing initiatives. Average unexpired lease length has remained steady over the period at approximately 6 years.

The Company’s portfolio has outperformed MSCI over three years and the Investment Manager has been paid a performance fee of £182,000, as this outperformance was in excess of the 115 per cent total return hurdle which is required before such a fee begins to accrue. Further details of the fee arrangements can be found in note 2 to the Consolidated Financial Statements in the Annual Report. 

The portfolio’s Industrial and Distribution assets were the key contributors to Company performance over the year delivering a 10.3 per cent total return. The portfolio’s exposure to this segment of the market is approximately 40 per cent of assets by value.

Positive contributions were made by the Group’s Rest of UK Offices, led by asset management initiatives at Lochside Way, Edinburgh and Standard Hill, Nottingham, let to HSBC and The College of Law respectively. There were also positive returns from West End Offices, where vacant floors at the Company’s largest asset at 14 Berkeley Street, London W1 were let.

The Company’s Retail assets underperformed the wider market. Despite being fully let, capital falls were greater for the portfolio than for the Index peers. The Company was impacted by the Company Voluntary Arrangement (‘CVA’) of Homebase who are tenants at three properties in the portfolio. The management of these is covered in detail in the Manager’s Review and the widespread use of CVA’s continues to impact on the marketplace. The Company did, however, benefit from having no exposure to Shopping Centres which was the poorest performing retail sector during the year.

The Company’s Retail portfolio remains under continual review given the structural challenges currently faced by this segment of the market, with further sales undertaken over the year at Gateshead and Swindon. The Company has disposed of seven retail assets over the past three years in order to reposition the portfolio.

Given competition for quality property and more cautious near-term forecasts for the property market in general, the Company has maintained a measured approach to deployment of capital despite a favourable cash position and no assets were purchased over the 12 months.

Cash Resources

The Group had £9.9 million of cash available and an undrawn facility of £13 million at 30 June 2019 and acquisition opportunities are constantly under review. There is no undue pressure to invest with the near-term focus being to concentrate available capital on worthwhile, cost effective asset management initiatives within the standing portfolio. Opportunistic sales may also be considered where appropriate. 

Borrowings

The Group currently has in place a secured £90 million non-amortising term loan facility with Canada Life Investments, repayable in November 2026. The Company also has an additional £20 million 5-year revolving credit facility agreement with Barclays Bank plc, £7 million of which was drawn down at the year-end, down from £13 million one year earlier. This facility is available until November 2020.

The Group’s gearing level, net of cash, represented 26.7 per cent of investment properties at 30 June 2019. The weighted average interest rate (including amortisation of refinancing costs) on the Group’s total current borrowings was 3.2 per cent. The Company continues to maintain a prudent attitude to gearing.

Dividends and Dividend Cover

Three interim dividends of 1.25 pence per share were paid during the year with a fourth interim dividend of 1.25 pence per share to be paid on 30 September 2019. This gives a total dividend for the year ended 30 June 2019 of 5.0 pence per share, a yield of 6.3 per cent on the year-end share price. In the absence of unforeseen circumstances, it is the intention of the Group to continue to pay quarterly interim dividends at the existing rate.

The level of dividend cover for the year was 89.4 per cent, compared to 95.7 per cent for the previous year. This fall is primarily as a result of a decrease in rental income, following the property sales over the last 18 months and the loss of income following the CVA at Homebase. There are also a number of asset management initiatives ongoing, which has resulted in a short-term reduction in the level of rents at those properties, and upon successful completion, these should begin to deliver improvement in the rental income in the future.

While the Board is conscious of the reduced dividend cover in the year, the sustainability of the dividend and the generation of total returns within the portfolio are of greater importance. The Board will, therefore, continue to explore opportunities that improve medium to longer term value within the portfolio, even if this has an adverse near-term impact on dividend cover.

Responsible Property Investment

I am particularly pleased with the progress that has been made with our Responsible Property Investment (RPI) strategy and the positive engagement we have had with a number of our key shareholders in this area.

The publication of the inaugural RPI Report for the Group for 2018 was a significant milestone in our pledge to drive greater transparency into our performance on material Environmental, Social & related Governance (ESG) factors and we have had some excellent feedback on it from shareholders. We continue to place considerable emphasis on our RPI commitments and are pleased to provide a further summary of progress in the Annual Report, complemented by our RPI Report 2019 which will be available on the Company’s website and gives greater detail and insight on our performance against relevant metrics.

Board Composition

Having served 15 years on the Board, Andrew Gulliford has indicated his intention to retire by the 2020 AGM. The Board have therefore commenced the search for a suitable non-executive director with the relevant property expertise and experience to replace Mr Gulliford following his retirement. As part of this process, consideration will also be given to the requirement to seek, where appropriate, additional diversity within the Board. A further announcement will be made in due course.

Outlook

The outlook continues to be dominated by the stresses in the retail sector and the Brexit process, with its political and economic ramifications. A slowdown in global growth offers additional challenges, with a period of muted rental growth now likely to be the outcome and meaningful differences in the prospect for the underlying property sectors. However, with fiscal policy potentially easing and the market expecting interest rates to remain at low levels by past standards, property market performance may receive some support once there is greater clarity on political sentiment.

Property continues to deliver an attractive income return. Prime property in established locations and emerging hubs is expected to out-perform. The Industrial and Distribution market should continue to be a major driver of performance, benefiting from the continued growth of online sales but perhaps to a lesser degree as supply increases. The retail sector is facing structural issues which will take time to resolve and this will continue to impact sentiment for much of the sector. Repurposing and repricing of property is underway, and the market is predicted to re-balance in due course albeit with significant casualties at the secondary end of the market and at lower rents for a majority. Alternatives are expected to continue to grow in importance as investors seek long-term contracted income. A period of positive single-digit total returns is in prospect, underpinned by the income return.

There remains considerable uncertainty surrounding the UK property market. The effect of this uncertainty is mitigated to a degree by the Company’s balanced and well let portfolio. At the current time, the more appropriate and attractive use of company resources lies in asset management opportunities which exist within the portfolio.

Vikram LallChairmanSource: BMO REP Property Management Limited, MSCI Inc

Manager’s Review

Portfolio Highlights

• Company portfolio delivered an ungeared total return of 2.9 per cent over the year.

• Income return of 5.3 per cent over the year.

• An encouraging year of leasing activity has led to the portfolio being practically fully let with a vacancy rate of just 0.1 per cent at year-end, well below the MSCI average of 7.2 per cent.

Property Market

The UK commercial property market delivered a total return of 3.3 per cent in the year to June 2019 as measured by MSCI. Performance was driven by an annual income return of 4.4 per cent, with capital values falling by 1.1 per cent.

The market recorded consistently positive total returns at the all-property level throughout the year, but performance has decelerated compared with a year earlier, with the second half of the period weaker than the first. The 4.4 per cent income return has slipped slightly from the 4.5 per cent reported a year earlier. Capital growth turned negative during the year, largely due to weakness in the retail market.

The UK economy has delivered muted but positive GDP growth for the year, although the unwinding of Brexit-related stockpiling affected performance during the final quarter. Consumer price inflation decelerated to finish the year at the Bank of England’s target level of 2 per cent. The labour market has continued to improve and annual wage growth is positive in real terms. The Bank of England raised its official rate in August 2018 but has kept it unchanged since then, as inflation moderated, and GDP growth remained subdued. Gilt yields have been on a generally downward trend since autumn 2018, finishing the period below 1 per cent and have fallen further since the end of the reporting period. The Brexit negotiations and the consequent economic and political turmoil remained a major concern for investors throughout the period and the ramifications remain unclear. This has affected sentiment towards UK property, intensifying in the second half of the reporting period. Slower economic growth overseas and the rise of protectionism globally are also areas of concern though it may not have fed through into pricing yet.

Investment activity weakened over the period. The year to June 2019 saw £53 billion invested in property versus £66 billion in the previous year. This trend intensified markedly in the latter half of the year. Initially there was a sharp fall in retail investment volumes but by the end of the reporting year, transaction levels were lower than the long-term average across the market. Concerns about Brexit as the initial deadline approached and changes to taxation affecting overseas investors may in part explain the decline. Overseas net investment however remained positive throughout the year. There were fewer large London office deals, but this was counterbalanced by interest in the regions and alternative sectors. Net investment by institutions turned negative in the second part of the year and private property companies were consistent net sellers. Local authorities remained in the market but at lower volumes and with a move to smaller lot sizes towards the end of the period alongside a reported focus on their local area. Open-ended UK direct property funds have seen net outflows consistently since October 2018, with concerns about liquidity returning. The banks are still net lenders to commercial property but there has been stress in the shopping centre market.

Investors have generally been cautious, favouring long-term secure income. There have been reports of more opportunistic investors waiting in the wings to capitalise on any forced sales or portfolio rebalancing, but pricing may need to adjust further before this occurs on any scale. Similarly, business plans linked to the repurposing of retail assets as alternative uses may provide some relief to structural tensions, but this often requires repricing or at least substantial capital injection to bring them forward. Initial yields edged out to 4.6 per cent at the end of the reporting period, compared with 4.5 per cent a year earlier. The softening was most apparent for shopping centres and retail warehousing, with yields hardening for industrials and offices outside London.

Total return performance by segment has broadly maintained the pattern seen since the referendum. Industrial and distribution property continued to out-perform but to a lesser degree in the second half of the year. The annual total return was 10.5 per cent with the south east out-performing the rest of the UK. Annual capital growth of c.6 per cent reflected both open market rental growth and the impact of the change in equivalent yield. Offices recorded a 5.2 per cent total return. Rest of UK Offices led the sub-markets and delivered a 6.2 per cent total return with West End offices lagging at 4.0 per cent but all segments out-performed the all-property average. The well-publicised problems of the retail sector have continued and intensified, characterised by company voluntary arrangements (‘CVAs’) administrations and store rationalisation. Annual retail total returns were minus 3.8 per cent. Shopping centres and department stores have been particularly badly affected but the problems are widespread with most parts of the market recording negative total returns. These changes are structural and are likely to lead to re-based rent levels and market pricing of investments. Alternatives, including healthcare, hotels and hospitality and student accommodation, out-performed the all-property average to deliver a 6.1 per cent total return. Alternatives are growing in popularity, helped by their generally longer lease profile and now account for 14 per cent of the MSCI Quarterly Property Universe, overtaking retail warehousing over the course of the year in terms of capital value in the Index.

Open market rental growth was marginally lower at the all-property level, hit by weakness in the retail market, where rents fell by 3.8 per cent. Retail rents have been affected by retail failures, but lease negotiations are difficult more generally, with stronger retailers seeking rent cuts to renew. Office rental growth was 1.2 per cent, led by City offices, despite earlier Brexit-related concern. Rental growth was 3.6 per cent for industrials, with the southeast out-performing. This represents a deceleration from the pace reported in the previous year. Alternatives saw 1.2 per cent annual rental growth, with little change from a year earlier. Gross income growth for the year to June 2019 was 2.2 per cent, led by offices and industrials.

The property market is slowing as it moves into a late-cycle phase. There is polarisation by sector and considerable uncertainty exists, with both investors and occupiers remaining cautious. Property looks fairly priced when measured against the post-GFC yield gap against gilts. An all-property annual income return of 4.4 per cent on relatively long-term contracted income still looks appealing when compared against other asset classes.

Portfolio

The Company’s property portfolio produced an ungeared total return of 2.9 per cent over the year to June 2019 versus an MSCI Index return of 3.3 per cent. The portfolio continues to outperform over three and five years and over the 15 years since inception. Performance was driven by an above market income return of 5.3 per cent but held back by a capital value fall of 2.2 per cent. The portfolio has delivered an annualised ungeared total return of 7.0 per cent per annum over three years and 8.9 per cent over five years.

The above market income yield, liquid asset base, weighted average unexpired lease term of approximately 6 years, and absence of vacancy remain the defining characteristics of the portfolio. The portfolio benefits from a yield premium to the MSCI Index but the quality of the underlying assets and the successful delivery of property level initiatives has ensured gross income growth of 4.4 per cent for the year verses 2.2 per cent for the Index. The strategy to maintain a comparatively high exposure to the industrial and logistics market and allocate Company resources to asset management initiatives within the regional office portfolio have been key factors in the delivery of medium-term outperformance. We believe that the high weighting to the south east geography continues to offer solid prospects for future performance as well as liquidity in the asset base, as does the average lot size within the portfolio which is currently £8.6m. As in the previous reporting period, portfolio turnover and the burden of associated transaction costs were relatively low, as were the non-recoverable costs linked to below benchmark property voids. In a lower returning environment, the control of these non-recoverable items is of increasing importance.

Despite a softening of values at the All Property level over the last 12 months, much of this has to date been concentrated within the retail sub sectors or for more secondary property. The market in general remains competitive for quality assets, particularly those with robust income characteristics. Against this backdrop and with selected worthy asset management initiatives under way on the existing portfolio, the Manager continues to be selective in deployment. In the event that there was a repricing of suitable assets later in the year, potentially linked to either political developments or selling activity within the open-ended fund space, the Manager remains vigilant and ready to engage on appropriate opportunities. 

The recent priority has been to continue the success of the disposal programme, designed in particular to exit some of the smaller legacy retail assets. A further two assets, at Regent Street, Swindon and Sands Road, Gateshead were sold over the reporting period. This continues the strategy of selling less desirable assets into a competitive, relatively late cycle market with eight having been successfully disposed of over the past three years. This capital has then been recycled into projects within the standing portfolio, the most recent of those being the Office refurbishment at Standard Hill, Nottingham which has resulted in the securing of a new 15-year lease to The College of Law at a new benchmark rental tone for the city. 

Retail

Despite consumer spending holding up relatively well over the period, retail as a sector has experienced significant structural headwinds. The Company’s Retail portfolio was no outlier in this regard and recorded comfortably the poorest nominal performance over the period at -6.3 per cent, anchored by capital return of -11.4 per cent. This return was below the MSCI Index, primarily on account of the performance of the portfolio’s Rest of UK and South East standard retail sub sectors which while fully let and delivering yield premium against the market, experienced higher capital value falls. This demonstrates, in our view, realistic adjustment of the market value for the Company’s assets from the portfolio valuers. The portfolio’s Retail Warehousing outperformed the Index over the year but still delivered a negative total return of -3.6 per cent, driven by capital falls of 9 per cent. Standout returns were delivered by the asset located at Beverly Way, New Malden which offers right sized, accessible accommodation in an area of very tight supply, with the additional benefit of indexed linked rents. The Company’s exposure is generally at the lower rented end of the market, with an absence of fashion tenants and benefitting from higher income yield than the index peers. This will by no means entirely insulate the asset base against the threats clearly evident within the sector, though we feel it should offer some relative defence. The sale of the retail warehousing asset at Sands Road, Gateshead to an institutional buyer in line with its latest valuation demonstrated both liquidity and pricing. A second disposal, the high street retail asset at Regent Street, Swindon, sold to an owner occupier, was also conducted at market valuation. Retail accounts for c.34 per cent of the portfolio’s assets, broadly in line with the MSCI Index in terms of weighting, with 19 per cent of assets accounted for by Retail Warehousing. Structurally the portfolio benefitted from the absence of any Shopping Centres or Department Stores.

Given downgrades to the sector linked to changing shopping patterns and the rise of online and consumer spending, we continue to see rents challenged in most locations. The increased use of CVA’s has undermined the perceived security of a lease contract with the feeling of injustice spreading to those occupiers operating successful strategies and paying historic market rents. There is clearly significant risk of the ongoing relevance of many retailing locations at the secondary end of the market while prime assets will not be beyond the reach of falling rents and rising yields. Vacancy rates are not as yet unduly high, however, there has been a recent jump up above the 10% threshold. There are retailers taking space and trading well but lease lengths are falling and turnover rents gaining in popularity with around a third of vacant space having been empty for more than two years. Some of this is now being repurposed for leisure, hotels, residential or simply demolished, although generally there is pricing impact or requirement for significant capital injection to realise these outcomes. It will take time but we anticipate that the thriving town centres of the future will encompass retail as part of a wider range of facilities and community uses. On a more positive note there is also an increasing recognition that stores and online shopping can be complementary in driving sales, something we are seeing within the Company assets with particular relevance to the retail warehousing portfolio, where accessibility, storage, stock capacity and lower global rents can play a role in a multi-channel offer.

As addressed in the previous period, the portfolio suffered some impact from the 2018 CVA of Homebase following the sale of the business to restructuring specialists Hilco. None of the Company’s assets let to Homebase were vacated, with rents unaffected at the store at Bromsgrove (where an insurance lease to an occupier with a Dunn & Bradstreet rating of 5A1 was put in place to cover for any future failure). There was a partial reduction at another store in Luton on a short lease expiring 2020, a property where planning consent has now been granted and a pre-let agreed for a food store redevelopment to create a fully let, long dated inflation linked asset. One unit was impacted on a meaningful basis and this was the retail warehouse unit at Northfields Retail Park, Rotherham where the CVA bound the Company to accepting a discounted rent. We continue to realise the business plan for the site having recently agreed terms to let the property at an improved rent. 

A number of sales have been conducted from the retail segment of the portfolio over recent years, both as part of a reweighting exercise and with a view to crystallising performance. There is no intention to embark upon a wholesale exit from the sector. Many of the portfolio’s assets continue to offer valuable contribution towards the Company objective and while demand from investors is undoubtedly thin at present, the Manager remains active in seeking exit strategies where appropriate, subject to achieving acceptable pricing.

Offices

The Company’s Office assets comprise 26 per cent of the portfolio and outperformed the MSCI Index by 80 bps over the year returning 6.0 per cent, driven by a higher income return. West End Offices and Rest of UK Offices led the way following successful asset management, refurbishment and leasing. Of particular note was the letting, post extensive refurbishment, of the office at Standard Hill, Nottingham to the College of Law on the basis of a new 15-year lease at a rent of £576,000 p.a. There has also been refurbishment work at the property at 14 Berkeley Street, London, to reposition the suites to satisfy demand for more flexible space. Following completion, the 1st and 5th floors were let during the second half of the period, above valuation assumptions. The office portfolio is fully let.

While there could be some Brexit-related nervousness in the short-term, the prime end of the Office market looks generally sound, benefiting from healthy demand, low new supply levels, which could be prolonged due to high building costs, and relatively attractive yields. Despite the uncertainty surrounding Brexit, take-up in Central London has held up reasonably well. The tech sector remains buoyant and demand is increasing from professional services. New supply is low and availability is falling, leading to a reduction in the vacancy rate both in the City and West End. Around 50 per cent of space under construction is pre-let. These supply constraints may be felt more keenly once the Brexit terms are finalised if delayed tenant moves are actioned. Rental growth is positive, rising by 1.6 per cent in the City and 1.1 per cent in the West End on an annual basis. Over the longer-term, we expect London’s performance to remain robust, helped by its role as a global city and low levels of new supply.

Occupier requirements are changing with leases becoming more flexible and tenants seeking well specified and connected buildings. Access to talent remains key. With building quality and flexibility becoming increasingly important to occupiers, there may be implications for capital depreciation. We expect city centres to out-perform given their generally greater amenity level and connectivity and for prime property to out-perform secondary assets.

Industrial and Logistics

The Company’s Industrial and logistics properties were again the standout performers over the year. Standard industrials out-performed distribution warehouses and both were well ahead of the all-property average. Industrials and Logistics properties comprised c.40 per cent of the portfolio by value as at the year end. This structural overweight to the best performing sub-market is a key reason for the portfolio’s outperformance over the medium and long term. The Company’s assets are located exclusively in the supply constrained south east where we continue to see strong demand from a range of occupiers. While there has been a supply pickup regionally, the low level of existing supply in the south east is compounded by intense competition for land from both commercial and residential uses as well as a generally restrictive planning policy. Against this background the Company’s Industrial properties have delivered 13 per cent income growth over the year. We remain wary of the compressing of yields across the sector as a whole and while income growth has continued to justify the sector, there is clearly a risk that Industrials become over bought. Stock selection and property fundamentals will be of increasing importance moving forward. The Manager continues to focus on mid-box clusters as the basis for the portfolio exposure, located in the key distribution locations and infrastructure hubs with both fit for purpose site and accommodation.

Most of the top performing assets within the portfolio over the year were South East Industrial properties and over three years, the Company’s top five performing assets all hail from this subsector. The whole subsector has shown attractive relative capital and income returns but the latter part of the period has shown some disaggregation based upon asset fundamentals and this will be of greater importance moving forward. A key contribution in the Company portfolio came from the holding at Southampton International Business Park, Eastleigh where rental growth in the open market was again combined with asset management to extend the lease terms and deliver income growth. A further positive contribution came from Lakeside Industrial Estate, Colnbrook where success in renewing existing leases and progress on re-gearing upcoming lease expiries combined with the continued strength of investor appetite for multi-let estates located in the Capital drove performance.

Despite the market being well bid for best in class stock, investment activity weakened in the latter half of the year to touch its lowest level since the referendum, with portfolio activity in particular being more muted. The occupational market is perhaps a little patchier than headline numbers and media commentary might suggest. Standard industrial rental growth out-paced that of distribution on an annual basis with some signs that rental growth is moderating in both sub-markets. Nonetheless it remains above the long-run average and remains one area of the market delivering growth. There is greater activity in the prime market, with demand in the secondary sector more static. Supply is edging higher and there is more than 7 million sq. ft. of space under construction according to Savills, with some meaningful geographic variance in availability. More than half the space currently available is Grade A space.

The industrials market is expected to continue to out-perform, but there are signs that the degree of out-performance could moderate. Demand is likely to be supported by the continued growth of online but increased supply and low margin contracts could cap rental growth prospects, while Brexit could simultaneously lead to both a shift to warehousing in mainland Europe and some nearshoring or stockpiling within the UK itself. Quality, flexibility and location to major markets and skill hubs is critical.

Alternatives

The Company does not currently own any ‘Alternatives’ in the strictest sense but does have exposure to long let automotive investments, classified by some as alternatives on account of their bespoke accommodation and leasing characteristics. By capital value this is c.5 per cent of total assets, currently allocated to the retail subsector for weighting purposes.

MSCI data shows Alternatives (other commercial) delivering an annual total return of 6.1 per cent for the year versus 3.3 per cent for all-property.

The alternatives market was a primary driver for investment activity early in the reporting period but weakened by the final quarter, with few large deals completed. Post-period end there has been one transaction over £1 billion and four more deals above £250m. Overseas interest remains significant and the specialist REITs are still buying, although we have also witnessed selected and opportunistic selling.

The sector is evolving and growing in importance. Certainly, access remains a medium-term strategic target for the Company given both the demographic and structural drivers and the policy support for many of the constituent segments of the market. However, there is a clear risk that some buyers are being pushed up the risk curve in order to obtain representation. This specific tenant and subsector risk needs to be correctly priced. There could be some challenges from regulatory changes, rising costs linked to Brexit and supply issues in some parts of the market. Despite this, the sector is expected to remain in favour with investors, but with some increased variation in performance between its component parts. At the asset level, issues regarding covenant and operational risk remain.

Outlook

Brexit, and its economic and political repercussions, is expected to remain a major influence on sentiment. Whilst the uncertainty remains unwelcome, the possibility of some fiscal easing and a prolonged period of low interest rates may not be entirely negative for property. The industrial market is expected to continue to out-perform, helped by the growth of online retailing but may face more headwinds than in the recent past. For offices, the demand for more flexibility in lease terms and improved building specification are likely to remain major factors for occupiers but a lack of supply could underpin improved rental growth once there is post-Brexit clarity. We expect retail property to undergo further correction but to stabilise at lower levels in due course. This unwinding is undoubtedly the largest risk for the market and the portfolio. We see Central London and affluent towns with a tourist or educational dimension being relatively resilient over the longer term, though not immune. With muted economic growth and investor sentiment restrained, we expect income to be the major driver of performance.

The Company’s high weighting to the supply constrained south east, held at yield premium to the market, alongside the c.40 per cent exposure to the Industrial and Logistics market, an area of the market forecast to outperform, place the portfolio on a solid defensive footing.

The consistent demand for the Company’s properties demonstrated both by the low vacancy rate and recent evidence of above market income growth, offer much to be positive about. The successful realisation of capital works projects at Standard Hill, Nottingham along with asset management at Berkeley Street, London and the Industrials at Eastleigh demonstrate a recent track record of value-add initiatives. Similar results at the pre-let supermarket development at Luton and the office scheme at Chelmsford in particular should add valuable income to the portfolio.

Peter LoweBMO Rep Property Management Limited 

BMO Real Estate Investments Limited

Consolidated Statement of Comprehensive Income

All items in the above statement derive from continuing operations. 

All of the profit for the year is attributable to the owners of the Group.

BMO Real Estate Investments Limited

Consolidated Balance Sheet

BMO Real Estate Investments Limited

Consolidated Statement of Changes in Equity

For the year ended 30 June 2019

For the year ended 30 June 2018

BMO Real Estate Investments Limited

Consolidated Statement of Cash Flows

BMO Real Estate Investments Limited

Principal Risks and Future Prospects

Each year the Board carries out a comprehensive, robust assessment of the principal risks and uncertainties that could threaten the Group's success. The consequences for its business model, liquidity, future prospects and viability form an integral part of this assessment.

The Board applies the principles detailed in the internal control guidance issued by the Financial Reporting Council and has established an ongoing process designed to meet the particular needs of the Group in managing the risks and uncertainties to which it is exposed.

Principal risks and uncertainties faced by the Group are described below and in note 2, which provides detailed explanations of the risks associated with the Group’s financial instruments.

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Other risks faced by the Group include the following:

The Board seeks to mitigate and manage these risks through continual review, policy-setting and enforcement of contractual obligations. It also regularly monitors the investment environment and the management of the Group’s property portfolio. 

The Manager seeks to mitigate these risks through active asset management initiatives and carrying out due diligence work on potential tenants before entering into any new lease agreements. All properties in the portfolio are insured.

The principal areas of particular focus encountered during the year, how they are mitigated and actions taken to address these are set out in the table below.

Viability Assessment and Statement

The Board conducted this review over a 5-year time horizon, a period thought to be appropriate for a commercial property Investment Company with a long-term investment outlook, borrowings secured over an extended period and a portfolio with a weighted average unexpired lease length of 5.8 years. The assessment has been undertaken taking into account the principal risks and uncertainties faced by the Group which could threaten its objective, strategy, future performance, liquidity and solvency.

The major risks identified as relevant to the viability assessment were those relating to a downturn in the UK commercial property market and its resultant effect on the valuation of the investment portfolio, the level of rental income being received and the effect that this would have on cash resources and financial covenants. The Board took into account the illiquid nature of the Group’s portfolio, the existence of the long-term borrowing facilities, the effects of any significant future falls in investment values and income receipts on the ability to repay and re-negotiate borrowings, maintain dividend payments and retain investors. These matters were assessed over an initial period to September 2024, and the Directors will continue to assess viability over 5 year rolling periods, taking account of foreseeable severe but plausible scenarios.

In the ordinary course of business, the Board reviews a detailed financial model on a quarterly basis, incorporating market consensus forecast returns, projected out to the maturity of its principal loan of £90 million which is due to mature in 2026. This model uses prudent assumptions and factors in any potential capital commitments. For the purpose of assessing the viability of the Group, the model has been adjusted to look at the next five years and is stress tested with projected returns comparable to the commercial property market crash experienced between 2007 and 2009. The model projects a worst case scenario of an equivalent fall in capital and income values over the next two years, followed by three years of zero growth. The model demonstrated that even under these extreme circumstances the Group remains viable.

Based on their assessment, and in the context of the Group’s business model, strategy and operational arrangements set out above, the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the 5-year period to September 2024.

The Group’s liquidity risk is managed on an ongoing basis by the Manager and monitored on a quarterly basis by the Board. In order to mitigate liquidity risk the Group aims to have sufficient cash balances (including the expected proceeds of any property sales) to meet its obligations for a period of at least twelve months.

In certain circumstances, the terms of the Group’s bank loans entitle the lender to require early repayment, for example if covenants are breached, and in such circumstances the Group’s ability to maintain dividend levels and the net asset value attributable to the Ordinary Shares could be adversely affected. 

BMO Real Estate Investments Limited

Going Concern

In assessing the going concern basis of accounting the Directors have had regard to the guidance issued by the Financial Reporting Council. They have reviewed detailed cash flow, income and expense projections in order to assess the Group’s ability to pay its operational expenses, bank interest and dividends. The Directors have examined significant areas of possible financial risk including cash and cash requirements and the debt covenants, in particular those relating to loan to value and interest cover. The Directors have not identified any material uncertainties which cast significant doubt on the Group’s ability to continue as a going concern for a period of not less than 12 months from the date of the approval of the consolidated financial statements. The Board believes it is appropriate to adopt the going concern basis in preparing the financial statements.

Directors’ Responsibilities in Respect of the Annual Report & Consolidated Accounts

We confirm that to the best of our knowledge:

In the opinion of the Directors:

On behalf of the BoardV LallChairman19 September 2019 

BMO Real Estate Investments Limited

Notes to the Consolidated Financial Statementsfor the year ended 30 June 2019 

1. The audited results of the Group which were approved by the Board on 19 September 2019 have been prepared on the basis of International Financial Reporting Standards as adopted by the EU, interpretations issued by the IFRS Interpretations Committee, applicable legal and regulatory requirements of the Companies (Guernsey) Law, 2008 and the Listing Rules of the UK Listing Authority as well as the accounting policies set out in the statutory accounts of the Group for the year ended 30 June 2019.

2. Financial Instruments and investment properties

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

Consistent with that objective, the Group holds UK commercial property investments. In addition, the Group’s financial instruments comprise cash, receivables, interest-bearing loans and payables that arise directly from its operations.

The Group is exposed to various types of risk that are associated with financial instruments. Financial risks are risks arising from financial instruments to which the Group is exposed during or at the end of a reporting period. Financial risk comprises market risk (including currency risk, price risk and interest rate risk), credit risk and liquidity risk. There was no foreign currency risk as at 30 June 2019 or 30 June 2018 as assets and liabilities are maintained in Sterling.

Market price risk

Market risk is the risk the fair value of future cash flows of a financial instrument will fluctuate because of changes in market prices.

Sensitivities to market risks included below are based on change in one factor while holding all other factors constant. In practice, this is unlikely to occur, and changes in some of the factors may be correlated – for example, changes in interest rate and changes in foreign exchange rates.

The Group’s strategy for the management of market price risk is driven by the investment policy. The management of market price risk is part of the investment management process and is typical of commercial property investment. The portfolio is managed with an awareness of the effects of adverse valuation movements through detailed and continuing analysis, with an objective of maximising overall returns to shareholders.

Price Risk

The Group has no significant exposure to price risk as it does not hold any equity securities or commodities. The Group is exposed to price risk other than in respect of financial instruments, such as property price risk including property rentals risk. Investment in property and property-related assets are inherently difficult to value due to the individual nature of each property. As a result, valuations are subject to substantial uncertainty. There is no assurance that the estimates resulting from the valuation process will reflect the actual sales price even where such sales occur shortly after the valuation date. Such risk is minimised through the appointment of external property valuers.

Any changes in market conditions will directly affect the profit/loss reported through the Consolidated Statement of Comprehensive Income. A 10 per cent increase in the value of the investment properties held at 30 June 2019 would have increased net assets available to shareholders and the increased the net income for the year by £33.9 million (2018: £34.9 million); an equal change in the opposite direction would have decreased net assets and decreased net income by an equivalent amount.

The calculations above are based on investment property valuations at the respective balance sheet dates and are not representative of the year as a whole, nor reflective of future market conditions.

Interest rate risk

Some of the Group’s financial instruments are interest-bearing. They are a mix of both fixed and variable rate instruments with differing maturities. As a consequence, the Group is exposed to interest rate risk due to fluctuations in the prevailing market rate.

The Group’s exposure to interest rate risk relates primarily to the Group’s borrowings. Interest rate risk on the £90 million Canada Life term loan is managed by the loan bearing interest rate on a fixed rate of 3.36 per cent per annum until maturity on 9 November 2026. 

Credit risk

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

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

The Group has a diversified tenant portfolio. The maximum credit risk from the rent receivables of the Group at 30 June 2019 is £802,000 (2018: £664,000). The maximum credit risk is stated after providing for expected credit losses of £9,000 (2018: £40,000). Of this amount £nil was subsequently written off and £4,000 has been recovered.

The expected loss rates are based on the payment profiles of tenants over a period of 36 months before 31 December 2018 or 1 January 2018, respectively, and the corresponding historical credit losses experienced within this period.

Apart form the rent receivable disclosed above there were no financial assets which were either past due or considered impaired at 30 June 2019 (2018: nil).

Deposits refundable to tenants may be withheld by the Group in part or in whole if receivables due from the tenant are not settled or in case of other breaches of contract.

All of the cash is placed with financial institutions with a credit rating of A or above. Bankruptcy or insolvency of these financial institutions may cause the Group’s ability to access cash placed on deposit to be delayed or limited. Should the credit quality or the financial position of the banks currently employed significantly deteriorate, the Manager would move the cash holdings to another financial institution.

The Group can also spread counterparty risk by placing cash balances with more than one financial institution. The Directors consider the residual credit risk to be minimal.

Liquidity risk

Liquidity risk is the risk that the Group will encounter in realising assets or otherwise raising funds to meet financial commitments. The Group’s investments comprise UK commercial property.

Property in which the Group invests is not traded in an organised public market and may be illiquid. As a result, the Group may not be able to quickly liquidate its investments in these properties at an amount close to their fair value in order to meet its liquidity requirements.

The Group’s liquidity risk is managed on an ongoing basis by the Manager and monitored on a quarterly basis by the Board. In order to mitigate liquidity risk the Group aims to have sufficient cash balances (including the expected proceeds of any property sales) to meet its obligations for a period of at least twelve months.

In certain circumstances, the terms of the Group’s bank loans entitle the lender to require early repayment, for example, if covenants are breached, and in such circumstances the Group’s ability to maintain dividend levels and the net asset value attributable to the Ordinary Shares could be adversely affected. 

3. The fourth interim dividend of 1.25p will be paid on 30 September 2019 to shareholders on the register on 13 September 2019. The ex-dividend date was 12 September 2019.

4. There were 240,705,539 Ordinary Shares in issue at 30 June 2019. The earnings per Ordinary Share are based on the net profit for the year of £3,206,000 and on 240,705,539 Ordinary Shares, being the weighted average number of shares in issue during the year.

5. These are not full statutory accounts. The full audited accounts for the year ended 30 June 2019 will be sent to shareholders in September 2019, and will be available for inspection at Trafalgar Court, Les Banques, St. Peter Port, Guernsey, the registered office of the Company. The full annual report and consolidated accounts will be available on the Company’s websites: bmorealestateinvestments.com

6. The Annual General Meeting will be held on 19 November 2019.

Alternative Performance Measures

The Company uses the following Alternative Performance Measures (‘APMs’). APMs do not have a standard meaning prescribed by GAAP and therefore may not be comparable to similar measures presented by other entities.

Discount or Premium – The share price of an Investment Company is derived from buyers and sellers trading their shares on the stock market. If the share price is lower than the NAV per share, the shares are trading at a discount. This usually indicates that there are more sellers than buyers. Shares trading at a price above the NAV per share, are said to be at a premium.

Dividend Cover – The percentage by which Profits for the year (less Gains/losses on investment properties and non-recurring other income) cover the dividend paid.

A reconciliation of dividend cover is shown below:

Dividend Yield – The annualised dividend divided by the share price at the year-end.

Net Gearing – Borrowings less net current assets divided by value of investment properties.

Ongoing Charges – All operating costs incurred by the Company, expressed as a proportion of its average Net Assets over the reporting year. The costs of buying and selling investments and derivatives are excluded, as are interest costs, taxation, non-recurring property costs and the costs of buying back or issuing Ordinary Shares.

Portfolio (Property) Capital Return – The change in property value during the period after taking account of property purchases and sales and capital expenditure, calculated on a quarterly time-weighted basis.

Portfolio (Property) Income Return – The income derived from a property during the period as a percentage of the property value, taking account of direct property expenditure, calculated on a quarterly time-weighted basis.

Portfolio (Property) Total Return – Combining the Portfolio Capital Return and Portfolio Income Return over the period, calculated on a quarterly time-weighted basis.

Total Return – The return to shareholders calculated on a per share basis by adding dividends paid in the period to the increase or decrease in the Share Price or NAV. The dividends are assumed to have been reinvested in the form of Ordinary Shares or Net Assets, respectively, on the date on which they were quoted ex-dividend.

All enquiries to:Peter LoweScott MacraeBMO Investment Business LimitedTel: 0207 628 8000The Company SecretaryNorthern Trust International Fund Administration Services (Guernsey) LimitedPO BOX 255Trafalgar CourtLes BanquesSt Peter PortGuernsey GY1 3QLTel: 01481 745001