Investment Update Global Real Estate Fund Quarterly Update Q4 2017

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1 The Global Real Estate Fund quarterly update provides an overview of the market; fund performance, positioning and portfolio changes; and the fund manager s outlook for the months ahead. Economic Overview There is a feel good factor around much of the global economy and some of the hallmarks of a boom are certainly present. The global manufacturing PMI reached an almost seven-year high in December with firms ramping up their investment plans. Crude oil prices have risen more than 50% since June, pushing up headline inflation rates around the world. Skills shortages are emerging as unemployment has fallen below estimates of its natural rate across a swathe of the advanced economies. Global equity and property prices have soared over the past 22 months, lifting wealth and encouraging households to pull forward their spending from the future. The US government is easing fiscal policy into an economy already at or close to full employment. Financial conditions remain highly accommodative and economic data have also been impressive. Industrial output and business investment are both growing at a healthy clip, lifting productivity growth. Wealth gains and elevated consumer sentiment have prevented consumer spending growth from slowing in line with weaker real income growth. And the monthly run rate of core CPI inflation has picked up. The Eurozone s economic status changed from recovery to a solid, broad-based and increasingly self-sustaining economic expansion following strong 3Q growth of 2.6% YoY with consumers playing an active part in the recovery. Sentiment is at its highest since the 2008 financial crisis and the manufacturing PMI hit 60.6 in December, the highest level since the survey started in While growth continues, inflationary pressures have remained largely absent. The ECB is to start scaling back on its stimulus measures, but the divergence between growth and inflation in the Eurozone makes policy all the more complex. Asia s trade-dependent economies enjoyed robust growth momentum, thanks to a sustained recovery in global demand. For the region as a whole, growth is estimated to have come in at 5% for 2017, with Asia continuing to outperform other parts of the world. The region benefits not only from the geographic diversification of its export base but also its exposure to the tech sector, which has been a key driver of trade flows in recent quarters. Japan s economy benefitted from a 1.1% QoQ increase in business investment and a 1.5% QoQ jump in exports in Q3 as a result of solid global demand. In annual terms output rose by an impressive 2.1% YoY, its fastest pace in two years. The performance of the Australian economy disappointed in Q3, with growth slowing to just 0.6% QoQ, raising questions about the long term future of the economy as it battles against sluggish consumption. Whilst the labour markets remain tight, with unemployment holding steady at a five year low of 5.4% in November, wage growth remains anaemic. Against a backdrop of high household debt in general, and mortgage debt in particular, consumers are reluctant to spend. Real Estate Market Continental Europe real estate shows no sign of slowing. Take up in key office markets increased by 7.7% over the year to Q3 2017, 30% above the long term average, with notable increases in Amsterdam, Dublin and the Tier 1 German markets. Across Europe, healthy demand is eroding existing supply, forcing office vacancy rates down to the lowest levels in 15 years. However, the supply response is gathering pace. The shortage of grade-a supply is supporting rental growth and incentives are now negligible in Berlin, Munich and Stockholm, while Paris CBD has seen a structural shift towards lower incentives in early Most recently, Amsterdam, Milan, Prague and Madrid have produced the strongest rental growth of the European markets, with only Warsaw continuing to see a decline. Prime logistics rents have increased by 6.2% since their trough in 2013, although low yields in the sector and tight profit margins amongst occupiers have kept a lid on rental appreciation. Commercial real estate investment volumes in Europe in Q reached 57.5 billion. This reflects a 4% increase year-on-year. However, when removing the UK from the sample, volumes on the continent were 15% higher. The US real estate market is softening. Commercial real estate volume is down 15% since the 2015 peak, but remains relatively elevated. Office vacancies are 100 bps below average, with demand softer than prior cycles but supply is mostly in check. Apartment vacancies are equal to the long-term average but overbuilding in the luxury CBD sector has weighed on rents. Retail vacancies overall are 80bps below last cycle and 130 bps below average. Malls are being pressurised by store closures and increased capex to keep malls competitive. Construction is still muted overall given how strong fundamentals are. It is expensive to build, banks continue to pull back, and appetite for risk from developers has been less this cycle. In Asia Pacific, office prime effective rents expanded in all the markets, except Brisbane and Perth. Sydney office rents are now 39% above their historic peak, Melbourne 8% and 10%. Prime office vacancy remains low in most markets, but remains double-digits in Perth, Brisbane, and the Chinese mainland markets. New office supply continues to grow and net absorption is starting to lag net additions in Shanghai, Beijing and Tokyo (2018) Melbourne (2019), Sydney and Seoul (2020), Brisbane (2021). Demand for smaller space remains strong, particularly in Hong Kong. Office yields compressed modestly in Melbourne and Sydney, and were stable elsewhere. Low yields have pushed investors to look for yield out with the region. Chinese capital outflows have been curbed by stricter regulation, but still find a way to invest globally. At a city level, CRE liquidity has declined steadily in the past five years in Tokyo and Perth, remains buoyant in Sydney, Melbourne, Shenzhen and Guangzhou and continues to increase in Seoul, Shanghai, Brisbane,, and Beijing. Chart 1: Healthy economic growth expected in 2018 Chart 2: Logistics markets are relatively undersupplied Prime/Class A logistics stock million m² China India Czech Poland Ireland Netherlands Spain Sweden Australia Germany US Mexico France UK Japan Brazil 0 Inland Empire Chicago Dallas Ft Worth Atlanta Sao Paulo Toronto Mexico City Monterrey New Jersey LA/OC Houston Tokyo Shanghai Tianjin Shenzhen Guangzhou Paris Midlands Moscow London Milan Dubai Frankfurt Hamburg Rotterdam D dorf/cologne Antwerp Source: Consensus Economics, January 2018 Source: CBRE 2015

2 Fund Positioning Top 10 direct assets Fund % Top 10 tenants (Direct only) % Contracted Rent 3 & 5 Custom House Plaza, Dublin 8.4 Ogier 12.6 WTC Almeda House, Barcelona 8.3 Goossens St Kilda Rd, Melbourne 8.0 Revlon Esplanade, Jersey 7.8 Dutch Heart Foundation 4.8 Galeria Gniezno, Poland 7.7 Citco 4.4 DC Goossens, Veghel, The Netherlands 7.0 Maxol Ltd St Georges Terrace,Perth 6.0 Bruel & Kjaer EMS Pty Ltd 2.1 Fleming Court, Dublin 5.2 Castorama 2.1 Retail Park Hana, Kafkova 4.5 Mobelix 2.1 ExtraVerde, The Hague 3.6 Carrefour 2.0 Source: Standard Life Investments, 31 December 2017, Source: Standard Life Investments, 31 December 2017, Fund Facts Fund size 403.9m Average lot size (direct) 21.7m Average lease length 6.1 years* Number of direct properties 14 Number of tenancies 168 Distribution yield 4.22%** Standing void 14.16% Source: Standard Life Investments, 31 December 2017, *Average Unexpired lease term (to first break) Yrs **Yields are historic based on the preceding 12 months distributions as a percentage of the mid market unit/share price at date shown. Yields will vary, do not include any preliminary charges, and investors may be subject to tax on distributions. Based on institutional income shareclass. Top 5 listed holdings Fund % Prologis 1.5 Hilton Worldwide 1.2 Simon Property Group 1.0 Duke Realty 1.0 Amer Tower 1.0 Source: Standard Life Investments, 31 December 2017, Performance % growth 3mths 6mths 1 yr 3 yrs* 5 yrs* Global Real Estate Fund Source: Standard Life Investments, 31 December 2017 Fund performance is quoted net of institutional fees (GBP). *Returns are annualised Sector allocation (Direct Only) Geographical breakdown Retail Offices Industrial % Source: Source: Standard Life Investments, 31 December 2017, direct assets only. Australia Ireland United States Netherlands Poland Spain United Kingdom Czech Republic Japan India Sweden France Germany % Source: Standard Life Investments, 31 December 2017

3 Portfolio Update Transaction and Asset Management Activity Early in the quarter, we completed the purchase of a fully let logistics unit in Veghel, the Netherlands. We rate the Netherlands as Very Heavy in our Real Estate House View, forecasting strong returns for the country over three and five years. Our asset in Melbourne, Australia, continued to perform well in the fourth quarter, increasing in value by almost 7% against the backdrop of a strong investment market and a number of lease renewals. The Nishi-Shinbashi asset in Tokyo experienced an uplift in value early in the quarter following the re-letting of the ground floor retail unit to a steak restaurant. This is the third letting completed in quick succession and maintains the building s 100% occupancy. There was a small write down in the valuation of the Fund s Jersey holding as a result of recent transactional evidence which suggested that the application of a higher valuation yield was appropriate. Within the listed portfolio, we trimmed our position in Unibail. While the company has a best-in-class portfolio, we expect the share price to continue to drift in the short term. We invested the proceeds into Gecina, which provides exposure to our favoured Paris office market at a price that implies a discount to net asset value. We also sold the Fund s holding in LEG and reinvested the proceeds into Deutsche Wohnen. The latter is now our preferred name in the German residential sector due to its weighting towards Berlin, a market that has significant reversionary potential. In the US, we diversified the Fund s hotel exposure by recycling part of the Hilton holding into Marriott. Finally we trimmed retail sector-focused Simon Property and invested the proceeds into data centre names Digital Realty and Equinix. We expect distributions from all three of the Fund s indirect holdings in the short term with the expectation being that the Saffron and Nordic Retail Fund will sell their assets and the corresponding capital (subject to end of Fund life retentions) by the end of the first half of Performance overview The Fund enjoyed a strong end to the year returning 2.13% over the fourth quarter. There were positive contributions from the majority of the direct portfolio in addition to healthy performance from the listed portfolio. The listed portfolio outperformed its benchmark over the fourth quarter with off-benchmark hotel names Hilton Worldwide and Marriott International notable performers returning 14% and 22% respectively. Property in Focus Asset Management 432 St Kilda Road, Melbourne, Australia A 13 storey office building located in the popular southern Melbourne office district of St Kilda Melbourne has a population of over 4 million and is experiencing population growth which translates into latent demand for office space During 2017 a number of lettings were completed, most notably the leasing of the part 3rd, 11th & 12th floors to engineering and electronics company Bruel & Kjaer The building is currently 97% leased Throughout 2017 the capital value of the building increased by 23% due to a combination of leasing activity (which demonstrated rental growth and increased the building s average unexpired lease term) and the strength of the investment market which justified significant yield compression

4 Forecasts In Europe, Paris CBD offices were upgraded on stable prime yields and strong rental growth expectations. By sector, we remain a bit more cautious on retail as a result of the structural pressures on the sector. Logistics is a net beneficiary from changing consumption patterns. As a result, we are slightly more positive towards the sector than we were already, although for the moment we are anticipating more of the performance to come from yield compression than rental growth. Office development activity has begun to increase and this continues to cool year 3 rental growth expectations. In terms of office space, 3.2% of total stock went under construction in Q across 17 European markets, an increase from 1.6% in Q Overall, forecast total returns are expected to reach around 6.0% per annum over the next three years. The ranking of the US markets remained fairly stable. The forecast for rent growth is slightly less in most markets as they move through the cycle as supply begins to weigh on markets. Logistics cap rates compressed more as investors try to increase their allocations to the property type. New York offices continued to show weakness. The Seattle forecast is down slightly as Amazon looks to add jobs elsewhere as part of HQ2. Toronto offices were upgraded as the market is primed for rent growth with historically tight occupancies and very little supply for the next two years. São Paulo offices were upgraded and continue to be the fastest rising market in the House View. From 3Q16 to 3Q17, Class AA+ CBD vacancies fell 410 bps from 28.4% to 24.3%. After four years of declining rents, Q3 was the first quarter in years to see positive annual rent growth in the CBD. In sum, the market is still in pain, but everything seems to be headed in the right direction. The three year annualised projection is 4.9%. There were only minor changes in the House View rank in Asia Pacific. We have moderated some of our outward yield expectations and expect modest yield compression in Sydney and Melbourne industrials. The rental growth expectation is muted across the region, despite historically low vacancy rates. China Retail and Guangzhou Offices were upgraded on more modest outward yield movement than previously anticipated and a more positive outlook for rental growth. Tokyo Retail was downgraded on lower expectations for rental growth and stable yields. Beijing Offices were downgraded as net additions are starting to outstrip net absorption, putting downward pressure on rents. The three year average total return reduced by 20bps to 3.7%. Outlook The global economy is sailing along nicely; with few signs of the cyclical upswing that took hold last year fading. This momentum is reflected in resolutely upbeat consensus growth forecasts suggesting that 2018 may be the best year since While market interest rates have been rising, the pricing embedded in these still suggests relatively cautious adjustments in policy over coming years. Four developments capable of delivering a radically different outcome for 2018, without significantly altering baseline growth assumptions are possible. These include the interpretation of the shift toward tighter monetary policy as a genuine tightening cycle, the dollar rising more than 5%, the low volatility environment coming to an end, and complacency around political risk. Commercial real estate continues to provide an elevated yield compared to other assets, but tighter monetary policy will put upward pressure on rates and hence real estate yields. Real estate fundamentals are expected to remain favourable in the short term. Vacancies are at historic lows, but supply is ramping up. The increased supply and low inflation are putting downward pressure on rental growth, but growth is expected to remain positive. The outlook for direct European real estate returns remains positive. The capital market cycle is in the latter phases of its development, while stronger income growth is now materialising. Direct Continental European property ungeared total returns are forecast to reach midsingle digits per annum over the next three years. Income growth is becoming a more prevalent driver of total returns. While attractive risk-adjusted returns are forecast in core markets such as France, Germany and Sweden, the recovering markets of Hungary, Spain and the Netherlands are expected to produce some of the strongest absolute returns. In North America, the overall positive momentum should continue as long as there aren t any major missteps by the administration or serious geopolitical events. Historically low vacancies continue to support rent growth in most property types and markets. The logistics sector is expected to remain the top performer against the backdrop of low supply and global growth backed by trading, followed by supply-constrained office markets. Further declines are expected in the retail markets as the sector adjusts to structural changes and the apartments sector where overbuilding is materialising. In Asia Pacific, the growing amount of new space coming to the office market is starting to impact performance. We see continued strength in the Australian office markets of Sydney and Melbourne in the short term, and expect the recovery in the office market to firm further as new supply is eroded. The Tokyo office market is peaking and we expect rent declines materialising in the medium term. Strong performance from the industrial sector is expected across the region, as central governments roll out transport infrastructure projects in response to the structural change in the logistics and retail sectors. Global TR Ranking 3yr return Very Heavy Portugal, Hungary, India, Netherlands, Canada Heavy Spain, Sweden, Germany, Denmark, France Neutral Czech Republic, Italy, Australia, Belgium, Finland Light Ireland, South Korea,, United States, Poland Very Light China, UK, Japan,, Latin American Offices

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