NATIONAL AUDIT OFFICE

REPORTBYTHE COMPTROLLERAND AUDITORGENERAL

The Performanceof the CrownEstate

ORDEREDBY THEHOUSEOFCOMMONS TOBEPRINTED 18JULY1994

LONDON:HMSO f6.60 NET 622 THE PERFORMANCE OF THE CROWN ESTATE

This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act.

John Bourn National Audit Office Comptroller and Auditor General 15 July 1994

The Comptroller and Auditor General is the head of the National Audit Office employing some 800 staff. He, and the NAO, are totally independent of Government. He certifies the accounts of all Government departments and a wide range of other public sector bodies; and he has statutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources. THE PERFORMANCE OF THE CROWN ESTATE

Contents

Page

Summary and conclusions 1

Part 1: Introduction 6

Part 2: The performance of the Estate 9

Part 3: Management of the Estate to meet the Commissioners’ objectives 13

Part 4: Managing Agents 20

Appendices

1: Recommendations by the Committee of Public Accounts in their 22 11th Report of 1988-89 on the Crown Estate

2: Details of the case studies of development projects examined by the 24 National Audit Office

3: Criteria used by the National Audit Office to identify ways in which 34 the Crown Estate could further develop their business systems

4: Possible measures and indicators to assess the performance of agents 36 employed by the Crown Estate THE PERFORMANCE OF THE CROWN ESTATE

Summary and conclusions

1 The Crown Estate consists of a wide variety of land and property spread throughout Great Britain. As at 31 March 1994 the Estate was valued at E2,032 million and in 1993-94 earnedE79 million for the Exchequer.

2 The Estate is managed by a Board of Commissioners who have a duty to maintain and enhance the value of the Estate as a whole and the return obtained from it, with regard to the requirements of good management. The Commissioners are the trustees of a varied estate held as a long-term investment rather than managers of a property portfolio to be traded for short-term profit. They operate under a number of constraints: the need to balance long-term estate management requirements with short-term revenue performance; an inability to borrow funds to finance new investments; and a statutory duty to finance the continued upkeep of Windsor Great Park. The Commissioners employ commercial agents to assist in the management of 74 per cent of their property by capital value.

3 The National Audit Office investigated:

. the performance of the Estate;

. whether the Estate is managed to meet the Commissioner’s statutory objectives; and

. the adequacy of the arrangements set up by the Crown Estate with their managing agents.

4 The National Audit Office also examined whether the Crown Estate have implemented recommendations made by the Committee of Public Accounts in their 11th Report of 1988-89.

The performance of the Estate

5 The National Audit Office found that, despite the downturn in the property market in 1990, the Commissioners have succeeded in enhancing the value of the Estate by some 1I486 million in real terms in the period 1985 to 1994 to meet their statutory objectives. The capital value of the Estate increased from cl,546 million in 1985 to ~F2,032 million in 1994 both at 1993-94 prices (paragraph 2.2).

6 The Commissioners have also steadily increased their revenue contribution to the Exchequer to meet, and on a number of occasions exceed, annual forecasts agreed with the Treasury. The net revenue surplus paid over to the Exchequer by the Crown Estate in 1985-86 was E39 million, at 1993-94 prices, rising to E79 million in 1993-94. This is a significant achievement for the Commissioners given the constraints placed upon them and the severity of the depression in the property market since 1990. The growth mainly arises from management activity related to rent reviews, the reversion of leases to the Crown Estate which have been relet at increased rents, and the income generated from new developments and acquisitions (paragraphs 2.3 and 2.4).

1 THE PERFORMANCE OF THE CROWN ESTATE

7 The Investment Property Databank, an independent research organisation, provides a benchmark of institutional property performance using the annual return which is a measure of the increase or decrease in the capital value of the properties and the income they generate. The Crown Estate has commissioned the Databank to produce annual comparative analyses of their urban commercial estate against the benchmark. These comparisons cannot be precise because of the different nature of the Crown Estate’s holdings and the portfolios in the Databank and because they depend heavily on professional judgements of capital value. Nevertheless, the Crown Estate and the National Audit Office consider that the benchmark is the best available external indicator of the performance of the Crown Estate’s urban commercial portfolio. The Databank’s 1993 report to the Crown Estate showed that the average annual return on the Crown Estate’s commercial urban property in the period 1986 to 1992 was 7.6 per cent against the Databank average of 8.3 per cent (paragraphs 2.6 to 2.7).

8 The annual return from the Crown Estate’s urban commercial portfolio is lower than the Databank average mainly because the mix of properties in the hereditary Crown Estate, with a heavy concentration in offices and Central London, differs materially from the other portfolios in the Databank which are more balanced geographically and by type of property. The Crown Estate’s dependence on Central London was a benefit during the property boom between 1986 and 1989, but has proved comparatively unfavourable in the poor market conditions that have prevailed since 1990 (paragraph 2.8).

9 In addition, whilst the annualised capital growth for the Crown Estate’s urban commercial portfolio in the period 1986 to 1992 was 3.0 per cent compared to the Databank’s 2.1 per cent, for each year since 1986 rental income returns from the Crown Estate’s urban commercial portfolio have been between one and two percentage points lower than the Databank average. The rental income return is a measure of the income received as a percentage of capital value (paragraph 2.9).

10 Income is restricted by the leasing arrangements that the Commissioners have inherited from their predecessors including many long-standing leases where rental income is only a haction of the current market rent and where there is no provision for rent increases (paragraph 2.9).

Management of the Estate

11 TheCommissioners have sought to investin propertyoutside Central London to reduce the risks arising from the heavy concentration of assets in one area. Their diversification portfolio consists of 19 properties acquired since 1984 at a cost of around E270 million, whichwere valued at aroundf224 million at 31 March 1994. The latter figure reflects the current, still depressed, state of the cyclical property market (paragraphs 3.3 to 3.5).

12 The Commissioners are currently re-considering their diversification policy. They recognise the need for investment in Cential London to protect key interests which offer potential for capital and revenue growth in the future, and that there would have to be an investment of many more hundreds of millions of pounds in diversification outside London to make any real impact in terms of spreading risk. Between 1995 and 2010 many valuable leases in Central London revert to the Crown and will enable the Commissioners to realise substantial capital sums.

2 THE Pm.FoRMANm OF THE CROWN EST‘4TE

Strategic decisions on how much capital investment to divert from Cenixal London will have a significant bearing on the performance of the Estate well into the next century [paragraphs 3.2 and 3.7).

13 In the mid and late 198Os, the Commissioners devoted substantial resources to developments, but have since reduced their involvement in such projects because of the market risks involved. The Databank’s 1993 report indicated that developments have reduced the annual returns achieved by the Crown Estate’s urban portfolio by 1.4 percentage points between 1986 and 1992. In the same period developments of commercial properties in the Databank reduced annual returns by 0.6 percentage points indicating that other property owners have experienced difficulties in the depressed market (paragraph 3.8).

14 The National Audit Office examined a sample of 10 developments on which the Crown Estate had spent some E247 million, not including the Regents Park Villas. As at 31 March 1994 the developments, which are generating substantial income for the Crown Estate, were valued at E283 million, not including the Regents Park Villas. The Crown Estate successfully limited their exposure when carrying out developments by agreeing maximum expenditure commitments and by sharing risk with investment partners where appropriate. In some cases, a more consistent approach to appraisal could have assisted performance (paragraphs 3.9 to 3.12).

15 Since 1989 when the Committee of Public Accounts last reported on the Estate, the Crown Estate have made a number of worthwhile revisions to their management procedures. These include:

. the establishment of a planning and budgeting cycle based on regular reviews of their investment strategy;

. the development of consistent appraisal procedures;

. the preparation of business plans for each part of the Estate; and

. the establishment of an Investment and Project Monitoring Committee to analyse investment performance, advise on investment strategy and appraise potential investments (paragraphs 3.13 and 3.14).

16 However, as a number of their procedures are still relatively new, the National Audit Office developed a check-list of issues that should be considered as the Crown Estate further develop their business systems. The key points are that:

. there should be more consistency in the information presented in the business plans produced for each part of the Estate: and

. further progess is required to develop clear and quantified internal objectives and targets, to meet the recommendations of the Committee of Public Accounts in 1989, whilst recognising the Commissioners’ desire to retain some degree of flexibility aa a long-term investor so that advantage can be taken as opportunities arise (paragraph 3.17 and Appendix 3).

3 TIE PERFORMANCE OF THE CRCIWN ESTATE

Managing agents

17 The Crown Estate have made only limited use of quantified standards and targets against which to measure the performance of their agents. They have recognised that more quantitative evidence about agents’ performance would be useful and could lead to value for money improvements and have developed a formal performance monitoring procedure for operation from 1994. Therefore, the National Audit Office, with the help of their advisers and drawing on best practice elsewhere, prepared a menu of possible indicators from which the Crown Estate might develop a cost-effective performance measurement system based on standards and targets for key activities in each area of the Estate (paragraphs 4.6 to 4.9 and Appendix 4).

4 THE PERFORMANCEOF THE CROWNESTATE

Part I: Introduction

1.1 The Gown Estate is part of the hereditary Gown, which are known as the heartland possessions of the Crown. It is not owned by estates; and to invest in low risk, good quality the Government nor does it form part of the property that is in keeping with their policy of private estate of the Sovereign. The Estate is good stewardship. The heartland estates are managed under the provisions of the Crown defined as Regent Street, St James’ and Pall Estate Act 1961 by a Board of Commissioners. Mall, Kensington and Regents Park and were The members of the Board consist of a First valued at E877 million at 31 March 1994. Commissioner who is Chairman of the Board, a Second Commissioner who is the senior 1.5 The Crown Estate Act 1961 prevents the Estate permanent official of the Crown Estate, and up fmm borrowing money and allows them to to six other Commissioners who, like the First hold reserves only as cash at the bank or in Commissioner, serve on a part-time basis. The Government securities. The Act also Commissioners have a statutory duty to distinguishes between capital and revenue maintain and enhance the value of the Estate income. The Estate cannot use revenue income and the return obtained from it, with due to develop or purchase property and by statute regard to the requirements of good the net revenue surplus must be surrendered management. each year to the Exchequer. Capital income is generated from the sale of leases, where the 1.2 The Gown Estate consists of a wide variety of lease is for over thirty years, and horn the sale property spread throughout Great Britain of property. The Estate are barred by statute including Regent Street and other property in from disposing of a small number of properties Central London, retail centres, business parks of special significance, including Windsor and offices, housing, farms and approximately Great Park. half the foreshore and the seabed lying below mean low water and the limit of territorial waters (Figure 1 opposite). At 31 March 1994 Scope of the National Audit Offke’s the value of the Estate was D,O32 million. In investigation 1993-94 the Crown Estate made a surplus on their revenue earning activities of E79 million 1.6 Against this background the National Audit from a turnover of El25 million. In 1993-94, Office examined: the Gown Estate employed at a total cost of ~11 million an average of 548 staff, of whom . the performance of the Estate [Part Two); 249 worked at Windsor Great Park and 299 on the remainder of the Estate. . whether the Estate is managed to meet the 1.3 Agents assist in the management of 74 per cent Commissioners’ statutory objectives (Part by value of the Estate. Expenditure on Three); and management fees and costs in 1993-94 amounted to E5.5 million, approximately 23 . the adequacy of the arrangements set up by per cent of operating costs. the Crown Estate with their managing agents (Part Four). 1.4 There are a number of important features that distinguish the Crown Estate from a 1.7 The National Audit Office also examined commercial property company or an insurance whether the Crown Estate, in seeking to company or pension fund with substantial develop their business, had implemented assets in property. The Commissioners are the recommendations made by the Committee of trustees of an estate that is held as a long-term Public Accounts in their 11th Report of investment rather than the managers of a 1988-89 on the Crown Estate. Appendix 1 sets property portfolio to be traded for short-term out the Committee’s recommendations, the profit. Their policy is to retain those properties in Central London traditionally held by the

6 THE PEF.FORMANCE OF THE CROWN ESTATE

Figure1: The urban and agricultural propertiesof the CrownEstate

0 n Agricultural Estates Urban Estates

37 Poy”ingr 6051)011 38 meridge 73 siiilms 38 ROrmeyMxsh 74 metford 40 Smmlaiie 15 Winchester 41 SCOtSCdldB‘ 15 wane*, 42 Sledmere 43 StaDlebrdAbb0m 44 We70 45 smx iJk”d 46 swine 47 nmm 48 iOral 49 Wtlaplode 50 Wtmiil Both 51 wqland 77 OXIhO” 52 WycIIwmd 78 Tmm” :‘-.. 19 Wi”d60,

270 60

520 70=

Source: TheCrown Estate Figure1 shows the locationof the CrownEstate’s urban and agriculturalproperties.

7 THE PERFORMANCE OF THE CROWN ESTATE

Treasury Minute response, and the Crown by the Crown Estate and discussions with Estate’s subsequent actions, as noted in this senior staff and agents employed to manage RPOrt. urban properties. The National Audit Office’s team also made visits to a number of the 1.8 The National Audit Office’s investigation Crown Estate’s properties: Regent Street and focused on the Crown Estate’s urban portfolio the Gothick Villa in London and the Crowngate which was valued at ?21,521 million at Shopping Centre in Worcester. 31 March 1994 and generated s79 million worth of gross surplus revenue in 1993-94. The 1.10 The National Audit Office employed Gerald urban estate consists of commercial and Blundell, Peter Matthews and Malcolm Naish residential properties located predominantly in of Jones Lang Wootton and Martin Avis, London. Chesterton Professor of Real Estate Management at Oxford Brooke-s University, as 1.9 The National Audit Office’s analysis of the advisers on aspects of the examination. Estate’s performance and management activities was based on a review of papers held

8 THE PERFORMANCE OF THE CROW ESTATE

Part 2: The performance of the Estate

2.1 Under the provisions of the Crown Estate Act 2.3 The net revenue surplus paid over to the 1961 the Commissioners are required to Exchequer has grown steadily from E39 million maintain and enhance the value of the Estate in 1985-66 to f79 million in 1993-94, at and the return obtained from it. In order to 1993-94 prices, mainly due to the growth in assess the extent to which the Commissioners income from the urban portfolio (Figure 3). have achieved this objective, the National This growth is mainly attributable to rent Audit Office analysed the performance of the reviews, the reversion of leases to the Crown Estate since 1985 when annual valuations were Estate which have been relet at increased first introduced. Performance was analysed rents, and the income generated from new against income forecasts agreed between the developments and acquisitions. Approximately Commissioners and the Treasury and against 78 per cent of the gross revenue surplus now relevant external benchmarks. This analysis comes from urban properties compared with must be considered in the context of the 70 per cent in 198586. downturn in the property sector since 1990. Figure 3: Growthin net revenuesurplus of the Crown The performance of the Estate since Estate 1985 f million 90 , 2.2 The value of the Crown Estate rc,se from S962 1 million in 1985 to E2,032 million in 1994 (Figure 2). In real terms, at 1993-94 prices, the value of the Estate has increased in this period born El,546 million to f&032 million.

Fioure2: Growthin caoital value of the CrownEstate

f million 3.500 / / Inflation adjusted value 3,000

2,500 1985 1986 1987 1988 1989 1990 1991 1992 1993 -86 -87 -88 -89 -90 -91 -92 -93 -94 2,000 ~:-:j

1.500 Source: CrownEstate ann~a, accounfs Historic Value /,’ Note: Historic valuesa&&d to 1994values using GDP 1.000 _-- indices. Figure3 showsthat revenueincome increasedsubstantially in ,,:I real terms from 1985-86to 1993-94. 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Performance against income forecasts Source: CrownEstate annual ~ccomNI1s

Note: Historic valuesadjusted to 1994values using GDP 2.4 Future revenue contributions to the Exchequer indices. are forecast annually by the Crown Estate and agreed with the Treasury. On performance Figure2 shows that the value of the CrownEstate increased greatly from 1986to 1990as the property marketreached its against these forecasts the National Audit peak.Between 1990 and 1993the inflationadjusted value fell Office found that: backto 1987 levels, but in 1994it started to rise again.

9 THE PERFOFMANCE OF THE CROWN ESTATE

. in recent years the Crown Estate have met achieved by other property owners and is the and on occasions exceeded the revenue best available external indicator of the contribution agreed with the Treasury. performance of the Crown Estate’s urban Projections by the Crown Estate indicate commercial portfolio. that, in future, revenue surpluses will not grow at the rate that they have achieved 2.7 In September 1993 the Databank reported to over the last five years and that a slight the Crown Estate that the average annual levelling off can be expected. In response return on the Crown Estate’s commercial urban to this, the Commissioners have recently property in the period 1986 to 1992 was 7.6 modified their urban investment strategy per cent against the Databank’s average return with the aim of purchasing properties with of 8.3 per cent. The annual return is a measure higher income potential; and of the increase or decrease in capital value of properties, which is a matter of professional . the Crown Estate have made successful judgement, and the income that they generate. efforts over the last three years to improve The Crown Estate significantly out-performed the accuracy of their estimating procedures the Databank benchmark for average annual and their control over outturn against return from 1986 to 1988, but comparative budgets. For example, in 1989-90 property performance has deteriorated since then expenses amounted to Q0.3 million which (Figure 5 opposite). In 1992, the annual return was 20 per cent more than the budget of on the Crown Estate’s urban commercial f16.7 million. In 1993-94 property properties was minus 6 per cent compared to expenses of E23.2 million were just under the Databank average of minus 2.8 per cent. four per cent less than the estimated figure of s24.1 million. This pattern of 2.8 The extreme range of the Crown Estate’s improvement is reflected in other budget investment performance shown in Figure 5 is areas. mainly the result of fluctuations in capital values. The commercial urban portfolio is particularly sensitive to such changes because Performance of the Crown Estate’s of the concentration of properties in Central London offices where the effects of the urban commercial properties downturn in the property market have been against the Investment Property particularly marked [Figure 4). The heavy Databank concentration in Central London, which accounts for 73 per cent of the Estate’s urban 2.5 The Investment Property Databank is an office assets and 76 per cent of their retail independent research organisation which properties, was a benefit during the property produces a database of commercial property boom between 1986 and 1989 but has since investments. Around 70 per cent of proved comparatively unfavourable. This institutional property investments in Great negative impact was most pronounced in 1991. Britain are now included in the database. The Databank have developed a re-weighted index to reflect mcxe closely the composition 2.6 Since1986, the CrownEstate have registered of the CrownEstate. This revisedindex will be with the Databank details of all their useful as an additional indicator to explain commercial urban properties, and have made variations in the Crown Estate’s performance. some use of the reports on Crown Estate performance commissioned annually from the 2.9 In 1993 the Databank reported that whilst the Databank in assessing returns on investments. annualised capital growth for the Crown The mix of properties in the Databank differs Estate’s urban commercial portfolio in the materially from the Crown Estate [Figure 4 period 1986 to 1992 was 3.0 per cent compared opposite), the nature of the holdings is to the Databank’s 2.1 per cent, for each year different, and the comparisons made by the since 1986 rental income returns from the Databank rely heavily on professional Crown Estate’s urban commercial properties judgements of capital value. Nevertheless both have been between one and two percentage the Gown Estate and the National Audit Office points lower than the Databank average. The consider that the Databank provides the most rental income return is a measure of the rental authoritative benchmark of the relative income received as a percentage of capital performance of the Crown Estate against that value. In 1992, the Crown Estate’s return was 6.6 per cent against the Databank’s figure of

10 THE PERFORMANCE OF THE CROWN ESTATE

Figure 4: The structure of the CrownEstate’s portfolio comparedto the averageportfolio held in the InvestmentProperly Databank

Percentageof porifolio

100 The Crown Estate 100 The Investment PropeQ Databank Restof GB L +r 80 80 Central London 60 60

-~~ ,.‘, ,. RestofGB + 4 40 ‘,‘,,,,(, 40 20 ,,, ., 20 Hi,, 1 0 Retail Office Industrial Other TOTAL Retail FOffice Industrial Other Source: InvestmentPropem Databankcomparativerepoii on the CrownEstate, September 1993

#vote: Thisanalysis is based on the performanceof the CrownEstate’s commercial urban portfolio at 31 December 1992, Figure4 showsthe hew concentrationof Crown Estatewowties in offices and in CentralLondon cornoared with the InvestmentPraoertv Databank.

Figure5: CrownEstate position againstthe InvestmentProperty Databank

Percentage return 72 Maximum Fund return X Crown Estate 60 IPD Weighted Average Return 48 4 RMinimum Fund return X 36 X 24 X 12 l-l 0 I -12 B X -24 +I -36

-48

Source: InvestmentProperty Databankcomparativereport on the CrownEstate, September 1993.

NOte: Thisanalysis is basedon the performanceof the CrownEstate’s commercial urbanpoHo/io. Figure5 showsthat the Crown Estatesignificantly out peltormedthe Databankbenchmark from 1966to 1968 but comparativeperformance has deterioriatedsince.

11 THE PERFORMANCE OF THE CROW ESTATE

7.6 per cent. In practice, the Crown Estate’s minimum return that the Commissioners rental income is restricted by the leasing should achieve on their property investments. arrangements that the Commissioners have The Databank’s 1993 report indicated that over inherited from their predecessors: the period 1986 to 1992 the average annual return on Government securities was 12.7 per . the Crown Estate have frequently sold long cent, compared to an average annual return on leases at a low rent with an initial capital the Crown Estate’s commercial urban property payment which they are permitted to of 7.6 per cent [Figure 6). The Crown Estate’s retain and reinvest; the alternative would view is that over a longer period the average have been a higher rent with no initial annual return on their property will have capital payment, generating larger revenue exceeded the return on Government securities. surpluses to be surrendered to the The National Audit Office is unable to verify Exchequer [paragraph 1.6); and this statement because valuations of Crown Estate property, which are the basis for . there are many long-standing leases, measuring annual returns, were not intioduced particularly in the heartland estates, where until 1985. rental income is only a small fraction of the current market rent, which can only be obtained by restructuring the leases many of which are constrained by a series of under leases.

Comparative performance against Government securities

2.10 Under the provisions of the Crown Estate Act 1961, the Crown Estate may invest only in property in the United Kingdom or in Government securities. Therefore, the return available from investment in Government securities represents a benchmark for the

Figure6: Comparisonof CrownEstate annual return against Governmentsecurities Percentagelefum 50 40 crownmate GOYemme”,Securities 30 20 1. _____---- 10 ,..- 0 t -10 -20

Source: CrownEstate annual accounts and investmentProoerfv Databank comoarative rep011 on the CrownEstate. September 1993. Note: Thisana/ysis is basedon the performanceof the CrownEstate’s commercial urban properties. TheCrown Estate annual return is a measure of the increaseor decreasein capital value of properties and the incomethat they generate.A negativereturn is producedby a larger fail in capital valuethan the rise in income. Figure6 shows that the CrownEstate commercial urban porttolio outperformedGovernment securities during the peak in the propeW market, but has since mdnmnrformnd~

12 THE PEWOFMAi’JCE OF THE CROWN ESTATE

Part 3: Management of the Estate to meet the Commissioners’ objectives

3.1 The Crown Estate Commissioners have 3.3 Since 1979, the Commissioners have sought to pursued a number of major initiatives to meet pursue investments away from Central London their objectives in the management of the by creating a diversification portfolio to reduce Estate. These include: the risks arising from the heavy concentration of assets in one area. This portfolio now l the creation of a diversification portfolio, consists ‘of 19 properties acquired mainly mainly to focus investments away from between 1984 and 1992 by purchase or by London; development. The total value of these properties at 31 March 1994 was Z224 million . a programme of major developments: and which is 11.5 per cent of the value of all Crown Estate properties. Most of the new investment,

l the introduction of revised management funded largely from the sale of residential procedures in order to develop a more leases, is in the Home Counties. structured approach to portfolio management. 3.4 The diversification initiative has so far had little impact on the geographic structure of the Urban estate. Excluding the five properties in The creation of a diversification Scotland, only three of the remaining 14 properties are located more than 60 miles from portfolio London (Figure 7 overleaf).

3.2 The Crown Estate have the oppokunity to 3.5 In 1993 the Crown Estate carried out their first realise substantial capital sums cwer the period analysis of the performance of the diversified 1995 to 2010 as many valuable leases in properties. They found that they had spent Central London revert to the Gown. The around f270 million since 1984 on enhancing Commissioners have recognised that this will or acquiring assets which were valued at E224 be a key period for the Crown Estate and that million at 31 March 1994. strategic decisions taken at this time will have a significant bearing on the performance of the 3.6 Further analysis by the National Audit Office Estate well into the next century. Accordingly, of diversification properties that the Crown they have instituted an annual review of the Estate had purchased, rather than developed, strategy for the Central London estates, and indicated that their investment performance property by property reviews which include a had in general been better than that of detailed analysis of properties in Regent Street. equivalent Central London properties. But The results of these reviews will be used to their short-term performance has often failed to determine: meet the Databank’s benchmarks for provincial office and retail investment (Figure 8 on page l the balance between reviewable ground 151. The Crown Estate are confident that over a rents and capital premium; longer period these diversification properties, which they have purchased as long-term . whether to sell the freehold of any investments, will match or out-perform the properties in the heartland estates; and Databank. The National Audit Office were unable to analyse in the same way the . whether to reinvest capital into Regent performance of the developed properties Street cr use the proceeds to pursue a more because the Databank do not produce the radical diversification policy. appropriate benchmarks for the Crown Estate.

13 THE PERFORMANCE OF THE CROWN ESTATE

Fioure7: The diversification arowties of the CrownEstate

w Diversification Properties

“YII.“I.“Y”- m Hereford HemelHempStead omrdI HighWycombe . ’ siAlbans Wi”dsop~Qn.: elackneu HOW.4 GUildford.

7 D-l

Source: The CrownEstate Figure7 showsthe locationof the CrownEstate’s diversification propelties and their proximity to London.

14 THE PERFORMANCE OF THE CROWN ESTATE

Figure 8: The investmentperformance of the CrownEstate’s diversification propertiesas affectedby short term market conditions

Value at Total return Totalreturn 31 March comparedto comparedto 1994compared CentralLondon peer group to Cost equivalent

VictoriaHouse, Harley 1985 0 29 and 31 Charlotte Square,Edinburgh 1986 0 m

FarleyHall, Bracknell 1966 I

RHMBuilding, Windsor 1986 0 0 Tescosuperstore. Hereford 1986 0 I

Be&h Court,Harley 1987 m TheWillows, Hemel Hempstead 1987 Lid 2and4BI hswaod Square,G ? asgow 1988 I The Chilterns HighWycom6e 1988 22 and 24 Blyihswood Square,Glasgow 1989 0

$~aB;?$woodSquare, 1989 0 $;!$!J;;$ BusinessPark, 1989 m 7 and 9 HopeStreet. Edinburgh 1989 0

8;;;; BusinessPark, 1989 0

SheetStreet, Windsor 198911990 Iii

AbbeyView, St Albans 1991 m

Crowngate,wmxster 1992 m The Shires, LearningtanSpa 1993 0 CambridgeBusiness Park, Not Cambridge Completed N/A

Key: lessthan -5% -5% to -1% -1% to +f% +f% to +S% morethan +S%

WOW m 0 0 0 m be”er

Source: NAOanalysis of Crown Estate data and InvestmentProperty Databankreports.

Notes: 1. Thevalue at completionis the valueat the valuationdate nearestto practical completfon. 2. Totalreturn figuresare to 1992.93on&~ 3. CentralLondon equivalent comparisons are based on InvestmentPrope@ Databankaveragereturns for CentralLondon Offtces (Mid-town)and StandardShops (West End). 4. Peergroup comparisonsare based on tnvestmentPropHy Databankaverage returns for officeand retail propetiies in the Sooth East, and the rest of the UnitedKingdom. 5. TheNational Audit Offtcewere unableto evaluatethe performanceof developmentpropefiies in the diversfficationportfolfo,because the InvestmentProperty Databankdo not produce appropriatebenchmarks. Figure8 showsthat many of the CrownEstate’s diversification properties were developedor purchasedtowards the peak of the propelty boom in the late 1980s. Investmentperformance has in generalbeen better than that of equivalentCentral London properties. but has oftenfailed to meet the Databank’sbenchmarks for provincialoffice and retail investment.

15 THE PERFORMANCE OF THE CROWN ESTATE

3.7 The Commissioners ape currently returns by 0.6 percentage points indicating that re-considering their diversification policy. other property owners have experienced They recognise the need for reinvestment in difficulties in the depressed market. The the he&lands estate to protect key interests Crown Estate have told the National Audit which offer potential for capital and revenue Office that the position will have improved growth in the future, and that there would have with the rise in values in 1993-94. to be an investment of many more hundreds of millions of pounds in diversification outside 3.9 The National Audit Office examined in detail a London to make any real impact in terms of sample of 10 developments from the 29 spreading risk. developments undertaken by the Crown Estate in the period 1984 to 1993. In view of the problems affecting an earlier development at The development programme Millbank, London on which the Committee of Public Accounts commented in their 1988-89 3.8 In the mid and late 198Os, the Commissioners Report, the examination focussed on the devoted substantial resources to a number of Crown Estate’s management of the projects. sizeable developments. At 31 March 1989 Case studies on each development are at properties under development were valued at Appendix 2. The sample comprised all major G!ZO million. By 31 March 1994 the value of developments with an open market value developments in progress had dropped to exceeding fl0 million at 31 March 1993, f40.5 million. A report in 1993 from the supplemented by a selection of projects Databank (paragraph 2.7) indicated that new representative of the various operational areas developments, while income producing, had of the Crown Estate’s urban portfolio (Figure 9). reduced the total return achieved by the Crown Estate’s urban commercial portfolio between 3.10 The Crown Estate spent f247 million, not 1986 and 1992 by 1.4 percentage points. In the including the Regents Park Villas, on the 10 same period developments of commercial developments which were valued at properties in the Databank reduced annual f283 million, not including the Regents Park

Fioure9: The 10 developmentpl ?ctsexamined bv the NationalAudit Mice Development Predominanl Completion :xQenditureto DevelopmentValue Value at 31 use Date 1 March 1994 Achieved March1984 income fmillion fmillion fmittion fmittion Abbey View Office 1991 27.1 17.8 (31.3.92) I 70 BalvairdPlace Residential Suspended 4.7 1.0 (31.3.90) N/A N/A 1989 BlythswoodSquare Office 1988 4.8 6.5 (31.3.89) 100 Crowngate Retail 1992 76.9 36.5 (31.3.93) f 79 GuildfordBusiness Park OHice 1989 49.8 40.9 (31.3.89) 67 LancerSquare Retail 1989 25.3 33.6 (31.3.90) 93 172-182Regent Street Retail 6.3 t t Nil Royal Mint Office 1989 31.7 100.0 (31.3.90) 100 31-47 Victoria Steet Office,Retail 1989 20.8 47.2 (31.3.89) 100 & Residentia The Villas: Ionic Villa Residential 1990 100 VenetoVilla Residential 1991 100 GothickVilla Residential 1991 Nil Total 247.4 283 19.84 Source: IVAOana/ysis of CrownEstate papers.

Note: * Thisinformation has not beenpublished as it is commerciallysensitive. Thedevetopment value is the first valuationfoflowtng completionof the development.The date beside each valuationis that of the first valuation. Figure9 summarisesthe details of the 10 developmentprojects examinedby the NationalAudit Office(Appendix 2). Excludingthe RegentsPark Villas, the historic cnst of the propertiesexamined is g47 million comparedto a market value of f283 million. The performanceof these propelties reflects the fact that much of the CrownEstate’s development expenditure was incurredbetween 1987 and 1990when the property marketwas at its peak.

16 THEPERFORMANCEOFTHECROWNESTATE

Villas, at 31 March 1994. Much of the fixed term contracts including 13 of the Crown expenditure on developments was incurred in Estate’s 16 senior managers (Figure 10 the period from 1987 to 1990 when the overleaf). Of these 13,lZ were employed in property market was at its peak. The Crown much the same capacity by the Crown Estate in Estate sought to limit their exposure by 1989 when the Committee of Public Accounts agreeing maximum expenditure commitments published their report. and by sharing the risk with investment partners where appropriate. By prudent project management they succeeded in avoiding many Management systems of the problems that badly affected the earlier development at Millbank (paragraph 3.9). The 3.14 The Crown Estate have established an annual National Audit Office examined a later strategic planning cycle based on regular development at Millbank: Balvaird Place (case reviews of their investment strategy and the study 2, Appendix Z), where the Crown Estate preparation of business plans for each part of withdrew when the market declined and large the Estate. To support this, they have losses were predicted. developed internal guidance on investment appraisal and budgeting. In 1993 they 3.11 When completed, the values of Abbey View St established their Investments and Project Albans [case study 1, Appendix Z), the Monitoring Committee made up of senior Crowngate Shopping Centre Worcester (case Crown Estate staff to analyse investment study 4) and the Guildford Business Park [case performance, advise on investment strategy, study 5) were below the cost of development to apprase potential investments and monitor the Crown Estate. Only the Royal Mint (case capital expenditure. study 8) shows significant capital growth. 3.15 Since 1989 the Crown Estate have employed 3.12 In some of the developments, a more Hillier Parker to produce annual forecasts of consistent approach to appraisal and marketing future capital value and rental income over a could have assisted performance. The Crowu five-year period. The Crown Estate have had Estate have to date carried out full post- limited success in translating these forecasts investment appraisals for four of the eight into realistic and challenging targets for each completed developments examined by the sector of their operations. The Crown Estate National Audit Office. They consider that it is are developing, in conjunction with the only appropriate to undertake post-investment Investment Property Databank, an enhanced appraisals when the developments are fully let property analysis and forecasting service which may be some years after completion. which will: They have, however, produced draft

investment guidelines in 1993 to ensure a l forecast the future income and capital consistent approach to investment appraisals returns on Crown Estate properties, setting and have introduced arrangements for agreeing out what the range of outcomes would be au annual programme of post-investment in various circumstances; appraisals. . allow comparison to be made between the performance of different agents employed Revised management procedures by the Crown Estate or different parts of the portfolio; 3.13 In 1989 the Committee of Public Accounts recommended that the Crown Estate should be . model the effects of alternative investment given greater flexibility to recruit and retain policies; and staff of the right calibre. Since then, the staff currently occupying two of the three key senior . analyse the annual performance of the management posts of Second Commissioner urban commercial estates against both the and Deputy Chief Executive (Property) have Databank benchmark and a reweighted been recruited. In 1991 the Crown Estate benchmark which matches the structure of introduced five year contracts for senior staff the Crown Estate’s portfolio. with salary increases averaging 10 per cent. Over 20 per cent of Crow” Estate staff [excluding Windsor] are now employed on THE PERFORh4ANcE OF THE CROWN ESTATE

Figure10:The CrownEstate Senior ManagementGroup and their joining dates

CorporateServices Manager (1989)

PersonnelManager (1987)

Internal Audit Manager (1986) Deputy Chief Executive InformationSystems Manager - (Financeand (1985) Administration) (1988) FinanceManager (1985)

PropertyAdvisory Manager (1987)

LegalAdvisor (1985) Second Commissioner Agriculture and ForestryBusiness Manager and - (1989) Chief Executive (1989) Scottish Business Manager (1985)

L Deputy Ranger Windsor (1974)

UrbanBusiness Manager (1982) Deputy - Chief Executive

(1986)

Key: Manageron a FixedTerm Contract Manaoernot on a Fixed TermContract Source: TheCrown Estate Of the 16 CrownEstate Managers. 13 are employedon FixedTerm contracts.Of these, 12 were employedin muchthe same capacity by the Crown Estatein 1989. THEPERFORMANCEOFTHECROWNESTATE

3.16 In addition, the Crown Estate have recently . there is a continuing need, as recognised employed consultants to review their by the Crown Estate, for a regular review of information technology strategy. In 1992, a investment strategy, taking account of past Touche Ross scoping study recommended a performance, progress against targets, strategy study to ensure close integration in the current and future trends, the likely effects development of information technology of alternative investment policies, and any systems. Following this, in 1993 Ernst and constraints; Young were asked to carry out further work to

analyse information requirements, including l there should be more consistency in the possible performance indicators, in information presented in the business preparation for the introduction of new plans produced for each part of the Estate: systems. This work has now been completed. and

3.17 The Crown Estate recognise that, although they . further progress is required to develop have made progress in updating their clear and quantified internal objectives management systems, many of their and targets, to meet the recommendations procedures can be further improved. The of the Committee of Public Accounts in National Audit Office’s investigation, therefore, 1989, whilst recognising the set out to identify ways in which the Crown Commissioner’s desire to retain some Estate could further develop their business degree of flexibility as a long-term investor systems to improve the value for money so that advantage can be taken as obtained from the resources that they manage. opportunities arise. The criteria used by the National Audit Office and their findings are at Appendix 3 and provide a check-list of issues that should be considered. The key points are that:

19 THE PERFORMANCE OF THE CROW ESTATE

Part 4: Managing Agents

4.1 The Crown Estate employ commercial agents The Crown Estate’s arrangements to assist in the management of some El,448 with their agents million worth of their property, representing 74 per cent by value of all Crown Estate 4.3 The Crown Estate delegate only limited properties. On the Crown Estate’s Urban responsibility and decision making to their portfolio, agents assist in managing 73 per cent agents. This is normal for an organisation in by value of all properties (Figure 11). Agents the property business such as the Crown Estate are contracted to administer specific areas of which has in-house expertise. Wherever the Estate, such as Regent Street, to provide possible, the Crown Estate are taking steps to strategic and investment advice, and to carry widen progressively the responsibilities of out annual valuations as required. The Crown their managing agents. Estate spent f5.5 million on management fees and costs in 1993.94, approximately 23 per 4.4 Some agents have acted for the Crown Estate cent of their total operating costs. for more than 25 years without being asked to x-tender on a competitive basis for the work. 4.2 The National Audit Office reviewed the Indeed one appointment for managing arrangements set up by the Crown Estate to agricultural property dates back to 1906. The ensure that their agents operate in accordance Crown Estate have introduced a rolling with the Commissioners’ objectives and best programme of competitive tendering for their practice in the property management urban estate and are using the results to profession, with particular emphasis on how renegotiate fees on other contracts. Of the six the Crown Estate measure the performance of contracts relet in 1992 and early 1993, one I agents. was the subject of competitive tendering which

Figure 11: ManagingAgents of the CrownEstate’s urban properties by capital value

HillierI Parker 27% . , In-house 27.1%

- Other agents 0.9%

Donaldsons 1.4%

Drivers Jonas 6.7%

Chestertons 11.0%

Source: CrownEstate

Note: Percentagesof the urban estate managedby agents are calculatedon the basis of the capital valueof propertiesat 31 March 1994. Figure11 shows the percentage of the capitavalue of the CrownEstate’s urban properties managed by individualagents at 31 March1994.

20 resulted in a possible reduction of fees by 25 provide information on a range of subjects per cent depending on activity levels. The including rent reviews and arrears, and voids, Crown Estate anticipate that all significant they have not been set performance standards management contracts on the urban estate will and targets. At present, standards of expected have been re-tendered or market tested within performance and operational targets are not two years. specified in agents’ contracts.

4.5 For most management tasks, the Crown Estate 4.7 The Crown Estate rely heavily on regular pay their agents a fixed amount for each contact and meetings between their asset teams tenancy that they administer. Acting on the and agents to establish how agents are results of a review that they commissioned performing. These meetings are important, but from D&it&s in 1990, the Crown Estate their usefulness would be increased if the increasingly reward their agents on an Crown Estate had a mechanism to evaluate on incentive basis, mainly for individual a quantifiable basis the information supplied transactions where the performance of the by agents. agent can be readily measured, for example, a percentage of any increase over the current 4.8 The Crown Estate recognise that more rental value agreed in a rent review. With a quantitative evidence about agents’ remuneration system in which the bulk of performance would be useful and could lead to payments are based on a fixed amount for each value for money improvements, provided that tenancy, it is all the more important for the this does not lead to a bureaucratic system that Crown Estate to be able to measure agents’ significantly increases costs. Therefore the performance against agreed standards and National Audit Office, with the help of their targets, to ensure that agents provide value for advisers and drawing on best practice llKUV?y. elsewhere, prepared a menu of possible measures and indicators from which the Crown Estate might choose to assess the How the Crown Estate measure performance of their agents. This is presented agents’ performance at Appendix 4 which also provides a commentary on the extent to which some of the various measures and indicators are 4.6 The Gown Estate’s urban properties are already used by the Crown Estate. managed by four in-house asset teams, who fulfil their duties by a combination of direct 4.9 The measures listed at Appendix 4 could be management and delegation to contracted used to form the basis of a cost-effective agents. In their business plans for 1993-94, the performance measurement system based on asset teams have set out a limited range of standards and targets for key activities in each quantifiable targets based on nxenue outturn area of the Estate, which would be against budget, rent arrears as a percentage of incorporated into contracts with agents. In total rent roll and the percentage of space for taking this matter forward, the Crown Estate which no rent is being earned, known as voids, will be aware that some of the agents against total lettable space. So far, only one of interviewed by the National Audit Office have these measures has been formally extended to sophisticated management systems that agents and used to measure their performance. already produce a comprehensive range of Each asset team assesses agents’ revenue performance information on many of the tasks expenditure and income against budget on a noted in Appendix 4. quarterly basis. Although agents are required to

21 THE PERFORMANCE OF THE CROWN ESTATE

Appendix 1 Recommendations by the Committee of Public Accounts in their 11th Report of 1988-89 on the Crown Estate

In reviewing the performance of the Crown Estate, the National Audit Office investigated whether the Crown Estate have implemented the Committee’s recommendations. References to the current C&AG’s report are given below, where appropriate.

PACRecommendation TreasuryMinute ResponseCM 697 of Referencesto the G&AG’sReport 1988 - 1989 Managementand recruitment We welcomethe progress madeby the Crown Estate The Commissionersagree that there continuesto be Fallowinga review of pay and grading carried out by in updatingits management?.tructure and systems some difticulty in recruitingand retaining peopleof MCP ManagementConsultants. the CrownEstate since our predecessorsexamined the Crown Estate the right calibre for the future developmentsof the introducedshort-term contracts an revised pay and in 1982.We are concernedhowever at the Estate’s organisationalong the lines envisagedby the conditionsin September1991. continuingdifficulty in recruitingand retaining Osmandand Pliatsky repotis. The Commissioners (paragraph3.13) people of the right calibre. We recommendthat the and the Treasuryare currently considering CrownEstate be given some greaterflexibility to proposalswhich will permit the CrownEstate Otfice offer pay and conditionssufficient to recruit and significantlyincreased flexibility to appoint and retain such staff rewardits employeesappropriately within a suitable (paragraph3 (i,, frameworkof financialdiscipline. Forthis purp,xe the Crown EstateOffice will wish to take into account independentadvice on the pattern of remuneration in similar employmentin the private sector. (paragraph71) Targetsetting We expect realisticand challengingtargets to be set The Commissionersnote the recommendationmade The Crown Estatehave not found the capital figures for the whole CrownEstate over the five year by the Committeein the requirementfor realistic and producedas part of the five year forecaststo be forward period announcedto Parliament.We expect challengingoverall targets and for theseto be palticularfy useful.Revised arrangements have been the CrownEstate to translatethese into internal translatedinto internaltargets coveringeach area of institutedin 1993. targets for each sector of its operations. the CrownEstate’s operations. The five year (paragraph3.15) (paragraph3 (ii)) forecastsof incomeand capital growth now being preparedannually by an independentfirm of charteredsurveyors are derivedfrom nationaland local forecastingmodels and applied to Crown Estateproperty holdings.These forecasts are aimed at providingthe CrownEstate with realistic investmentperformance guidelines. In arriving at consolidatedforecasts the Crown Estateis broken down into the fallowing sectors CentralLondon (subdividedinto regions).Provincial, Agricultural and Miscellaneous(ie fareshy. foreshores,minerals, fish farming, etc). The CentralLondon and Provincial sectors are further analysedby investment. developmentand residentialpropelties. Annual budgets(incorporated into the BroadProgramme for agreementwith the Treasury)are gearedto the organisationof the CrownEstate and preparedfor each area of responsibility Thesearrangements are being further developedas part of the programmeof improvementsin managementstructure and systems. (paragraph72)

22 THE PERFORMANCE OF THE CROWN ESTATE

PACRecommendation TreasuryMinute Response Referencesto the WAG’s Report Paymentsto the Exchequer We accept the essentialdifference between the As regardsthe recommendationfor flexibility in the The Treasuryhave consideredthe casefor flexibility CrownEstate and a private sector company.We paymentof the Estate‘srevenue surplus to the and no changehas bee” made. recommendsome flexibility be allowed in the Exchequer,the Treasury has previouslyagreed that paymentof the Estate’srevenue surplus to the one paymentonly should be madeat the end of each Exchequerso as to enableit to containits liquid financialyear. The Treasurywill considerthe case reservewithin a reasonabletarget level. for flexibility over the timing of this payment. (paragraph3 (iii)) (paragraph73) investmentAppraisal We underlinethe needfor consistentpre- and The Commissionerswell understandthe point made The Crown Estatehave produceddraft investment post-investmentappraisal of individualprojects. by the Committeeregarding consistent pre- and guidelinesin 1993to ensurea consistentapproach We acknowledgethe casefor diversifyingthe Crown post-investmentappraisal. The computer-based to investmentappraisals and have introduced Estate portfolio but recommendthat this policy be managementinformation systems currently being arrangementsfor agreeingan annual programmeof regularly reviewedin the light of the continuedhigh developedwill assist in ensuringthat this post-investmentappraisals. appreciationof the CentralLondon estate. requirementis met. The Commissionersare pleased (paragraph3.12) (paragraph3 (iv)) to note the Committee’sacknowledgement of the casefor diversifyingthe CrownEstate portfolio. The Crown Estatecarried wt their first appraisalof Investmentpolicy for the diversifiedportfolio is the diversificationpotifolio in 1993. reviewedregularly in the light of markettrends and (paragraphs3.2 to 3.7) the requirementfor further priority investmentwithin the healtland LondonEstate. lnarnornnh741

Millbank project We are surprisedthat no w-appraisal of the Millbank The three main lessonsof the Millbank project were The Crown Estatehave learntthe lessonsof the project had taken place Since1982 until prompted that there neededto be very clear funding Millbank developmentand appliedthem to later by the NationalAudit OfficeReport. We expect future arrangementswith other palties where development developments. projectsto have clear funding arrangements.a costs were sharedwith them; that a single (Appendix 2) single managementteam and to excludeany managementproject team was necessary;and that impracticabilityin the choice of design. an unrestrainedcompetition was unsuitablefor the (wwaph 3(“H choice of architectfor the type of building concerned.These lessons are now applied in the planning of new projects.It should be stressedthat the Millbank schemeas a whole has proved a sound long-terminvestment, as well as providing benefits to the communityand the environment. (paragraph75)

23 THE PEFCFORMANCEOF THE CROWNESTATE

Appendix 2 Details of the case studies of develoDment projects examined by the National Audit Office

Case Study 1: Abbey View, St Albans

Expenditure: f27.1 million

Lease: 25/15 year with 5 yearly upward only rent reviews

Percentage currently let: 70 per cent (60,000 square feet)

Source: TheCrown Estate

Background An office development within easy ‘wavelling distance of St Albans, comprising three separate blocks with a total letting area of 86,810 square feet. Construction commenced in July 1989 and was completed in August 1991 three months behind schedule.

FUndbIg The development was a funding agreement with Overley Properties Ltd. Under the terms of the contract the Crown agreed to purchase the freehold, finance the development up to a maximum amount and pay the developer further monies once the offices were let.

The investment appraisal produced by the appointed agents, Richard Ellis, estimated the gross commitment to the Crown to be f36.7 million.

The Crown Estate and the developers actively marketed the site with three agents simultaneously employed. On 14 February 1993 the developer’s involvement ceased and the Crown Estate gained sole responsibility for marketing and letting. Of the three agents Richard Ellis were retained. A new marketing campaign has been launched which includes new brochures, strategic advertising and the appointment of an on site marketing representative.

Audit observations Although the development was completed in 1991, the property is still being marketed and as yet the Crown Estate have undertaken no post-investment appraisal of the scheme although an interim analytical review of performance has been carried out.

Since completion a number of problems have been experienced with letting the development. Primarily this is the result of an over supply of good quality offices in the area.

24 THE PERFORMANCEOF THE CROWNESTATE

Case Study 2: Balvaird Place, Millbank, London

Expenditure:f4.7 million

Source: TheCrown Estate

Background The construction of 40 new townhouses, including gardens and an estate road, within the Millbank Estate in Central London. Constmxtion commenced in May 1989 with an anticipated completion date of July 1991.

Funding In December 1987 the Crown Estate decided to fund the development of Balvaird Place The scheme was architecturaUy similar to an adjacent development in Lindsay Square therefore a conbact was negotiated with the same builder.

By October 1989 the market had substantially declined and the development was m-appraised at the Crown Estate’s instigation by their quantity surveyors, Gacdiner and Theobald. Large losses were predicted due to:

. unlikely sale realisation figures;

l the sudden collapse of the residential housing market: and

. the poor sales from similar adjoining properties

As a result of the reappraisal the Crown Estate suspended the development once construction reached the ground level.

The Crown Estate are now waiting for market conditions to improve to review the future of the site. Possible options involve selling the site or continuing with the original scheme.

Audit observations The Crown Estate’s decision to suspend the development at a convenient stage where the construction can easily be restarted prevented the building of further houses in a declining market and reduced a potentially large loss.

25 THE PERFORMANCE OF THE CROW ESTATE

Case Study 3: 2-4 Blythswood Square, Glasgow

Expenditure: E4.8 million

Lease: 25.year with 5 yearly rent reviews.

Percentage currently let: 100 per cent

Source: TheCrown Estate

Background Blythswood Square is a development in the central business district of Glasgow providing 27,700 square feet of office space. The scheme involves the redevelopment of three terraced houses behind the existing listed facade. Demolition commenced in August 1987 and was handed over to Crown Estate in September 1988.

Funding The development was a joint venture between the Crown Estate Commissioners, Sheraton Caltrust (Blythswood) Limited and Sheraton Securities International plc. The Crown Estate purchased the site, advanced the construction costs and fees to the joint developers and agreed to make a balancing payment to the developers based on the rental income achieved. In return the developers were responsible for fully letting the offices on terms approved by the Crown Estate. and agreed to guarantee the rental income for a period of three years after completion should no tenants be found.

The investment appraisal by the appointed agents, Hillier Parker, anticipated that the Crown Estate’s maximum commitment would be E4.8 million.

The accommodation was fully let to one tenant in September 1988 with no delay between completion of the development and date rental income was receivable.

The Crown Estate carried out a retrospective appraisal of the development in September 1991. This showed that the scheme was achieving an internal rate of return of 11.78 per cent.

Audit observations The funding agreement protected the Crown Estate against the financial risk of not being able to let the premises. By making the developer responsible for letting the offices and using incentives to accomplish this, the Crown Estate have achieved a successful development.

26 THE PERFORMANCE OF THE CROWN ESTATE

Case Study 4: Crowngate Shopping Centre, Worcester

Expenditure: f 76.9 million

Leases: All leases vary from 1 year to 150 years with regular rent reviews.

Percentage currently Jet: 79 per cent (220,800 square feet)

Background Crowngate is a major city centre retail development in Worcester comprising two parts. Chapel Walk is the redevelopment of property behind the High Street and provides 155,000 square feet of retail space. Friary Walk is the refurbishment of an existing shopping centre to provide 125,000 square feet of retail space plus a car park and bus station. Construction commenced in March 1990 and the centre opened for trading in April 1992. Source: TheCrown Estate

Funding The Crown Estate entered a funding agreement with Centiovincial Estates that included several safeguards for the Crown Estate. An investment limit of E70.5 million was set with no profit to be paid to the developer except for letting3 achieved within 12 months of completion.

In March 1991 all dealings in the shares of Centiovincial’s parent company were suspended. Relations with the Crown Estate and Centrovincial worsened as formal notices were served to rectify sub-standard work. After a full investigation of possible options by Chesterton the funding agreement was terminated in June 1992 when the Crown Estate made a payment to Centrovincial Estates to relinquish all interests in the scheme. Hillier Packer and Chesterton were appointed as joint agents and the main letting campaign commenced in October 1991. Although pre-letting agreements were signed with Beatties and C&A, the Crown Estate have experienced difficulties in attracting tenants. To encourage lettings considerable sums, included in the expenditure figure above, have been spent on payments to tenants. The Agents have informed the Crown Estate that letting prospects am improving.

Audit observations Appraisals carried out by the Crown Estate since completion show a poor return on the capital invested. A final post-investment appraisal has not yet been completed as the development is not fully let. The Crown Estate have drawn a number of lessons from this development including:

. the need to research adequately local economic factors in advance:

l the need for developers to be substantial enough to buffer risk;

. where a developer appears to rely on growth for profit the strength of covenant of the developer is fundamentally important;

l the need to set out clearly, when making an investment decision, the sensitivity of the analysis to changes, for example in the rise ofrents, and the risks attached to the investment.

27 THE PERFORMANCE OF THE CROWN ESTATE

Case Study 5: Guildford Business Park

Expenditure: f49.8 million including notional interest

Leases: All leases are 25 year with 5 yearly upward only rent reviews.

Percentage currently let: 67 per cent (207,000 square feet)

Source: TheCrown Estate

Background An office development adjacent to the A3 on the north side of Guildford. Construction commenced in February 1987 and was completed in January 1989. The total letting area is 309,000 square feet.

FUnding In a funding agreement with London and Edinburgh Trust and Balfour Beatty in February 1987, the Crown Estate agreed to purchase the l&hold of the site, finance the development expenditure up to a maximum amount and pay the developer further monies on full letting. In return the developer guaranteed to lease any u&t properties for a period of 3.75 years following completion.

Prior to commencement of the scheme Hillier Parker produced an appraisal which estimated the maximum capital commitment to the Crown Estate to be E43.9 million [not including up to ES.lmillion subsequently added for improvement to specification and to meet changing market conditions).

Audit observations Although the development was completed in 1989, the Crown Estate have not undertaken a full post investment appraisal and do not intend to carry out the appraisal until it is fully let.

In August 1993 only 67 per cent ofthe development was let four years after completion. The Crown Estate was sheltered from the financial impact of unlet units under the terms of the funding agreement. This ageement has now expired.

28 THE PERFORMANCEOF THE CROWN ESTATE

Case Study 6: Lancer Square, London

Expenditure: S~5.3 million (This figure included the profit payout to Capital and Counties plc)

Leases: All leases except two shops are 25 year with 5 yearly rent reviews

Percentage cumntly let: 93 per cent (72,973 square feet)

Construction commenced in February 1988 and was completed in late 1989. The scheme is an office, retail (13 units) and restaurant development in Kensington. The total letting area is 78,244 square feet, including offices 55,110 square feet, restaurant 4,760 square feet and ground floor retail 11,733 square feet, plus basement 6,641 square feet. Source: TheCrown Estate

Funding The development was funded by the Crown Estate (80 per cent) and Capital and Counties plc (20 per cent]. The terms of Agreement originally anticipated an open market investment value on completion, that is when the development was 80 per cent let, of B4.5 million. An independent valuation in April 1990 put the open market investment value at f36 million. The Crown Estate’s share of costs was initially projected at E16.7. million. Actual costs, including interest, were E17.1 million.

Following identification of the final investment value, and in accordance with the Development Agreement the Crown Estate purchased Capital & Counties 20 per cent share in the scheme. Thus the total cost to the Crown Estate of developing the site was f25.3 million (inclusive of the payment to Capital & Counties), compared to the open market investment value of g36 million as at April 1990.

90 per cent of rental income derives from the offices and restaurant, which are let to strong covenants. The retail tenants are now trading successfully. Four retail units have been kept vacant due to the proposed repair works to the structure of the building (see below).

Audit observations The Crown Estate did not market the retail part of the scheme until co&auction was almost complete in order to take advantage of the then rising market. Lettings of all but one of the retail units were agwed at open market rentals by Donaldsons. There were subsequent difficulties in completing some leases, because of the recession: smne shop tenants failed and other shop rentals were reduced, but this only affected the 10 per cent of the total income attributable to the shops.

Since completion of building works, the roof and brickwork of the development have been found to be faulty. The repair cost is estimated at f3.0 million. Legal action is being pursued initially against the original contractor, and depending on the outcome further action will also be taken against the original architect and project manager as appropriate.

During the course of the development Capital & Counties employed three different project managers. This may have contributed to the delayed completion of the scheme by 3-4 months. The Crown Estate recognise the need in future to ensure, so far as possible, that the project manager’s staff are contracted for the full duration of the development to ensure continuity.

29 THE PERFORMANCE OF THE CROWN ESTATE

Case Study 7: 172-182 Regent Street, London

Expenditure: f6.34 million (excluding VAT, site value and notional interest) at 26 April 1994

Leases: Still under construction. Lease to Warner Bra. completed. Approximately 29,000 square feet net

Source: TheCrown Estate

Background In April 1984 the Crown Estate accepted, in principle, a proposal for the redevelopment of 172.182 Regent Street. The completed redevelopment will consist of a mix of office space and retail units with a total letting area of 104,892 square feet (retail 53,427; offices 51,465J.

FUIldiIlg The Crown Estate invited tenders from five firms of developers in May 1987. The tender envisaged a significant capital contribution to the scheme from a joint developer in exchange for a share of the profits. From the three proposals submitted, Bredero was selected and a development agreement was signed on 31 October 1988.

Under the terms of the agreement Bredero were to manage the development and provide f12 million towards the estimated costs off236 million. The Crown Estate agreed to provide the site with vacant possession and the balance of the funds.

A number of development appraisals were produced by the Cmwn Estate’s agents Drivers Jonas between 1986 and 1990 chiefly on schemes proposed by Bredem after May 1987. Each appraisal showed negative returns. By mutual consent the agreement was terminated with a Deed ofRelease completed in July 1992.

The Crown Estate appointed Chestertons to advise on the future of the site in January 1992. A comprehensive report was prepared which tested all the options open to the Crown Estate. The Crown Estate agreed to proceed independently with a completely new scheme. Demolition behind the existing listed facade commenced in February 1993.

Audit observations Delays to the redevelopment of this site have increased the Crown Estate’s holding costs and have resulted in lost revenue. Actual construction work on the new scheme did not commence iutil June 1993 following demolition. During the intervening period of two years the properties on site were income producing on short term lets. Chesterton have now informed Crown Estate that they take an optimistic view of letting. The Crown Estate has taken advantage of a very competitive construction market.

30 THE PERFORMANCEOF THE CROWNESTATE

Case Study 8: Royal Mint Court, London

Expenditure: E31.7 million

Leases: 4 head leases to Britel for 127 years at a peppercorn (Half the rent from sub-leases is payable to the Crown Estate!.I

Percentage currently let: 100 per cent

Source: TheCrown Estate

Background The site is adjacent to the Tower of London and housed the Royal Mint until its relocation in 1969. The scheme consists of two listed buildings, which were completely renovated and internally rebuilt, and two new blocks to provide office space. Construction commenced in January 1987 and was completed in May 1989. The total letting area is approximately 440,000 square feet.

FUnding The development was a joint venture with City Merchant Developers Ltd and Britel. The Crown Estate contributed the site, which had reverted from the Ministry of Defence at a cost to the Crown Estate of E23 million, and Britel paid the entire costs of the development. In return the Crown Estate agreed to lease the 4 main office blocks to Britel for 127 years at a peppercorn rent. As a condition of these leases the Crown Estate receives half the rental income received by Britel.

Prior to the funding agreement, the Crown Estate spent six years obtaining control of the site. This involved negotiating planning consent, selecting a design, managing an archaeological dig and choosing a development partner. The Crown Estate received a number of proposals from potential partners. Britel were selected as co-developers because they offered the best financial return and the least financial risk.

The Crown Estate appointed joint letting agents in February 1987 to market the development. Au active campaign was undertaken which included information packs, press releases and an on-site marketing centxe. This resulted in the development being substantially pre-let with no significant void periods following completion.

Audit observations The Crown Estate have undertaken two post-investment appraisals of the development since its completion. These have shown that the development has achieved success with an annual return of 25 per cent on the initial cash cost.

Detailed analysis of the original expenditure was not possible because of the poor quality of estate records in the initial stages of the scheme. The financial risk to the Crown Estate was successfully reduced by avoiding the need for any significant capital investment in the development.

31 THE PERFORMANCE OF THE CROWN ESTATE

Case Study 9: 31-47 Victoria Street, London

Expenditure: f20.8 million

Leases: Shops and offices are let on a 25 year lease with 5 yearly upward only rent reviews from July 1997.

Residential units are held on leases expiring in October 2088 at ground rents.

Percentage currently let: 100 per cent

Source: TheNational Audit Office

Background The development consists of 70,000 square feet of offices, 2,300 square feet of retail units and 29 flats in central London. Construction commenced in 1985 and was completed in the summer of 1987.

Funding The Crown Estate funded the scheme which was carried out in tandem with United Real’s construction of offices at 55 Victoria Street. The two buildings provide office space of 133,000 square feet and can be interlinked. Both schemes used the same project managers - Capital and County PLC. Gluttons and Jones Lang Wootton jointly marketed the development from March 1987.

Audit observations The Crown Estate have been advised by their agents, Gluttons, that the project was successful at a completion value of f47 million. Rental income and sales proceeds were realised. However, there was no detailed post-investment appraisal.

32 THE PERFmh4‘QKE OF THE CROWNESTATE

Case Study 10: The Villas in Regents Park, London

Information about the expenditure, sales and leases of the Villas has not been published as it is commercially sensitive.

Background Planning permission was granted in 1987 for the construction of six villas, based on the picturesque principles of design of John Nash, on land adjoining Regents Park.

The Crown Estate decided to phase construction of the villas at six monthly intervals because of the limited market. Construction of the Ionic Villa commenced in August 1988 and was completed in August 1990. The Veneto and Gothick Villas were started in February and The VenetoVi//a August 1989 and completed in March and August 1991 respectively. Source: TheCrown Estate The cons’ruction of the final three villas is being held in abeyance.

Funding The Crown Estate funded the construction of the first three villas. As sole developers they set a target profit.

The Ionic and Veneto villas were marketed through joint agents Savills and Lassmans using press launches. private previews, direct mailing and targeting of potential buyers. Knight Frank and Rutley and Lassmans are marketing the Gotbick Villa.

Audit observations The Crown Estate performed a post- investment appraisal for the sale of the Ionic Villa in December 1992. This showed a substantial developer’s profit for the villa. Thelounge of the GothickWI/a Source: TheCrown Estate An evaluation of the sale of the Veneto Villa shows a profit on total development costs for the villa.

The Got&k Villa remains unsold. The decline in the market makes it unlikely that the Crown will achieve its profit target for the villas project as a whole. But the Crown Estate told the National Audit Office that the result will be substantially better than if the land had been sold as individual lots.

33 no3 PERFORMANCE OF TKE CROWN ESTATE

Appendix 3 Criteria used by the National Audit Office to identify ways in which the Crown Estate could fkrther develop their business systems

Risklo value for money Criteria Audit Findings Developingor revisingan investment strategy The capital value of the Crown Estateand/or the The investmentstrategy should be clearly recorded, The CrownEstate produces a single statement rental incomefrom it may not be maintainedor preferablywithin a single document. setting out investmentstrategy. This is agreed by enhancedover time as a result of poorly informed Commissionersas part of the planningand control strategic decisionmaking. The strategy should: cycle Reviewsof performance,forecasts and modellingare dealt with separatelybut as part of the . review past performanceand progressagainst same cycle. The main drawbackof not adopting a targets; fully co-ardinatedapproach is that closely related - review currentand future investmenttrends aspects,such as the review of past investment and the likely performanceof the current performanceand the seding of strategic objectives. portfolio; may not be discussedtogether. . considerthe likely effectsof alternative investmentpolicies; . re-appraisethe validiry of any constraints.for example.financial; . establishor revise strategic objectivesin the light of the above;and . contain a forward capital programmeshowing how the strateqicobiectives are ta be funded. Businessplanning Poor businessplanning may result in the failure to Businessplans should set out how strategic Thereis no businessplan coveringthe CrownEstate achievelong term strategic aims, and to exploit objectivesand targets are to be achieved.They as a whole.The BroadProgramme presented to the individualinvestment opportunities. should contain: Treasurycontains some elementsof such a plan and is the most completestatement of Crown Estate . specificoperational policies to be pursuedover objectives.But it is draftedonly at the end of the the planningperiod: and planningcycle, some eight monthsafter the * quantifiedtargets againstwhich progresscan Commissioners’annualreconsideration of be monitored. investmentstrategy. It is thereforeof limited utility internally. In December1993 the Second Commissionerissued a statementof the vision, aims. and objectivesof the Crown Estateto all senior managers.

Businessplans are now being producedby the various Estates.But there is little consistencyin the materialthey contain or the extent to which they reproduceor expand on ObjectiveSset at a higher level. For example, UrbanBusiness plans contained few specific policies,targets or periormance measures.The CrownEstate intends to improvethe consistencyof businessplans in line with recommendationsfrom Ernstand Young fparaqraph3.16).

34 THE PERFORMANCE OF THE CROWN ESTATE

Risk to value for money Criteria Audit Findings Settingobjectives and performance targets Resourcesmay be misdirectedand uncoordinated Strategicobjectives could be set for: The Crown Estate’sinvestment objectives contained: in the absenceof clear objectives. . the desiredstructure of the fund,for example, - only five out of 37 objectiveswhich were by sector or geographicallocation; quantified: . a broad policy on the timing, nature,and extent * very few performancemeasures in use; of investmentand disinvestment: . only one target relatingto the investment . the absoluteand comparativereturn on performanceof the Urban Estate; investments:and . a mixture of generalisedaims and specific . operationalaspects such as budgets,rental objectives.A more structuredapproach to arrears,voids, overheadcosts and efficiency setting aims and objectivesmight help to savings. identify quantifiabletargets: and . no clear policy or quantifiedtarget set for Quantifiedstrategic targets should be set for the disinvestmentor the desiredstructure of the above and should be broken down into more Urban Estate. detailedoperational targets for various sectorsand brancheswithin the organisation. The Commissionersconsider that some degreeof flexibility is essentialfor a long term investor so that advantagecan be taken as opportunitiesarise. They concur with the setting of broad policy objectives but they considerthat, as trusteeswith a needto balanceshort and long term financial objectiveswith environmentaland social consequences,they should not attempt to modelthemselves on an investment fund. Monitoringof performance Inadequateinformation may lead to an unsound There should be regular comparisonsof the The Commissionerscurrently receivebroad data on investmentstrategy and deteriorationin the investmentperformance of the portfolio against investmentperformance in the previousyear and long-term investmentperformance of the Crown relevantInvestment Property Databank data and also property by propelty reports.The Broad Estate. other external benchmarks,for example,returns Programmecontains some data in various availableon Governmentsecurities. appendices,but narrativaldiscussion is very limited. Reportsby the InvestmentProperty Databank This should involve an analysisof portfolio analysingthe pelformanceof the commercialUrban structure, and should highlight significant portfolio are not presentedto the Commissioners, differenceswith InvestmentProperty Databank but they are usedto inform the block by block benchmarks. WPOlls. InvestmentProperty Databankreports containa Thereshould be systematicand regular appraisals comparisonof porifolio performancewith external of the performanceof each individualproperty. benchmarksincluding Governmentsecurities. In the past, the structure of the reports did not reflect On the basis of this, senior managementshould operationaldivisions within the CrownEstate nor reconsiderthe appropriatenessof the current allow various paris of the portfolioto be easily investmentstrategy. compared.From 1993 Databankrepolts have been producedat property level and aggregatedby estate, agent and asset manager.

The current absenceof performanceindicators and targets is now being addressedthrough the review of informationtechnolagy requirements.

The InvestmentProperty Databankprovide an analysis of those propelties registeredwith them. However,within the Crown Estatethere is no systematicexception reporting of poorly performing propertiesor specific managementconsideration of their future.

35 THE PERFORMANCE OF THE CROWN ESTATE

Appendix 4 Possible measures and indicators to assess the performance of agents employed by the Crown Estate

Task functions Performancemeasures Extentused by CrownEstate Comments General Management Preparebudgets for income.expenses Outturnagainst budgets. Undertakenby all assetteams an a Quantifiable.Budgets must be realistic. and service chargesand repolt on quarterly basis. pelformanceagainst budgetson an annual basis. Dealwith all tenant enquiries. Levelsof complaintfrom tenants Not formally measured. Quantifiable.Different areas of the Estatewill requiredifferent targets for the level of tenants’complaints. Advise on leaseextensions, renewals. Qualityof advice. Not formally measured. Qualitative.Professional review of a grant of new leasesand dilapidations. sample of advice. Inspectionof propertiesto monitor Spot checksal Stateof repair and Spat checksare undertakenby some Quantifiable.Spot checksshould be state of repair and to ensure compliancewith covenants. assetteams on an informal basis. undertakenregularly, far example,on compliancewith leasecovenants. an annualbasis. Monitor arrearsof rent. Arrearsas percentageof rent roll. Undertakenby all assetteams on a Quantifiable.The CrownEstate should quarterly basis. However,no targets set individualtargets for each agent for rent arrearsare set at agent level. againstwhich performancecan be measured. Initiate procedureson terminationof Timelinessof initiation procedures. Not formally measured. Quantifiable.This measurecan be IeBB. usedin conjunctionwith a diary system to point up key dates. Maintain property recordsand update Spot checksof databaseinformation. Spot checksare undertakenby only Quantifiable. database. Measurepercentage of errors. one of four assetteams. Annuallyreassess insurance cover. Adequacyof insurancecover. Not formally assessed. Largelyqualitative. Professional review of a sample of insurancearrangements.

Rent reviews, lettings and lease renewals Serve noticesin goad time and seek Percentageof noticesserved within Not formally measured. Quantifiable.On occasionsit may be in legal advice as appropriate. set timescale. the interestsof the Crown Estatenot to serve a rent review notice,but in these casesone can still measurethe timelinessof the agent’s adviceto the CrownEstate. For letdngs preparemarketing strategy Adequacyand successof marketing Not formally measured. Qualitative.Professional review of a and budgetas appropriate. strategy. sample of marketingstrategi’a Percentageof void propertiesby agent Voids as a percentageof all properties Quantifiable.Results need to be over time. are shownin the AnnualReport and interpretedwith care becausea high comparedwith Databankfigure?. level of voids is not necessarilya reflectionof poor pertormanceby the agents but may be due to the poor quality of the individualproperties.

36 THE PERFORMANCE OF THE CROWN ESTATE

Taskfunctions Performancemeasures Extentused by CrownEstate Comments Inspectproperty and report rental lImeliness and quality of reportsand Not formally measured. Mainly qualitative valuation,camparables and analysesproduced. recommendation. Measurementof results against Not formally measured. Ouantifiable. comparablerent reviewson other propelties. Negotiatebest possible rental levels Annualpercentage growth in rental InvestmentPrapelty Databankhave Ouantifiable.Current yield an propelty and terms and report at agreed value comparedwith the Investment been used by the CrownEstate to can also be measuredagainst the intervals. Property Databank. produce repotis on performance Databankindices. againstthe Databankindices far some time but little use has beenmade of

Valuation Undertakeannual valuation in Annualvaluation undertaken in Not formally measured. Quantifiable.Some property accordancewith timetable and accordancewith instructionsand companiescommission multiple instructionsissued. submitted by agreed deadline. valuationsof a small sample of propertiesto checkthe accuracyof the annualvaluation. They considerthat the independentassurance provided is worth the additionalcost. Strategic and investment advice Provideadvice and recommendations Qualityof reports and submissionby Not formally measured. Dualitative.Professional review of a on poiifolio strategy and policies. agreeddeadlines. sample of advice. Identifyand report on investmentand Percentageof investmentproposals Not formally measured. Quantifiable. disinvestmentoppoltunities. given serious consideration. Investigateinvestment proposals Duality of reports and analyses Not formally measured. Oualitative.Professional review of a fOllOWlngInitial approval and report “ndenaKe.n. sample OflnveStmemproposals. with recommendations. Negotiatebest possibleterms for Post investmentand disinvestment Some post-investmentappraisals Quantifiable.Wherever possible, it is investment. appraisalsto measuresuccess of undertaken. importantto meawe whether investmentsagainst cornparables. investmentshave performedas well as alternativemarket opportunities. Note: Some functionsare notedas ‘not formaltymeasured: howeverdetailed reviews of agents’peflormanceon these tasks and a// caseworkare undertakenat liaison and control meetings.

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