Chief executive officer Francis Salway is overseeing Land Securities’ split into three new companies.

Land Securities Group, the largest U.K. REIT, will divide into three separate companies

By Charles Keenan .

Land Securities Group (LSE: Land.L), once the United Kingdom’s largest publicly traded property company according to the FTSE EPRA/NAREIT Global Real Estate Index, has decided that three heads are better than one.

The London-based REIT announced in November 2007 that its three divisions—retail, properties located in London and property outsourcing—would eventually morph into three separately traded companies. The proposal is significant in part because of Land Securities’ size: the company had an equity market capitalization of $13.6 billion in mid-December, making it the largest REIT in Europe and one of the five biggest in the world.

However, the proposal also reflects a sign of the times, as the U.K. REIT market follows the specialization trends already in favor among listed real estate companies in the United States and Australia. Institutional investors are looking for companies that have a clear business focus, are easier to value and are more clearly aligned by property type. Land Securities theorizes that breaking the REIT into three separate companies will help lure investment from overseas, says Francis Salway, chief executive officer.

“We’re not only a U.K.-listed company, but also part of the global REIT universe,” Salway says.

Breaking Away

While Land Securities would lose its status as the country’s biggest REIT, the new companies would be a presence in their own right. “We are a very substantial business,” Salway says. “We’ve had some of the largest development projects in the United Kingdom, and they were great successes. Yet, at the moment, the profits are spread across a diversified balance sheet.”

Total returns for the company had yielded 206 percent over a six-year period ended Mar. 30, 2007, versus 195 percent for the FTSE EPRA/NAREIT Global Real Estate Index and 36 percent for the FTSE 100. Yet, for most of last year, Land Securities’ stock had been caught in a downdraft, having dropped 34 percent for the year.

Piccadilly Lights in London is not only a national icon and global tourist attraction but also generates more income from advertising than the building.

Earnings per share forecasts are modest over the next few years, including $1.76 per share for the fiscal year ending Mar. 30 and the same for FY09, according to Deutsche Bank Securities. Also holding the stock down are persistent concerns about the credit crunch and how far property values will fall, fueled by expectations of a pullback in the financial services industry and broader economic weakness, says John Perry, an analyst at Deutsche Bank in London. “Clearly, Land Securities is suffering from a lack of visibility,” Perry says. “Unfortunately, we expect that lack of visibility to persist.”

London and Retail Sectors

Approximately 55 percent of Land Securities’ assets are in its London portfolio, valued at $17 billion as of Sept. 30, 2007, which does not account for debt on the books. The REIT owns many landmark buildings, such as Piccadilly Lights, the site of famous advertising billboards in London’s West End. The portfolio is also concentrated in two other districts: Mid-town and the City. Today, Land Securities’ properties account for roughly 4.5 percent of all London office floor space.

Despite concerns about London’s economy, vacancy rates have declined, helping boost rental growth. Land Securities’ office portfolio had a 4.5 percent vacancy rate at the halfway mark of its fiscal year, Sept. 30, 2007. That’s down from 5.4 percent in March 2007. The portfolio’s valuation increased 7.6 percent to $17 billion for the 12 months ended Sept. 30. Much of its latest development is nearing completion, including mixed-use projects in the Mid-town section. “We are responding to our customers’ needs with innovative, relevant buildings and top-quality customer services,” Salway says.

Buchanan Galleries in Glasgow is currently expanding to become one of the largest shopping centres in the U.K. with more than 1.3 million square feet of retail space.

Land Securities might also be better prepared for further weakening in London’s economy, which has softened due to the problems among financial companies. All told, a third of its rents come from the central government and the Metropolitan Police Authority. “Land Securities’ London office portfolio is well-positioned to weather a potential downturn,” Perry says.

The company has also timed the real estate slowdown well. Of the 1.6 million square feet of office space it is completing for fiscal year 2008, 93 percent was leased as of Sept. 30 last year, Perry notes. It will deliver only 275,000 square feet of space in fiscal year 2009 and fiscal year 2010 combined.

“We have made progress on leasing agreements before starting the next development,” Salway says. “We had a degree of caution that the rate of growth in the city might slow a little.”

Land Securities is also getting better rents than its competitors for new space, notes Steve Bramley-Jackson, an analyst at Credit Suisse in London. The REIT signed Central London law firm Speechly Bircham at $110 a square foot in July for a 77,000 square-foot space. Land Securities “has been more successful on attaining higher rents than many of its competitors,” Bramley-Jackson says.

Meanwhile, Land Securities’ retail division—valued at $13.8 billion on Sept. 30, 2007—has focused on developing mixed-use projects across the United Kingdom, often on sites in city centers. Two examples include Princesshay, a 480,000 square foot complex with shops, residences and restaurants that opened in September 2007 in Exeter; and Christ’s Lane, a similar mixed used 75,000 square foot facility that opened in Cambridge in November 2007.

Often, these projects involve development near historic locations, requiring an expertise in design and the process of getting approvals. “We have a very strong track record on developing sensitive retail projects in historic cities,” Salway says. “Our track record in doing that in historic locations is second to none.”

Outsourcing Sector

Land Securities has also ramped up investment in the property outsourcing business. The division, Land Securities Trillium, manages commercial sites for a number of clients nationwide, including the Royal Mail, Department for Work and Pensions, and Barclay’s. With these types of contracts, Trillium assumes long-term ownership—20 years or so—and invests in property improvements and services, valued at $4 billion as of Sept. 30, 2007. Land Securities assumes the risk of upgrading and managing the property, but also reaps the benefit of increasing cash flows, which are linked to price indices to account for inflation.

140 Aldersgate Street in London is the company’s first exposure to the city of London market.

“With the current tighter economic situation we’re entering, corporations will be looking more at the efficient use of their real estate,” says Ian Ellis, chief executive officer of Trillium. “They will look to how they can release surface space, maximize asset values and reduce running costs. That is what will drive the customer towards us.”

Trillium has also delved into another type of property outsourcing known as “public-private” partnerships, where it partners with government by taking a stake in the investment. Trillium last year bought the Secondary Market Infrastructure Fund for nearly $2.1 billion, the largest owner of social infrastructure in the United Kingdom after the government. The deal added 79 partnerships to its portfolio, including sites such as schools, hospitals and prisons. Trillium now manages more than 100 partnerships. Floor space under management increased 57 percent in the 12 months ended Sept. 30, 2007, alone. The portfolio now manages more floor space than the London and retail portfolios combined.

“The growth of Land Securities Trillium is significant,” Salway says. “Property outsourcing and private-public partnerships bring greater benefits of economies of scale than property investments.”

Modest Beginnings Land Securities began its rise in the U.K. real estate ranks in 1944, when Harold Samuel, the company’s founder and chairman, bought Land Securities Investment Trust Ltd., then a small company that owned three houses in London’s Kensington district, and some government stock. Samuel’s strategy was to partner with the country’s local authorities and work with them to rebuild the ravaged towns and cities after the war. Land Securities grew rapidly, buoyed by low interest rates and shortages of properties and materials—all of which helped raise property values. By 1969, the company had become the largest U.K.-quoted property company. Land Securities never looked back over the decades. The company dipped its toe into the property outsourcing business in 1998, then made a large splash by purchasing the specialist Trillium for $698 million two years later. The REIT started laying the groundwork in 2004 for its structure to become three separately traded companies. It shed its industrial business, allowing it to focus solely on its three divisions. The businesses “now have a record of strengthening their positions within their sectors and delivering performance that can be readily identified separately,” Salway says.

Anyone’s Guess

Still, the big question is when Land Securities will break up into three. The REIT has yet to issue a timetable, since it will have to restructure the equity and the debt of the company. The current credit climate would make restructuring debt expensive; analysts estimate it will be at least a year before anything happens.

When it does happen, investors could realize $3.49 to $3.69 per share of potential unlocked value in Trillium, says Credit Suisse’s Bramley-Jackson. “It’s a robust platform,” he says. “It has contractual income going 15 to 20 years out, with most of it indexed.”

The down side of the de-merger, analysts say, is that Land Securities will lose the steady cash flows of Trillium—which may be just the tonic it might need to smooth out earnings if market conditions for its London and retail divisions worsen down the road. The de-merger will also cost around $154 million in legal and advisory fees.

However, let the investors decide on how to allocate their portfolios against market downturns, Salway says. “Clearly, this is about allowing investors to choose sector allocation, rather than the company management making that selection on their behalf,” Salway says. “We recognize that technically it is more efficient for shareholders to do it, because shareholders have greater liquidity in shares and lower transaction costs than we do with direct property.”