Schroder Exempt Property Unit Trust Quarterly Progress Report 31 December 2005

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1 Tom Dorey Product Manager Phone +44 (0) Fax +44 (0) Schroder Property Investment Management Limited 31 Gresham Street London EC2V 7QA Authorised and regulated by the Financial Services Authority

2 Contents Page Fund objective and summary 1 Fund facts 3 Key activities over the quarter 5 Performance 7 Fund strategy 8 Market Commentary 9 Feature: Legislation Update 11 Appendix 1: Fund characteristics 12 Appendix 2: Risk warning 15

3 Page 1 Fund objective and summary Fund Objective The investment objective of the (the Trust) is to achieve a blend of capital and income growth for investors through investment in commercial property. Risk is diversified by the Trust holding a mixed portfolio of retail, office, industrial and other property (including residential and leisure) throughout the UK. The Trust seeks to provide a return of 0.5% above its benchmark (HSBC Pooled Property Fund Indices - All Balanced Funds Median) over rolling three year periods. Portfolio Activity Three retail warehouse units were purchased at Monks Cross, York for a contribution of 2.4 million. The purchase of Dean Street, London W1 was completed for 20.2 million. Performance Over the quarter the Trust return was 7.3%. The twelve month return was 19.2% to the end December At the quarter end, the Trust s net asset value was 1.6 billion. The distribution yield was 3.4%. Strategy We are targeting a significantly underweight position in the retail sector, reflecting relatively weak consumer demand. We continue to favour retail warehousing and convenience shopping in preference to traditional high street shops. With growth in the financial and business services sectors double that of the overall economy, we are maintaining our target overweight position to offices in London and the South East. Prospects for rental growth here look attractive compared with other provincial centres. We expect relatively weak rental growth in the industrial sector. This leads us to have an underweight position, although we favour the South East over the rest of the UK. This is on the grounds of occupier demand and alternative use value. We are targeting a modest overweight to other property. This includes leisure, student accommodation, healthcare and other non-traditional sectors. We will be selectively adding properties where we believe the assets will outperform the wider market. Economic Background There have been mixed signals from the UK economy in recent months. GDP growth was relatively weak at 0.4% in the third quarter while unemployment has increased for nine consecutive months. By contrast, financial and business services have continued to grow strongly, house prices appear to have stabilised and retail sales held up well in the run up to Christmas. Schroders are forecasting GDP to remain relatively weak in 2006 at 1.7%, which is below consensus (2.2%). We expect this below trend growth to continue impacting on the labour market, forcing the Bank of England to cut interest rates.

4 Page 2 Property Market The property market continues to be driven by falling yields; all property produced a return of 18.0% in the 12 months to November 2005 (source: IPD). The sectors continue to converge, although retail returns have held up surprisingly well given the weaker consumer. As at the end of November, retail property recorded a return of 18.7%, compared with 17.3% for industrial and 17.1% for offices. Investment demand has already surpassed the record 42.5 billion set last year, and is likely to be close to the 50 billion mark for the year as a whole (source: Property Data as at November 2005).

5 Page 3 Fund Facts Trust Information As at Net asset value (NAV) 1,636,118,744 Offer price per unit Mid price per unit Bid price per unit Net asset value per unit Distribution yield 3.4% Bid-offer spread 6.25% Debt 0% on direct (of NAV) 22.5% on direct and indirect (of NAV) Cash 5,611,794 Property Portfolio As at Property value (including indirect investments) 1,631,673,469 Net initial yield (direct portfolio and includes, Cardiff Bay, Monks Cross and West India Quay) Net reversionary yield (direct portfolio and includes, Cardiff Bay, Monks Cross and West India Quay) Void rate (as a % of estimated rental value of direct portfolio only excluding developments) Void rate (as a % of estimated rental value of entire portfolio excluding developments) Number of holdings (including indirect investments) % 6.2% 7.0% 6.2% Number of tenants (indirect and direct portfolios) 1,252 Top five holdings by value 1. The Hercules Unit Trust 2. Bracknell Property Unit Trust 3. Schroder Emerging Retail Property Unit Trust 4. Monks Cross Shopping Park, York 5. Chiswick Park Unit Trust Unitholder Information As at Number of units in issue 36,930,022 Number of units redeemed over the quarter 0 Number of units issued over the quarter 334,122 Number of units matched over the quarter 717,393 Value of units matched over the quarter 31,014,228 Unit availability Phone for availability

6 Page 4 Sector Weightings Excluding Cash (as at ) 40% 30% 25.9% 20% 10% 0% 9.4% 9.6% 9.7% 9.7% 12.2% 0.9% 14.2% 2.9% 5.5% Standard Shop Units Shopping Centres Retail Warehouses City of London Offices West End and Mid Town Offices South East Offices Rest of UK Offices South East Industrials Rest of UK Industrials Other Property Source: Schroders (These figures may differ from the HSBC Pooled Property Fund Indices due to rounding differences)

7 Page 5 Key Activities over the Quarter Purchases Julia Retail Park, Monks Cross, York Three retail warehouse units totalling 12,000 sq ft (1,170 sq m) were acquired at Monks Cross for a contribution of 2.4 million. The purchase reflects an initial yield of 4.5%. The units are currently let to Carphone Warehouse and American Golf for a further ten years with one vacant unit. The property is at the entrance to the Trust s existing holding at Monks Cross. We are exploring the possibility of transferring the planning consent onto the main park. This will enable us to expand and improve the tenant mix further, and to secure higher rents than on the existing park Dean Street, London W1 The Trust completed on the purchase of Dean Street for 20.2 million. This reflects an initial yield of 6.5%. The 32,800 sq ft (3,000 sq m) six storey office building has been refurbished in the past three years and is let to TBWA, a leading advertising agency, on two leases which expire in 2010 and The purchase of Dean Street is in line with strategy and offers a number of asset management possibilities. Asset Management Initiatives Planning consent Europa House, Cranford Planning consent was granted for change of use from offices to hotel on this site near Heathrow. This resulted in a 4 million valuation uplift. We are in negotiations with the adjoining property owner for the granting of additional access rights. We are also considering our options, which could include the development and pre-let to an established hotel operator. Lettings and Rent Reviews New lettings and rent reviews were completed during the quarter which increased the rent roll by 157,000 per annum. At the time of writing, there were a number of important new lettings and rent reviews in progress. We expect to report these next quarter. Developments Greenford, Development Site An outline planning application for a new 85,000 sq ft (7,900 sq m) distribution warehouse has been submitted. This is adjacent to the existing 250,000 sq ft (23,000 sq m) warehouse. We expect to secure a resolution for consent in late February. Negotiations are well advanced with two prospective pre-lets. Deykin Avenue, Birmingham Work has commenced on the building of two distribution warehouses close to spaghetti junction on the M6. The larger 150,000 sq ft (13,970 sq m) unit is pre-let to Innovate Logistics, a soft

8 Page 6 drinks distributor, for a term of 20 years. Marketing has started on securing a tenant for the 85,000 sq ft (7,900 sq m) building. Completion is expected in May Indirect Investments The Trust has exposure to a number of indirect investments. The property management activities within these investments can have a material impact on the Trust s performance and gearing. Key activities within selected holdings during the quarter include: West End of London Property Unit Trust (WELPUT) WELPUT continued to invest the second tranche of equity raised in In the fourth quarter, 16/17 Connaught Place, London W2 was bought for 48 million. 16 Connaught Place is multi-let on six tenancies and 17 is let entirely to the RAC. The property currently produces rental income of approximately 3.2 million at an average rent of 38 per sq ft. It provides a number of refurbishment and lease re-gearing opportunities. The business plan is to undertake a rolling refurbishment programme between Hercules Unit Trust During the fourth quarter, Hercules (a specialist fund investing in retail warehouses) returned 17.2 million of capital to the Trust, or 10% of the Trust s holding. This increased its gearing which, when coupled with a refinancing of debt, is expected to improve returns further. This, and some significant asset management activities, helped Hercules produce a return of 16.9% over the quarter and 35.5% for Chiswick Park Unit Trust (ChisPUT) Chiswick Park is an office development of 600,000 sq ft (56,000 sq m) in west London, on the site of a former bus depot. The Trust has a 19.6% stake in the 400 million scheme. In the past 12 months, there has been strong tenant demand leading to new lettings from Singapore Airlines, CBS and Tullow Oil, amongst others. A further 155,000 sq ft (14,400 sq m) building will be completed in March More recently, planning permission was granted for an additional 650,000 sq ft of office space. This provided a valuation uplift of around 30 million, leading to a fourth quarter total return of 16.8%. ChisPUT was the Trust s top performing investment during 2005, with a total return of 48.1%. Further information on this asset can be found at

9 Page 7 Performance Over the quarter and twelve months to, the Trust provided a total return of 7.3% and 19.2% respectively. The early analysis of these returns shows that: The Trust s positive performance can be attributed to a fall in yields as a result of continued strong investor demand for property. In the indirect portfolio, the best performing holding this quarter was The Hercules Unit Trust (+16.9%), followed by Chiswick Park Unit Trust (+16.8%) and the City of London Office Unit Trust (+11%). Bracknell Property Unit Trust and The Residential Property Unit Trust produced flat returns for the quarter. In the direct portfolio further yield compression in our South East industrial holdings was particularly pronounced in December. Total Trust Returns Q Q Q Q Year to date 1 year to end Dec years to end Dec 2005 (% pa) 5 years to end Dec 2005 (% pa) SEPUT years to end Dec 2005 (% pa) Source: Schroders at December 2005 Note: Performance is calculated on a net asset value (NAV) to NAV price basis plus income distributions paid for the relevant periods, compounded monthly. Performance information has been provided in accordance with the calculation methodology adopted by the HSBC Pooled Property Fund Indices. This accounts for the declared income at the time of reporting and an unrounded net asset value.

10 Page 8 Fund Strategy Despite a better than expected Christmas there is continued weakness in consumer spending; compared with more robust demand from business space occupiers, this leads us to favour offices over retail. We remain underweight to industrials where rental growth prospects are weak. Given the expected lower returns and convergence between traditional property sectors, we are targeting a 5% allocation to alternative commercial property sectors. We prefer better quality buildings with enduring occupier appeal as these offer the best prospects for rental growth. We also favour multi-let property which offer a variety of asset management opportunities. The bright spot within the retail sector is out-of-town retail warehouses, where we remain overweight. Here, strong rental growth is still being generated by the continuing trend of traditional high street occupiers expanding out of town. Convenience retail locations are expected to outperform the high street as consumer demand is likely to remain solid and asset management initiatives deliver above average rental growth. We are part way through an active sale program of retail properties which no longer fit our strategy. Elsewhere, we have maintained our target allocation to offices. We favour the South East over the rest of the UK and expect to benefit from improving business sentiment. This should lead to increased competition for space and rental value growth. Outside the South East, office rents have proven more stable in recent years. Looking ahead, however, we find it difficult to see these rents growing significantly from current levels. We maintain an underweight to industrials, but prefer the South East over the rest of the UK. Here, we believe values are underpinned by restricted supply and alternative land uses.

11 Page 9 Market Commentary Economy There have been mixed signals from the UK economy in recent months; GDP growth was 0.4% in the third quarter, and 1.7% higher than the same period a year earlier. This relatively weak growth has been reflected in the labour market, with unemployment increasing for nine consecutive months. On a positive note, UK retail sales surprised on the upside towards the end of the year, and house prices appear to have stabilised. For 2005 as a whole, Schroders expects GDP growth to be 1.8% (in line with consensus), with growth remaining weak this year. Schroders is forecasting GDP growth of 1.7% in 2006, below consensus of 2.2%. We expect this below trend growth to continue impacting on the labour market, forcing the Bank of England to cut interest rates. Property Market Review The property market continues to surprise on the upside, driven by falling yields; all property produced a return of 18.8% in the 12 months to December 2005 (source: IPD). The broad sectors continue to converge, although retail returns have held up surprisingly well given the weaker consumer data. As at the end of December 2005, retail property recorded a return of 19.3%, compared with 18.4% for offices and 18.2% for industrial. Investment demand has already surpassed the record 42.5 billion set last year, and is likely to be close to the 50 billion mark for the year as a whole (source: Property Data). Property Total Returns Sector 12 months to end Dec 2004 Q Q Q Q months to end Dec 2005 Retail Office Industrial All Property Gilts Equities (All Share) Real Estate Equities Source: Investment Property Databank Schroders economic forecasts suggest a cut in base rates (3.5% by end 2006), and a fall in five year swap rates and ten year gilt yields. If the yield curve were to shift in this manner, it would be very accommodating to property investment (particularly property financing). However, with the net initial yield at 5.2% (IPD Monthly, December 2005), the gap between property initial yield and five year swaps (4.5% at the end of December 2005, according to Thomson Financial) is not as large as it has been in the recent past, see chart. Property initial yield minus five-year swap rate % Source: Schroders, based on data from IPD and Thomson Financial Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04

12 Page 10 Property Market Outlook In the twelve months to December 2005, rental value growth for all property rose by 2.6%, having reached its highest level for four years in November 2005 (2.7%). We expect a gradual reduction in rental growth for all property in 2006, due to the anticipated slowdown in retail rental growth and this will be only partially offset by rising office rents. We are forecasting growth of around 1.5%-2.0% per annum over the three year period to December The total return for all property exceeded expectations in 2005, aided by the favourable interest rate environment and low bond yields. We expect this to continue into next year, and have upgraded our forecasts accordingly. Our latest interim forecasts are suggesting a return of around 12.0% for 2006, above consensus forecasts of 8.6% (Source: Investment Property Forum). Over the three year period to December 2008, we expect the total return for all property to average % per annum. The main concern surrounding these forecasts is the favourable economic scenario of low interest rates and bond yields. If economic growth picks up quicker than expected and interest rates and bond yields remain flat, or even move upwards, then it would be hard to justify any additional inward yield shift for the property market as a whole. Under this scenario, lower capital growth would be counteracted by stronger rental growth but we do not believe it would be sufficient to rebuild returns Retail Retail sales picked up towards the end of 2005, but remain relatively weak. Data from the British Retail Consortium showed December like-for-like sales (ie. excluding store openings and closures) were 2.6% higher than the previous year. Many stores are now discounting goods, which is likely to lead to divergence in retail sales volume and value growth, squeezing retailers margins. Several well-known retailers have recently gone into administration, including MVC, Unwins and Kookai. With consumer expenditure expected to remain weak in 2006, compared with previous years, we expect retail rental growth and returns to underperform the all property average in the short to medium term the exception being the retail warehouse market, in particular fashion parks, which will continue to benefit from retailers out-of-town expansion plans. Offices The office market has been picking up steadily during 2005, supported by strong financial and business services (FBS) growth; this totalled 3.2% per annum in the third quarter, compared with 1.7% for the economy as a whole. Strong FBS growth will benefit the central London office market in particular, which is likely to be the top performing sector in With the Rest of the South East office market also performing well, we expect the total return for offices as a whole to finally replace retail as the top performing sector for the first time since Over the three years to the end of 2008, we expect the office market to comfortably outperform the all property average. Industrial We expect rental value growth to remain limited, and do not foresee significant downward movement in yields to counter this. However, we believe the prospects for the sector are better than high street retail, and we therefore predict the total returns for industrial property to be marginally below the all property average over the three years to December

13 Page 11 Feature: Legislation Update In December, the government provided additional details of its plans for UK Real Estate Investment Trusts (UK-REITs) and the Planning Gain Supplement, both of which are summarised below. REITs The government has finally given the go-ahead for the introduction of UK-REITs on 1 January Under the proposed REIT structure, property companies would pay no corporation tax on property income, but would hand 95% of net profits back to investors, who will be taxed at their marginal rate. REIT investors would pay the basic rate of tax of 22% on their income distributions; this may make REITs less attractive to overseas investors. In addition, under trust status the Treasury would lose substantial Capital Gains Tax and other corporate taxes. For this they will charge a conversion fee at present, there is no news on the conversion charge, but an announcement is expected in the next Budget. There are two further issues, which may be potential stumbling blocks: first, there is a proposed minimum interest cover, which would restrict gearing to around 40% loan-to-value. The second issue is that no investor can own more than 10% of shares. These conditions may restrict the number of property companies able to convert to a UK-REIT. In general, analysts agree that Slough Estates and Land Securities are the best equipped for conversion to REITs, as both broadly meet these conditions. Although Schroders are happy with the progress made by the government towards the introduction of UK-REITs, we believe it would be beneficial to relax some of these requirements to assist the transfer of more property companies to UK-REIT status. In general, the introduction of UK-REITs will increase the accessibility of property to the average investor, which may increase demand, although the flip side of this is that it may impact on the volatility of the market. Planning gain supplement In the Pre-Budget Report in early December, the Chancellor announced that he is opening consultation on the Planning Gain Supplement (PGS) until the end of February The details of the tax may change following the consultation process, but at present the key features are as set out below. The PGS will apply to both residential and non-residential development on brownfield and greenfield land. It is likely to be introduced in 2008, and any planning permission not fully granted before that date will fall within the new tax. The tax will not replace Section 106 (s.106) agreements, but these will be limited to matters relevant to the environment of the development site and affordable housing. The tax will be calculated on the grant of full planning permission, but will be payable by the developer when development begins. It will be charged on the difference between current use value of the land and the value afterwards so if there is land with existing planning permission, this will be the start value from which to calculate the uplift. The rate is currently unspecified, but there is likely to be a lower rate for development on brownfield sites. In general, Schroders is content to see the introduction of a fair, efficient tax to replace s.106 agreements, which can often be unpredictable but developers may have to pay both. Any significant increase in costs for developers will make some projects unviable, restricting the level of development undertaken. Therefore, given that the new levy is likely to exceed the share of planning gain which developers currently pay to local authorities under s.106 agreements, the extent of this should be limited. Previous attempts to introduce similar development land taxes have ended in failure, so the government needs to ensure the fine details of the PGS are well thought through to avoid going the same way.

14 Page 12 Appendix 1 Fund Characteristics Investment and Borrowing Powers The Trust Deed requires that the underlying property of the Trust is managed in accordance with the investment and borrowing powers set out in the Trust Deed. Within these investment and borrowing powers, the Supervisory Board may set additional investment and borrowing powers to which the Property Manager must adhere in conducting its property investment management activities. Portfolio Investment and Borrowing Guidelines The Trust shall have an exposure of not more than +/- 10% in retail, office, industrial or other property relative to the HSBC sample of Balanced Property Funds. Not more than 10% of the Trust s net asset value shall be invested in a single asset or in any specific collective investment scheme or joint ownership structure at the time of purchase. The maximum investment permitted in collective investment schemes is dependent upon the banding. For the combined total of Bands 0, 1 and 2 a maximum investment of 60% is permitted and for the combined total of Bands 1 and 2, a maximum investment of 50% is permitted. The banding relates to the liquidity of the investment. Band 0 can be considered most akin to direct property investment in terms of control of the asset. Band 1 open ended collective investment schemes as well as closed ended collective investment schemes with proven liquidity. Band 2 closed ended collective investment schemes with unproven liquidity. Not more than 10% of the net asset value of the Trust shall be invested in short and medium length leasehold properties (of equal to or less than 50 years). Not more than 20% of the net asset value of the Trust shall be invested in contractual commitments relating to development, of which not more than 15% of the net asset value of the Trust shall be invested in contractual commitments in respect of speculative development. Not more than 10% of the net asset value of the Trust shall be held in undeveloped and nonincome producing land. Not more than 10% of the Trust income shall be derived from the government, and not more than 5% of the Trust income shall be derived from any single non-government covenant. In accordance with the provisions of the Trust Deed, the Property Manager may borrow directly up to 30% of the net asset value of the Trust. Within this limit, the Supervisory Board has set a borrowing guideline limit of 30% of net asset value for direct and indirect borrowing to which the Property Manager must adhere. Environmental Policy Statement In undertaking its investment activities, the Property Manager may acquire, develop and manage both commercial and residential property in the UK. The Property Manager recognises

15 Page 13 that these activities can have both direct and indirect harmful effects on the natural environment. It is the Property Manager s policy to reduce these to a minimum without prejudice to any fiduciary duty it may owe to the Trust and/or to unitholders. It aims to meet, and where practical, exceed, the environmental standards set out in legislation, and to continuously improve its environmental performance. The Property Manager will work in close partnership with its principal suppliers, agents, contractors and tenants in order to achieve these standards. This policy will be implemented through a set of corporate environmental objectives and associated targets, against which the Property Manager will monitor progress on a regular basis. Socially Responsible Investment Policy The manager has a policy on socially responsible investment which is available on request. Fund Administration The following is a brief summary of certain provisions relating to the Trust. For full details, reference should be made to the Trust Deed. New investors must complete a Form of Authority and any relevant documentation for money laundering checks before their investment will be accepted. The property portfolio is independently valued on the last working day of each month. The offer and bid prices are set on the basis of this valuation. Monthly prices are quoted daily in the Financial Times. The bid/offer spread of 6.25% reflects the costs of buying and selling property. New units are issued on the valuation day and payment must be received by the Trustee within the first five working days of the following month. Title to units will be evidenced by an entry in the Register of unitholders. To redeem units, a written notice must be received by the Manager prior to a quarterly redemption notice date, being 31 March, 30 June, 30 September and 31 December in any year. Unitholders will then be advised of the fair value of each unit (usually bid price) within six weeks and the proceeds will be paid on the next quarterly redemption notice date. Net income of the Trust is distributed monthly. Distribution payments are accompanied by a tax voucher to enable all unitholders to reclaim tax. Registered unitholders receive a factsheet on a quarterly basis. The report and accounts are audited and published annually as at the Trust s year end date of 31 March. A semi-annual unaudited report and accounts is published as at 30 September.

16 Page 14 The Supervisory Board Members of the Supervisory Board and their details are shown in the report and accounts. The Trust Deed establishes a Supervisory Board consisting of not more than ten and not less than five members and no more than two members of the Board may at any time be officers or employees of the Manager or Property Manager. The principal role of the Supervisory Board is to set out strategic investment and borrowing guidelines for the Trust. It will also monitor risk control and ensure that principles of sound corporate governance are observed in the management of the Trust s assets and approve the key appointments made in relation to the Trust and the remuneration of the Manager and Property Manager. Manager and Property Manager Schroder Property Investment Management Limited. The Property Manager provides discretionary investment and property management services in respect of all aspects of the investment strategy, purchase, sale and ongoing property management of the assets of the Trust. The Manager is responsible for the operation and administration of the Trust and is authorised and regulated by the Financial Services Authority in the performance of this role. Trustee The Royal Bank of Scotland plc. The Royal Bank of Scotland plc is authorised and regulated by the Financial Services Authority in its role as trustee.

17 Page 15 Appendix 2 Risk Warning This report has been prepared for existing investors in (the Trust) only and this material should not be relied upon by persons of any other description. In any case, a recipient who is in any doubt about investment in the Trust should consult an authorised person who specialises in investments of this nature. Units in the Trust are only available to exempt funds. In general terms exempt funds are persons who are wholly exempt from capital gains tax or corporation tax on capital gains. A potential conflict with the Manager s duty to the unitholder may arise where a transaction is effected for the Trust in the units of a fund(s) managed by an Associate. Investors should be aware that past performance is not a guide to the future. The Trust invests in real property, the value of which is generally a matter of a valuer s opinion and which may not be readily saleable. Reliable information about the value of units in the Trust or the extent of the risks to which they are exposed may not be available. As there is no recognised market for units in the Trust, an investment in units may not be readily realisable. It may be difficult to deal in the units or to sell them at a reasonable price. The price of units and the income from them may fluctuate upwards or downwards and cannot be guaranteed. The information and opinions contained in this report have been obtained from sources we consider to be reliable. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroder Property Investment Management Limited has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in this report when taking individual investments and/or strategic decisions. Schroder Property Investment Management Limited (SPrIM) 31 Gresham Street London EC2V 7QA SPrIM is authorised and regulated by the Financial Services Authority