Surveyor Review of Q4 2017

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1 Q Legal & General UK Property Fund For Professional Advisers UK Property Fund Quarterly Report Surveyor Review of Q Sherwood Park, Nottingham Investing in commercial real estate since 1971, LGIM Real Assets is one of the UK s largest landlords, investing through a fully-resourced and specialist platform.

2 The L&G UK Property Fund benefits from the broad-ranging resource, expertise and capabilities of the wider LGIM Real Assets platform that help inform its strategy and support its operational activities. We are able to draw on the synergies across our integrated real assets investment business to help drive innovation and identify opportunities. Matt Jarvis Co-fund manager of Legal & General UK Property Fund THE L&G UK PROPERTY FUND IN CONTEXT Legal & General has been investing in commercial real estate since In 2015, we brought together our investment capabilities across property and infrastructure for the first time in the formation of LGIM Real Assets. The synergies across our unified platform have helped support the growth of the business; we are one of the UK s largest landlords with 27 billion under management as at 31 December LGIM Real Assets manages over 20 direct real estate strategies across a range of risk profiles. The L&G UK Property Fund is one of our flagship balanced property funds, which invests across all commercial property sectors. Alongside these larger, diversified portfolios, we also manage award-winning sector-specialist strategies and single-asset joint ventures. Owing to the size, diversity of sector specialisms, and depth of market knowledge, the L&G UK Property Fund benefits from a wealth of in-house skill, expertise and network of industry contacts. The Fund team is supported in sourcing and delivering assets by the LGIM Real Assets dedicated Transactions team, whose market reach is evidenced by the 3.3bn of property transactions undertaken over In addition to this, the Fund Manager and his team have access to the LGIM Real Assets Research team, which develops strategic thought leadership, sector-specialist market analysis and micro-level forecasting to help drive outperformance. The Research team also draws on analysts across LGIM s wider investment management business, covering macroeconomics, equity and fixed income markets. The expansive knowledge of the Research team is supported by nominated Sector Specialists across the platform each covering a specific sub-sector of the property market (such as industrials; alternatives; retail; and offices) and providing collaborative, detailed information in an advisory capacity for fund transactions. The L&G UK Property Fund is able to leverage the significant and broad-ranging resource, expertise and capabilities of the wider LGIM Real Assets platform. This stands the fund in the best possible stead to continue to deliver strong returns to its investors through innovative deals; thought leadership; forecasting; and creative, active management. Figure 1: LGIM Real Assets Supportive Platform Structure Legal & General Investment Management Macro Themes/Trends Tenant Credit Analysis Corporate Governance Corporate Relationships Legal and Compliance Operational Risk Management Transactions Team Research Development and Planning Fund Team Fund Manager Asset Managers Finance Legal Sustainability Sector Specialist Asset Management Retail Offices Alternatives Industrials Residential 2

3 Q Legal & General UK Property Fund Overview Economic overview We expect another strong year for growth, with the global economy firing on almost all cylinders. However, it s important to draw a distinction between the economy and investment markets. As risk asset markets have already moved to reflect much of this economic optimism, we believe there is now greater vulnerability to disappointment for investors. Our Chief Investment Officer, Anton Eser, highlights in his latest update his concern over the outlook for investment markets and believes that this global reduction of central bank support could end up in a rude awakening for investors. After almost nine years of uninterrupted equity market gains, it could be time for a reversal of fortunes, or at least a slowing in the rate of asset price appreciation. We need to be particularly wary of growing recession risks in This takes into account the typical 6-12 month lead of markets over the economic cycle. At that stage, unemployment will likely be well below sustainable levels. Higher interest rates could also start to bite into corporate and household budgets. While interest rates could drift up, however, we do not think this is the beginning of the end for the bond markets. Property pricing continues to offer a historically robust income arbitrage to gilts. While investors remain optimistic about the performance of equities over 2018, there are concerns emerging about the sustainability of their valuations. We expect real estate capital allocations to be broadly maintained; inflows may well be more modest given the pressures on rental growth. However, without a tangible rationale for a correction in capital values, we believe many long-term investors will choose to remain invested rather than rotate tactically out of the asset class. 3

4 Property market over Q4 Commercial All Property rental values rose over the quarter, which was led by industrials. The office and retail sectors were some way behind. Over the full year, All Property rental values improved by almost 2% ahead of consensus expectations made at mid-year. Investment volumes reached 17 billion over Q This was driven by overseas investors purchasing 37% of the market, rising to 84% within Central London offices. Positive investor sentiment toward the sector was reflected by the increase in capital values, particularly for industrial assets. The benchmark total return of 11.2% exceeded predictions made half-way through the year, although this was notably skewed by returns generated in the industrial sector, which exceeded 21% over the year. The office and retail sectors average returns were both sub-10% over

5 Retail. The latest data also suggest consumers are continuing to devote a growing share of disposable income towards eating out. This does not negate the risks in the restaurant occupational market, which is struggling with excess supply in some locations where brands have scaled-up too quickly. There continue to be active requirements in the retail market from both new and established brands, although decisions are becoming more focused on resilient locations. These are towns and cities that benefit from the urbanisation trend of people movement back into urban locations; that foster localism and community involvement within retail schemes; and that have a varied recreational and cultural offer. Office. Little is certain regarding the future ability of financial services to trade with the EU. Such uncertainty may restrict office leasing activity, with knock-on effects to other sectors. However, London leasing volumes of 11 million sq. ft. over 2017 were up 9% on 2016, with rental growth ahead of expectations. However, structural uncertainties mean London offices are expected to be the weakest performing segment over the next five years. Although the banking and finance industry drove a reasonable proportion of take-up last year, there remains caution over this sector over the medium term. Beyond London, take-up volumes have been reasonable at 8.8 million sq. ft. across the Big 6 cities and Western Corridor, 23% up on A tilt to locations with attributes which best support employment growth remains prudent. Industrial. The economic drivers supporting the industrial sector are robust. UK manufacturing was one of the leading sectors of the economy last year and exports of goods remains strong. However, industrial leasing volumes were disappointing over the 12 months to Q at 30 million sq. ft. This apparent contradiction could be explained by larger requirements being fulfilled over while limited supply options restricted take-up for smaller light industrial units in We remain convictional on the fundamentals: the structural shift to online and e-commerce; an expanding trade sector; and a buoyant small enterprise sector supported by lending at attractive rates. Furthermore, pressure from residential and limited development will support demand for space. Industrial rents and returns outperformed significantly over We believe this trend could continue in Figure 2: MSCI IPD quarterly property performance, Q Quarterly performance, Q Total Return Income Return Capital Return All Property 3.3% 1.2% 2.1% Offices 2.6% 1.0% 1.5% Industrials 6.2% 1.2% 5.0% Retail 1.8% 1.3% 0.5% Source: MSCI IPD Q Quarterly Digest 5

6 Legal & General UK Property Fund REVIEW OF THE QUARTER The fund delivered positive returns in the fourth quarter of the year, and over 2017 as a whole. The fund remains overweight to cash but is making progress with acquisitions activity. Q During the quarter, we completed on the acquisition of a Tesco superstore in Kettering for 51.55m. The asset is let to Tesco for 12 years with annual RPI indexation in the rents. It is a dominant store, and whilst over-rented, this is reflected in the relatively high yield. We also completed on the INTO Exeter student accommodation investment in early December for 49.6 million. Total new property investments in 2017 reached 334 million. In terms of sales, we completed on the sale of a high street shop investment, located on Princes Street in Edinburgh for 2.98 million. 6

7 Asset allocation Geographic breakdown Sector breakdown 7.1% 13.3% London 7.1% 17.4% South East 22.9% South West 22.9% 12.0% East Midlands / Wales 5.8% North England / Scotland 3.1% Cash 6.6% 18.1% 17.7% REITs / Derivatives 4.1% 21.1% 20.8% Retail Office Industrial Leisure Alternatives Cash REITs / Derivatives Top 10 holdings, sector and lot size Asset Sector Lot size ranges Lichfield - Fradley Park Distribution Warehouses 130m - 140m Leeds - Birstall Shopping Park, Birstall Retail Parks 100m - 110m London - 15 Bonhill Street & 18, 20 & 22 Epworth Street Offices - City 90m - 100m Birmingham - One Colmore Square Offices - Rest UK 90m - 100m Gateshead - Follingsby Park Industrials - Rest of UK 70m - 80m Priestley Way,Staples Corner,London Industrials - South East 60m - 70m INTO Exeter Other 50m - 60m Cambridge - 214, 216, 240, 220 and 230 Cambridge Science Park Office Parks 50m - 60m Tesco Kettering Retail Parks 50m - 60m Hampton By Hilton Stansted Leisure 40m - 50m 10 Largest Properties as a % of fund (value) 26.46% Top 10 tenants Top 10 tenants Contracted rent (% fund) Tesco Stores Limited 3.07% INTO University Of Exeter LLP 2.87% Argos Limited 2.84% Waitrose Limited 2.80% Jvckenwood U.K. Limited 2.63% Newell Rubbermaid Uk Services Ltd 2.08% Leonardo Mw Ltd 1.88% Tradeteam Limited 1.78% Next Holdings Limited 1.72% Ernst & Young Llp 1.70% Total (Sum of all leases by contracted rent) 23.37% Source for all: LGP, IMA, Lipper. 7

8 Fund performance Key facts Key facts Fund size 2.99 billion Number of direct properties 95 Average lot size Cash million million Source: LGP. As at 31 December Annualised fund performance 9% 8% 8.8% 1 year 3 years 5 years 10 years 8.5% Annualised Return (%) 7% 6% 5% 4% 3% 6.9% 7.0% 4.8% 6.4% 4.3% 2% 2.5% 1% 0% Legal & General UK Property Fund Lipper Peers Source: LGIM, Lipper as at 31 December Past performance is not a guide to future performance, and may not be repeated. Note: Lipper Peers are key comparable UK funds that primarily invest directly in UK commercial property assets: median, annualised. Legal & General UK Property Fund shows I class total return net of fees. Yields Legal & General UK Property Fund Net initial yield 4.74% Void rate (excluding development) 4.59% Historic yield - I class 2.90% Source: LGIM as at 31 December

9 Q Legal & General UK Property Fund Transactions: Case study In Q4 the fund built on its portfolio of alternative assets with a student accommodation acquisition at Exeter University for a consideration of 49.6 million. The accommodation comprises 517 rooms, including 160 studio rooms; 355 en-suite cluster rooms; and two staff rooms across five blocks. The buildings occupy a prime location - situated a short walk from the main University campus, to the North of the main University buildings. The assets are let for a term of 35 years to INTO University of Exeter, with rental uplifts linked to inflation built into the lease. The INTO organisation is affiliated with a worldwide network of universities, helping to provide specialist degrees and pathway programmes for international students. The long-income sector performed well over 2017 and is forecast to continue to generate strong returns going forward; investor-demand for long-let assets producing secure, index-linked income has driven asset values. The L&G UK Property Fund achieved good pricing for this transaction relative to other comparable recent transactions. In the current projected market scenario where income returns are set to underpin performance, this purchase will contribute to the security and longevity of the fund s contracted income stream while providing a helpful hedge against inflation. This transaction by the L&G UK Property Fund formed part of a larger 76 million deal which LGIM Real Assets undertook with the University of Exeter, which also encompassed teaching facilities. The deal was facilitated by our ability to take a combined, collaborative approach across the platform; deploying capital from two different funds to satisfy wide-ranging investor needs. 9

10 Outlook Commercial property performance over full-year 2017 surprised to the upside. Returns generated from industrial assets were particularly notable. The near-term outlook for returns is likely to be more modest. Sluggish rental growth, broadly flat yields and typical rates of depreciation result in expected average annual returns for All Property of between 4-5% p.a. over the next five years. Such returns would be low relative to both recent history and long-term averages and may seem unattractive on this basis. However, this would still offer a historically robust income arbitrage to gilts. And while investors remain optimistic about the performance of equities over 2018, there are concerns emerging about the sustainability of their valuations. There is likely to be a meaningful spread in sector performance. This is due partly to specific risks around performance for London offices, suffering from uncertain demand and an elevated level of new supply coming to market. We maintain a positive view on industrials, residential and leisure; sectors that are connected by resilient yield and a solid underlying demand and supply dynamic. Thematically, our Research team has highlighted the need to balance resilience and optionality: resilience against downside risk combined with optionality to maintain sufficient growth potential to respond if the economy surprises to the upside. We therefore expect real estate capital allocations to be broadly maintained inflows may well be more modest but without a tangible rationale for a correction in capital values, we believe many longterm investors will choose to remain invested rather than bearing the cost of disinvesting out of the asset class. 10

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12 CONTACT US For further information about our UK Property Fund, please contact us: * lgim.com Important Notice This is not a consumer advertisement. It is intended for professional financial advisers and should not be relied upon by private investors or any other persons. This document should not be taken as an invitation to deal in any Legal & General investments including the stated investments. Remember, the value of investments and any income from them may fall as well as rise and investors may get back less than they invest. Past performance is not a guide to future performance. The value of property is generally a matter of valuer s opinion rather than fact. *Call charges will vary. Legal & General Unit Trusts are brought to you by Legal & General (Unit Trust Managers) Limited, which is authorised and regulated by the Financial Conduct Authority. Q /18 H