Taliesin Property Fund : Annual results for the year ended 31 December 2013

Taliesin Property Fund Limited

Annual results for the year ended 31 December 2013

Taliesin Property Fund Limited and its subsidiaries ("Taliesin" or the "Group"), the AIM quoted company focused on the Berlin residential market, is pleased to announce its preliminary results for the year ended 31 December 2013.

A full version of the preliminary results announcement will be available on the Company's website www.taliesinberlin.com.

For further information, please contact:

Taliesin Property Fund Limited

Mark Smith, Director                                          01534 700000

Westhouse Securities Limited

Alastair Moreton                                                0207 601 6100

Hannah Young

Darren Vickers

Highlights

·      Adjusted NAV* per share rose 12.5% in 2013 to end the year at €20.10 (2012 restated: €17.87).  On an EPRA basis**, NAV per share was €20.21 at the end of 2013 (2012 restated €18.36).

·      In 2013, Taliesin integrated the new portfolio purchased at the end of 2012, which increased Taliesin's estate by around 50% in terms of rentable area, and began preparing a number of buildings for privatisation in 2014 and beyond.

·      In September 2013, Taliesin issued 5 year zero dividend preference shares, the gross proceeds of which amounted to £11.6 million.  This permitted the pre-payment of a more expensive short term junior loan of €6.0 million taken out in 2012 as part of the financing of the new portfolio.

·      The balance of the proceeds of the preference share issue is being applied primarily to refurbishment of the new portfolio and the building out of loft space.  During 2013, capital spending on properties more than doubled to €2.7 million (2012 €1.3 million), partly financed by the profitable sale of a non-core building.

·      Profit before tax for the year was €10.7 million. (2012 €10.8 million).

·      Rental income continues to rise, notably on the new portfolio, where average residential rents increased by over 9%.

·      The Berlin property market performed well in 2013, as net migration to Berlin and strong investor demand drove up asset prices and kept vacancies low.

·      Notwithstanding central government efforts to make it harder for landlords to raise rents, we expect continued capital appreciation in Berlin's property market, driven by demographic and economic factors and we therefore believe that Berlin property remains cheap on any metric.

·      Although our property portfolio was revalued upwards by 8% in 2013, it is being carried at an undemanding €1,500 per square metre (psqm).  In 2013, the average cost of an apartment in Berlin, according to Jones Lang LaSalle, was €2,570 psqm.  If we are able to negotiate successfully the challenges associated with privatising our entire portfolio - challenges which I discuss later in this report - we estimate that the adjusted NAV would,  all other things being equal, exceed €40 per share.

·      The crystallization of surpluses on our investment properties via our privatisation programme should enable us to start to return money to shareholders.

·      Operational cash flow remains positive.

* The Adjusted NAV takes the IFRS NAV and adds back gross deferred tax liabilities. ** The EPRA NAV takes the IFRS NAV and excludes the cumulative mark-to-market movements in Taliesin's interest rate swap contracts and excludes net deferred tax liabilities.

Chairman's statement

I am delighted to present Taliesin's results for 2013, a year in which, as we expected, the trajectory of the Berlin property market continued to move upwards. The valuation of our portfolio at end-2013, conducted by Jones Lang LaSalle, was €187.7 million, compared with €174.8 million at end-2012.  Adjusting for the sale of one property during the course of the year, the uplift during 2013 was 8%.

This increase in the value of our investment properties helped our adjusted NAV to close 2013 at €20.10 per share, representing a rise of 12.5% on end-2012 and a doubling from when Taliesin commenced operations in 2006. On the EPRA definition of NAV, our NAV per share was € 20.21 at the end of 2013.

The upward revaluation of our property portfolio reflects positive demographic and economic dynamics in Berlin. However, we have supplemented these external factors by spending prudently on refurbishment, while continuing to drive rents as close as possible to "market-clearing" levels.  I will expand on this later in my commentary. 

At this juncture I would like to state that, even with the higher valuations put on our properties, the Taliesin portfolio remains distinctly conservatively valued. At the end of 2013, the average value of our property portfolio was only €1,500 psqm.  This is well below replacement cost and does not fully allow for the privatisation potential of our portfolio.  According to Jones Lang LaSalle, individual apartment prices (as opposed to those for a whole building) in Berlin averaged €2,570 psqm in 2013.  We hope that, in 2014, we can begin to privatise and this should make our overall portfolio more attractive. If we are able to negotiate successfully the challenges associated with privatising our entire portfolio - challenges which I discuss later in this report - we estimate that the adjusted NAV would,  all other things being equal, exceed €40 per share.

Last year, I outlined the rationale for purchasing the new portfolio at the end of 2012 and described how that purchase was financed.  In 2013, Taliesin issued 5 year zero dividend preference shares on the London Stock Exchange, the gross proceeds of which amounted to £11.6 million.  This allowed the Group to pay down the €6 million of more expensive junior debt incurred in the purchase of the new portfolio, while leaving a "pot" of cash to finance refurbishment and the building out of roof space.  It is worthy of note that, partly because of continued reduction of bank debt, Taliesin ended the year with a loan to value ratio of only 57.2%.

In 2013, the main priority for Taliesin was to integrate the new portfolio and to manage it in a more optimal way than had been the case under the previous owner. When purchased, residential rents on the new portfolio averaged €5.41 psqm.  Through the efforts of our property managers and by carrying out some freshening up of the buildings, average residential rents on the new portfolio ended 2013 at €5.90 psqm, an increase of over 9%.  Meanwhile, the pace of rent increases on the existing portfolio slowed to 4% in 2013.  This development was to be expected, as tenant turnover declined - in part owing to the shortage of supply in the Berlin rental market - and because rents had been hiked sharply in earlier years.   As a whole, rental income was €9.8 million in 2013, compared with €6.5 million in 2012. 

Although operating expenses rose in 2013 to €10.8 million (2012 €8.4 million), much of this increase comprised "one off" expenditures relating to the acquisition of the new portfolio, including legal fees. That being said, the portfolio cost only €1,075 psqm and was transacted in such a way as to minimize associated deal costs. In order to help compress costs, Taliesin Management Limited cut its annual Investment Advisory fee from 2% to 1.75%.  The Group's financing costs actually fell in 2013, to €3.1 million from €3.3 million in 2012.  The biggest contributor to this turn-round was a part reversal of mark to market "losses" incurred on interest rate swaps.

Including the contribution from the net change in the fair value of our properties stemming from the Jones Lang LaSalle valuation at end-year, Taliesin's total profit before tax in 2013 amounted to €10.7 million (2012 €10.8 million).

As part of the integration of the new portfolio, Taliesin began work on refurbishing some of the newly-acquired buildings, including the large property on Mehringdamm. This  building has been under-occupied, partly because of leakage from a badly-installed heating system.  Ultimately, this property, situated in the rapidly gentrifying area of Kreuzberg, has huge condominium potential and can also be partly converted into quality office space, a shortage of which prevails in this area. Taliesin has commenced remedial refurbishment and is engaging with the local authority on proposals to build out roof space and convert some of the former commercial space into a mix of residential and commercial units.  This, alongside refurbishment work on other segments of our portfolio, led capital expenditure to rise to €2.7 million (including property enhancements yet to complete) in 2013, against €1.2 million in 2012. 

Now, I would like to offer some observations on recent developments in the Berlin property market and thoughts on the outlook.

In 2013, the residential property market witnessed strong growth in Berlin.  During  the year, rents increased by 7.9% according to Jones Lang LaSalle, while the prices of condominium apartments grew by 8.7%.  The two charts alongside this text show how far things have moved since Taliesin began operations in 2006.  Rents have gone up by around 50%, apartment prices by over 70%. Berlin is out-pacing any other region of Germany on these metrics.

Last year, I dwelt on the demographic factors supporting the boom in residential property in Berlin. Those factors are still present. The population of Berlin is rising apace, both because of immigration and a high birth rate.  At the end of 2012, Berlin's population stood at 3,394,000. In the first half of 2013, the population increased by 44,000.  As new build has lagged, partly because it is still (just) possible to buy blocks of flats below replacement cost, there is a shortage of rental accommodation. The vacancy rate in Berlin has fallen to below 2%. The Federal Institute for Research into Building, Urban Affairs and Spatial Development has estimated that Berlin needs at least 16,000 new apartments to be constructed each year, yet far fewer apartments are being built: preliminary estimates suggest that building permits for some 12,000 apartments were granted in 2013. While this issubstantially up on 2012, building on that scale will not arrest the rising shortage of rental accommodation, even if every single one of these apartments gets built which, if the past is any guide, is unlikely.

Amplifying this demographic influence on the property market is the strong performance of the Berlin economy. Berlin is consistently out-growing the German economy as a whole.  The trend continued in 2013. In the first half of 2013, Berlin's GDP gained 0.5%, while the German economy shrank.  In 2013 as a whole, German GDP rose by 0.4%, while the forecast for Berlin is 1%. Employment growth in Berlin has risen more rapidly than in Germany as a whole every year since 2005 and, in both 2012 and 2013, Berlin employment has grown faster than any other state.  Jobs growth in 2013 was 32,700. There are significant public works projects underway in Berlin, but the biggest contributions to growth are coming from the private sector, especially services. Tourism continues to blossom. In 2013, 11.3 million people visited Berlin, an increase of 4.4% on 2012. Overnight stays rose 8.2% to 27 million. The yet-to-be completed Berlin Brandenburg Airport is now widely regarded as having inadequate capacity to meet demand in the coming years and it now appears that Berlin Schoenefeld Airport will remain open to cater for the large visitor numbers.

Aside from tourism, two other factors are acting as growth spurs. First, centripetal forces are increasingly drawing private companies to Germany's capital: Mercedes-Benz, Fujitsu, Amazon, Bayer, Takeda Pharmaceuticals, Corning, Etihad Airways and Groupon are among the international companies recently setting up shop in Berlin. These companies are not creating token presences in the city, but meaningful operations. For example, Berlin is the second biggest Groupon location outside its HQ in Chicago.

The second development worth highlighting is the emergence of Berlin as a start-up hub for technology companies. Berlin is the biggest attractor of venture capital in Germany, pulling in close to €1 billion of start-up capital in 2013. There have been over 2,500 tech startups.  Some of these are already globally significant, including SoundCloud (music sharing) and Wooga (computer games). Microsoft has established ResearchGate in Berlin as an "accelerator" for tech start-ups.  The government in Berlin is being relentless in seeking to establish Berlin as the high tech centre for continental Europe.

With the Berlin property market having performed so well, are we to expect any headwinds or some form of correction near term? 

In October 2013, the Bundesbank warned that property in German cities might be over-valued by between 5 and 10%.  In February 2014, they raised the estimate of possible over-valuation to 25%. Both the government of Berlin and the national government have protested strongly against the uptrend in rents and in property prices and have felt the need to "do something". In Berlin, stamp duty (purchase tax) on property was raised from 5% to 6% at the start of 2014.  In December 2013, the Berlin government clamped down on the short-term rental sector, where property owners have been letting their flats to tourists for short stays.  This latter move was designed to increase the availability of affordable housing in the capital. Meanwhile, Germany's Grand Coalition has signalled new controls on rent rises, including limiting rent increases on re-lets to 10%.

At the margin, these efforts might take a nibble out of property market. The pace of rent increases will certainly continue to slow down. Nevertheless, these policies will not, I believe, interrupt the secular trend to higher prices, especially in Berlin, where it's incomparable demographic and economic factors are so supportive of further re-rating. As for the "bubble" theory, bubbles are usually associated with huge surges in mortgage lending.  It is hard to identify such a thing in Germany.  In 2006, according to the OECD, mortgage lending to German households was €1,058,200 million.  At the end of 2012 (the last datapoint available), outstanding mortgage debt was €1,074,800 million, an increase of 1.6%.  As the chart shows, the debt splurge evident in the bubbliest property markets of the "noughties" is absent in Germany.

German and Berlin property prices may be playing catch-up with other property markets, but valuations are still distantly adrift. The increase in transactions volume in Berlin - transactions amounted to €6.7 billion in 2013, a four-fold increase on the whole of 2012 - seems to be driven by foreign buyers and by German investors switching from low-yielding deposits and bonds into higher yielding residential property.  German households are not spending excessively.  As they are tending to buy property by diverting moneys from other financial assets, rather than incurring debt, there is very little scope for negative equity to arise.

A final question: is residential property banging up against any affordability ceiling? As for Germany as a whole, research undertaken by the OECD suggests that Germany has the most inexpensive residential property, relative to incomes, in the Eurozone. The following chart shows Germany to be substantially under-valued relative even to residential property in Ireland, Portugal and Greece, where incomes have plummeted in the course of the Euro crisis. 

In the case of Berlin, the thesis is often articulated that incomes in Berlin are lower than the national average, with estimates varying between 91 and 95%, suggesting that Berlin has now become "unaffordable". Yet, as the following chart on affordability indicates even with lower incomes, rents in Berlin are still affordable relative to the other property hotspot in Germany, Munich, and in comparison with other European capital cities.  

Longer term, according to forecasts by the Deutsches Institut fur Wirtschaftforschung , incomes in Berlin will rise to 110% of the national average by 2030. That study was based on an estimated increase in population of 100,000 in that period. In contrast, the Berlin government is working on an increase in population of 400,000 in the period to 2030.  The latter forecast may suggest slower growth in average incomes, but it implies a much higher demand for living space.

Finally, I would like to turn to Taliesin's plans and strategy.

With such a significant gap between the prices of single apartment units and the prices of apartment blocks, privatisation is a priority.  We hope to complete our first individual apartment sales in 2014.  The preparatory work for privatisation is laborious and time-consuming.  Each individual unit has to be measured by an approved architect and these measurements registered with the Berlin authorities.  The next step is to seek permission to split the freeholds on buildings, permission first from the relevant bank lender, then from the Berlin authorities.  Where the building is in a "listed area", another layer of bureaucracy has to be confronted.

Taliesin is seeking to split the freeholds on as many properties as possible.  Even if particular buildings are not ultimately privatised, buyers are willing to pay a premium for apartment blocks where the rigmarole of freehold partition has been completed.  This also enables us to preempt any politically motivated tightening of the rules of freehold-splitting further down the line. Our current lenders are being reasonably supportive in our plans, although we are seeking out alternative financing to maximize our flexibility. Certain banks seem to want to finance privatisation portfolios, despite the fiddliness of dealing with the fragmentation or division of their collateral, as it enables them to capture new customers for mortgages and deposits. Another reason for seeking alternative finance is that we are currently reducing loans too rapidly, which restricts our ability to return money to shareholders, the cardinal reason for engaging in privatisation.

Taliesin also remains alert to the possibility of a whole portfolio sale as price rises intensify and institutional investors diversify.  In the pensions fund and sovereign wealth fund sectors, surveys suggest that allocations to property could double by 2023, as funds invest in real assets as an alternative to low-yielding bonds. Meanwhile, the EU Solvency II Directive, which will be implemented in January 2016, raises the capital insurance companies have to retain against government debt relative to property and infrastructure assets.

I am optimistic that 2014 will see further upward revaluation of our portfolio, as the market dynamics described above are supplemented by Taliesin's ability to demonstrate the "privatisability" of their portfolio.  Taliesin will continue to implement its refurbishment programme.  With cheap portfolios seemingly no longer available, Taliesin will increase its estate by building out roof space, which attracts higher rents and purchase prices than lower floors.  And as, via privatisation, we crystallize the capital appreciation embedded in our investment properties, we can at long last begin to return money to shareholders.

Notes to the preliminary results

1.    General information

Taliesin Property Fund Limited (the "Company") is a company domiciled in Jersey.  The address of the Company's registered office is PO Box 1075, Elizabeth House, 9 Castle Street, St Helier, Jersey, JE4 2QP.  The financial statements of the Group as at and for the year ended 31 December 2013 comprise the Company and those subsidiaries which it held during the year (together the "Group"). The Group's principal activity is selective investment in primarily residential property in Berlin and the former German Democratic Republic.  The Company's Ordinary shares are traded on the AIM market of the London Stock Exchange and the Company's Zero Dividend Preference Shares are admitted to the Official List and to trading on the Main Market of the London Stock Exchange.

The financial information set out in this preliminary results announcement does not constitute the Group's financial statements for the year ended 31 December 2013, but has been extracted from them.  The auditors have yet to sign their report on the 2013 financial statements. The financial statements for the year ended 31 December 2013 will be finalised on the basis of the financial information presented by the Directors in this preliminary announcement, and will be delivered to the Companies Registry. Whilst the auditors have not yet reported on the financial statements for the year ended 31 December 2013, they anticipate issuing an unqualified report.  The financial information for the year ended 31 December 2012 is derived from the financial statements for that year. The auditors have reported on the 2012 financial statements; their report was unqualified.

The financial information set out in this announcement was approved by the board on 14 April 2014

Principal accounting policies

The financial information have been prepared in accordance with International Financial Reporting Standards (IFRSs and IFRIC interpretations) as adopted by the European Union.

The financial information have been prepared under the historical cost convention as modified for the revaluation of investment properties at fair values and certain financial instruments measured at fair value through profit or loss.  They have also been prepared on the going concern basis.

The preparation of financial information in accordance with IFRSs requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group's accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial information are disclosed in note 3.

Adoption of new standards and interpretations in the year .

The Group and Company have adopted a number of new and amended IFRS and IFRIC interpretations during the year, including IFRS 13: Fair Value Measurement.  The effect of the adoption of this standard is to enhance the disclosure of financial assets and liabilities carried at fair value.  

Accounting Standards and interpretations not yet adopted .

The IASB and IFRIC have issued a number of standards and interpretations with an effective date subsequent to the date of these financial information.  The following standards and interpretations are relevant for the Company and the Group but the directors are of the opinion that adoption of these standards and interpretations would not have a material bearing on the presentation of these statements:

IFRS 9: "Financial Instruments: Classification and Measurement";

IFRS 10: "Consolidated Financial information"; and

IFRS 12:  "Disclosure of Interests in Other Entities".

2.      Principal accounting policies

The principal accounting policies are set out below:

Consolidation

Where the Company has the power, either directly or indirectly, to govern the financial and operating policies of another entity or business so as to obtain benefits from its activities, it is classified as a subsidiary.  The consolidated financial information present the results of the Company and its subsidiaries as if they formed a single entity.  Intercompany transactions and balances between Group companies are therefore eliminated in full.

Business combinations and goodwill

The consolidated financial information incorporate the results of business combinations using the purchase method. In the consolidated statement of financial position, the acquiree's identifiable assets, liabilities and contingent liabilities are initially recognised at their fair values at the acquisition date.

In a business combination, where the fair value of net assets acquired is less than the fair value of the consideration, that excess will be recognised as goodwill in the statement of financial position.  Where the fair value of the net assets acquired exceeds the fair value of the consideration, that excess will be recognised as negative goodwill in the statement of comprehensive income.

Amounts payable to third parties in relation to a business combination are recognised in the statement of comprehensive income as incurred.

Segmental reporting

For the purpose of IFRS 8, the chief operating decision maker takes the form of the Directors and the Investment Advisor, Taliesin Management Limited.

The Directors are of the opinion that the business of the Group comprises a single activity, being selective investment in primarily residential property in Berlin and the former German Democratic Republic. At the meetings between the Directors and the Investment Advisor, the income, expenditure, cash flows, assets and liabilities are reviewed on a whole-group basis.

All of the Group's income and non-current assets are derived from Germany, with the exception of immaterial income generated in Cyprus.  No single customer accounts for more than 10% of the Group's income.

Based on the above considerations, there is considered to be one reportable segment: selective investment in primarily residential property in Berlin and the former German Democratic Republic.

Internal and external reporting is on a consolidated basis, with transactions between Group companies eliminated on consolidation.  Therefore the financial information of the single segment is the same as that set out in the consolidated statement of comprehensive income, the consolidated statement of financial position, the consolidated statement of changes in equity and the consolidated statement of cash flows.

Investment properties

Properties held for long-term rental yields or for capital appreciation or both are classified as investment properties and the provisions of IAS 40 "Investment Property" apply.  The changes in fair values are presented in the consolidated statement of comprehensive income.

Investment properties comprise undeveloped land, land and rights equivalent to land with buildings, and land with third party hereditary building rights. Investment properties are measured initially at cost including related transaction costs. After initial recognition, investment properties are measured at their fair values, with subsequent changes in fair values recognised in the consolidated statement of comprehensive income.

The property portfolio, which is carried in the balance sheet at fair value, is valued six-monthly by professionally qualified external valuers and the Directors must ensure that they are satisfied that the valuation of the Group's properties is appropriate for the accounts. Investment properties are valued by adopting the 'investment method' of valuation. This approach involves applying market-derived capitalisation yields to current and market-derived future income streams with appropriate adjustments for income voids arising from vacancies or rent-free periods. These capitalisation yields and future income streams are derived from comparable property and leasing transactions and are considered to be the key inputs in the valuation. Other factors that are taken into account in the valuations include the tenure of the property, tenancy details and ground and structural conditions.

Property acquisitions yet to complete

All costs directly associated with acquiring properties are classified as "Property acquisitions yet to complete" and are stated at cost until the acquisitions are completed, whereupon they are reclassified as part of the capital cost of the associated property within "Investment properties".

Property enhancements yet to complete

All costs directly associated with improving and enhancing properties are classified as "Property enhancements yet to complete" and are stated at cost until the enhancements or improvements are completed, whereupon they are reclassified as part of the capital cost of the associated property within "Investment properties".

Impairment of assets

The Group assesses, at each reporting date, whether there is any indication that an asset may be impaired. If the carrying amount of an asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In assessing the recoverable amount, the value in use is determined by estimating future cash flows of the asset and discounting to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset.  Impairment losses are recognised in the consolidated statement of comprehensive income.

An assessment is made at each reporting date as to whether there is any indication that previously recognised impairment losses may no longer exist or may have decreased. If such indication exists, the recoverable amount is estimated. A previously recognised impairment loss is reversed only if there has been a change in the estimates used to determine the asset's recoverable amount since the last impairment loss was recognised. If that is the case, the carrying amount of the asset is increased to its recoverable amount. That increased amount cannot exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognised for the asset in prior years. Such reversal is recognised in the consolidated statement of comprehensive income unless the asset is carried at its re-valued amount, in which case the reversal is treated as a revaluation increase. After such a reversal, the depreciation charge is adjusted in future periods to allocate the asset's revised carrying amount, less any residual value, on a systematic basis over its remaining useful life.

2.            Principal accounting policies (continued)

Revenue recognition

The Group recognises revenue when the amount of revenue can be reliably measured and it is probable that future economic benefits will flow to the entity. Rental income from operating leases is recognised on a straight line basis over the term of the lease, net of any sales-related taxes, at the fair value of the consideration receivable. Service charges are accounted for on an accruals basis, and are based on property expenses expected to be recovered by occupants.

Corporate income tax expense

The corporate income tax expense represents the sum of the tax currently payable and deferred tax. The tax currently payable is based on taxable profit for the year. Taxable profit may differ from net profit as reported in the consolidated statement of comprehensive income because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible.

Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial information.  However, the deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit nor loss.

Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the end of the financial period and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled. Deferred tax assets and liabilities are offset against one another where both assets and liabilities arise within individual taxable entities to the extent that only overall amounts payable or recoverable are carried in the statement of financial position.

Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which the temporary differences can be utilised.

Deferred tax assets on losses, temporary differences and property valuation differences have been recognised within the German subsidiaries to the extent that it is sufficiently probable that they will be realised in the future against taxable profits, reversals in underlying temporary differences and appreciations in property valuations prior to any disposals of subsidiaries.

Deferred income tax is provided on temporary differences arising on investments in subsidiaries, except where the timing of the reversal of the temporary difference is controlled by the Group and it is probable that the temporary difference will not reverse in the foreseeable future.

Shares to be issued

The Company has entered into an arrangement with its investment advisor, Taliesin Management Limited (TML), under which TML may be paid a performance fee which may be settled, at the option of TML, up to 40% in cash, with the balance being settled in ordinary shares or options over ordinary shares, or any combination thereof.

Where TML has given advance notice of its intentions prior to the year end, the Company accounts for the performance fee as follows. In the statement of financial position, the component to be settled in cash is treated as a current liability and included in Other liabilities and payables and the component to be settled in equity-based instruments, i.e. shares and/or options, is included in shareholders' equity as provisions for shares and/or options to be issued in the following financial period, at their fair values (i.e. market value).  The combined value of these components of the performance fee is charged to profit and loss through the consolidated statement of comprehensive income during the financial period to which the performance fee relates.  Where TML has not given advance notice of its intentions prior to the year-end the whole fee is treated as a current liability and included in Other liabilities and payables and the whole amount is charged to profit and loss through the consolidated statement of comprehensive income during the financial period to which the performance fee relates.

Investments in subsidiary companies

A subsidiary is an entity in which the Group and the Company have power to control the financial and operating policies so as to obtain benefits from its activities. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group has such power over another entity.

An investment in a subsidiary, which is eliminated on consolidation, is stated in the Company's separate financial information at cost less impairment losses, if any. On disposal of such an investment, the difference between the net disposal proceeds and its carrying amount is included in statement of comprehensive income.

Foreign exchange

(i)            Functional and presentation currency

The financial information are presented in Euros as this is the primary currency of the economic environment in which the entity operates, and in which the material transactions of the Group are undertaken.

(ii)           Transactions and balances

Transactions undertaken in foreign currencies are translated into Euros at the rate ruling on the date of the transaction.  Monetary assets and liabilities denominated in foreign currencies are translated into Euros at the rate ruling at the end of the financial period.  Non-monetary assets (investments in subsidiary companies and investments held at fair value through profit or loss) denominated in foreign currencies are translated into Euros at the rate ruling on the date of acquisition.  Profits and losses on exchange are taken directly to the statement of comprehensive income.

Financial assets and liabilities

The Group classifies its financial assets and financial liabilities into one of the following categories, depending on the purpose for which the asset was acquired. Financial assets and financial liabilities are recognised when the Group becomes party to the contractual obligations of the instrument and derecognised when the contractual obligation is met and any monies are settled. The Group's accounting policy for each category is as follows:

(i)            Investments designated at fair value through profit or loss

Investments designated at fair value through profit or loss comprise Structured Loan Notes where the underlying financial assets of the notes are equity investments held by the note issuer.  The fair value assessment of each note is determined by the net asset values of each share on each reporting date.  The notes have a five year maturity after which the notes can be renewed or repaid.  Repayment proceeds would come from the sale of the underlying shares.

Changes in the value of investments designated at fair value through profit or loss and gains and losses on disposal, together with interest income therefore, are recognised in the consolidated statement of comprehensive income as "Gain/loss in fair value of financial assets".

(ii)           Derivative financial assets and liabilities

The Group uses interest rate swaps to manage its exposure to upward movements in interest rates. Such derivative financial instruments are initially recognised at fair value and subsequently re-valued at the end of each financial period according to market conditions. Gains or losses are taken directly to the consolidated statement of comprehensive income as part of net financing costs.

(iii)          Loans receivable

Loans receivable are recorded initially at fair value and subsequently accounted for at amortised cost using the effective interest rate method, which ensures that any income over the period to repayment is recognised at a constant rate on the balance of the loan receivable carried in the statement of financial position.

(iv)          Cash and cash equivalents

Cash and cash equivalents in the statement of financial position comprise cash at bank, short-term deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less.

(v)           Trade and other receivables

Trade and other receivables are recognised at fair value on initial recognition. Where there is objective evidence that the asset is impaired, its carrying value is adjusted as necessary for any estimated irrecoverable amounts and the adjustment is recognised in the consolidated statement of comprehensive income. When the asset is settled the necessary adjustments will be processed through the consolidated statement of comprehensive income and the statement of financial position.

(vi)          Equity instruments

An instrument is an equity instrument if it includes no contractual obligation to transfer cash or other assets to the holder. Such instruments issued by the Company are recorded at the proceeds received.  Direct expenses relating to the raising of equity share capital are deducted from the proceeds of any equity issued.

(vii)         Loans payable

These liabilities are initially recognised at the fair value of the amount advanced net of any transaction costs attributable to the issue of the instrument.  Such interest bearing liabilities are subsequently measured at amortised cost using the effective interest method, which ensures that any interest expense over the period to repayment is at a constant rate on the balance of the liability carried in the statement of financial position.

(viii)        Zero Dividend Preference Shares

Preference shares, which are mandatorily redeemable on a specific date, are classified as liabilities. The redemption premium on these preference shares is calculated using the effective interest rate method and is recognised in the income statement as interest expense.

Expenditure and other operating income

Expenditure and other operating income are accounted for on an accruals basis.

Interest income and expense

Interest on loans, both receivable and payable, is recognised using the effective rate of interest method, which is the rate that exactly discounts estimated future cash flows through the expected life of the financial instrument to the net carrying amount of the financial asset or liability. Other interest receivable from cash and short-term deposits, or interest payable on variable bank overdrafts and short-term loans is accrued to the end of the financial period.

Provisions

Provisions are recognised when the Group has a present obligation as a result of a past event, and it is probable that the Group will be required to settle that obligation and the amount can be reliably estimated. Provisions are measured at the Directors' best estimate of the expenditure required to settle the obligation at the end of the financial period and are discounted to present value where the effect is material.

3.            Critical accounting estimates and judgements

The preparation of the financial information requires the Directors to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and disclosures of contingencies as at the end of the financial period. If, in the future, such estimates and assumptions, which are based on the Directors' best judgement at the end of the financial period, deviate from the actual circumstances, the original estimates and assumptions will be modified, as appropriate, in the period in which the circumstances change. The following policies are considered to be of greater complexity and/or particularly subject to the exercise of judgement.

Critical accounting estimates

Fair value of investment properties

The Directors employ the services of professional property valuers but are still ultimately responsible for ensuring that such valuers are adequately qualified, competent and base their results on reasonable and realistic assumptions.

The Group operates in Germany where there is a well-developed and active market in the type of properties in which the Group is aiming to invest. This ensures an ample supply of various types of evidence upon which to make judgements on fair values, having regard to adjustments made necessary by differences in condition or location or changes in economic conditions. Such evidence includes current and recent sale prices of similar properties, and rents based on current market rates with which to calculate discounted cash flows based on reliable estimates of future rental income and discount rates that reflect current market assessments of uncertainties in the amount and timing of cash flows.  Estimates of the values of investment properties include assumptions regarding vacancy rates, discount rates and rental income are noted in note 4. However, there is a further risk that in times of downturns in economic activity, there may be a reduction in the number of transactions in the market from which to extract evidence upon which to make valuation judgements.

Fair value of financial instruments

(a)    Financial assets

Investments designated at fair value comprise Structured Loan Notes where the economic value is determined by reference to the value of certain Group companies. The value of the financial assets is determined by reference to the financial information of those companies.

(b)    Financial liabilities

In valuing financial liabilities, the Directors make judgements based on discounting future cash flows and on current market interest rates and the likely trend in future market interest rates. In order to ensure that loans will run for their full term without default, the Directors must ensure that there are sufficient balancing net cash inflows from rents after providing for administrative and other running costs. Where loans are secured on property assets and financial assets of the Group, the Directors must also be certain that the values of such secured assets will be at least greater than the amount which would be required to repay the lender in the event that the Group was in default and obligated to make such a repayment.

The derivative financial liabilities which the Group holds are interest rate swap arrangements, which are held in order to manage exposure to upward movements in interest rates. The effectiveness of these arrangements is continuously monitored in order to determine whether it is in the Group's interest to maintain these arrangements, extend them, or close them in part or in their entirety.  These instruments are valued in close collaboration with the instrument providers and other market counter-parties on a regular basis by reference to relevant interest rate movements and credit status of the contracting parties.

Critical accounting judgements

Income taxes

There are certain transactions and computations for which the ultimate tax determination may be different from the initial estimate. The Group recognises tax liabilities based on its understanding of the prevailing tax laws and estimates of whether such taxes will be due in the ordinary course of business. Where the final outcome of these measures is different from the amounts that were initially recognised, such difference will impact the income tax and deferred tax provisions in the period in which such determination is made.

Recognition of deferred tax assets

The recognition of deferred tax assets is based upon whether it is more likely than not that sufficient and suitable taxable profits will be available in the future, against which the reversal of temporary differences and losses can be deducted.  Recognition, therefore, involves judgement regarding the future financial performance of the particular legal entity or tax group in which the deferred tax asset has been recognised.

The fair values of the investment properties held at 31 December 2013 are based on valuations performed by an independent valuer, Jones Lang Lasalle. These are in accordance with the appropriate sections of the current Valuation Standards (VS) contained within the current Appraisal and Valuation Standards, 8th Edition (the 'Red Book') published by the Royal Institution of Chartered Surveyors (RICS) as well as the standards contained within the TEGoVA European Valuation Standards, and in accordance with IVSC International Valuation Standard 1 (IVS1), the International Accounting Standards (IAS), International Reporting Standards (IFRS) as well as the current guidelines of the European Securities and Markets Authority (ESMA) on the basis of Market Value.  The Market Value is defined as:

"The estimated amount for which an asset or liability should exchange on the valuation date between a willing seller in an arm's length transaction after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion."

The above definition concurs with that the concept of "Fair Value" defined by the currently valid International Financial Reporting Standards and the appropriate International Accounting Standard 40, paragraphs 1-86.

The level 3 fair values are based on certain unobservable input assumptions including vacancy rates for the 10 year period from 2014 to 2023 of between 3.2% and 18.3%and rental value increases.  Changes in vacancy rates by 1% would not result in a material difference to the fair value assessment.  In the directors' view rental increases are based on empiric values over recent years and so the directors do not expect significant fluctuation in the rental revenues.

Fair value was determined as the net present values calculated on perpetual useful economic lives, and discount rates of between 3.5% and 7.0%. An increase of 1% in the discount rate would reduce the fair value by €30.5 million and a decrease of 1% in the discount rate would increase the fair value by €44.1 million. The fair value of the properties has also been undertaken in accordance with the requirements of IFRS 13.

As noted in "Critical accounting estimates and judgements", real estate valuations are complex, derived from data which are not widely publicly available and involve a degree of judgement. For these reasons, and consistent with EPRA's guidance, we have classified the valuations of our property portfolio as Level 3 as defined by IFRS 13. Inputs to the valuations, some of which are 'unobservable' as defined by IFRS 13, include nominal equivalent yield and rental income. All other factors remaining constant, an increase in rental income would increase valuations, whilst increases in nominal equivalent yield and discount rate would result in a fall in values and vice versa. However, there are interrelationships between unobservable inputs as they are determined by market conditions. The existence of an increase of more than one unobservable input would augment the impact on valuation. The impact on the valuation would be mitigated by the interrelationship between unobservable inputs moving in opposite directions. For example, an increase in rents may be offset by an increase in yield, resulting in no net impact on the valuation.

All of the properties owned by the Group have been pledged as security for the Group's financial liabilities.

During the year ended 31 December 2013 the Group sold one property.  On 7 June 2013 the Group signed a sale contract on Clayallee 58-60 and this deal was completed on 13 September of this year. The property was purchased in 2008 for €1,020,000. The 2012 year end valuation was €1,070,000 and the sale price €1,100,000 with all fees paid by the buyer. Outstanding debt on the property was approximately €800,000.

On 7 January 2014, the Group announced that it had entered into a conditional sale agreement in respect of Karl Marx Str. 180 for a minimum consideration of €925,000, increasing to €950,000 subject to certain confirmations. This building was valued at €919,000 at 31 December 2013.  Both of these buildings were not core to the central strategy of the group.

On 15 January 2104 the company entered into an agreement to sell Dammstr. 2/Roedelstr.9, Leipzig  for € 1 million. The building was valued at €1 million at 31 December 2013.

The movement in the fair value of the investment properties is included in the statement of comprehensive income within the net change in fair value of investment properties.

All rental income recognised in the consolidated statement of comprehensive income was received from investment properties. Expenditure on investment properties during the year amounted to €2,350,000 (2012: €1,201,000) and was capitalised as part of the costs of the properties concerned.  Direct operating expenditure on investment properties during the year amounted to €1,242,000 (2012: €823,000) and was charged to the consolidated statement of comprehensive income.

Taliesin Management Limited (TML) acts as investment advisor and provider of management services to the Company and the Group for which it receives a semi-annual advisory fee based on the Adjusted Net Asset Value, as defined in note 12 but prior to the accrual of the advisory fee. The semi-annual fee was an amount equal to 1 per cent of this until 30 June 2013 and 0.875% thereafter, payable in arrears. However TML has also restricted its fee to 0.875% for the first half of the year.  Since 1 May 2009, part of the overall Group fee has been borne by a German subsidiary company.

In addition, TML is entitled to an annual performance fee which is equal to 20% of that portion of the return (before the accrual of the performance fee and advisory fee) obtained by shareholders during the calendar year in question which is in excess of a 12 month EURIBOR rate on the first business day of such calendar year based on the adjusted net asset value at the beginning of the year or a "high water mark" if higher. Under the terms of the Investment Advisory Agreement, the portion of the performance fee payable in cash shall not exceed 40% of such fee and the balance of the fee is paid by the issue of ordinary shares.

The Financial Assets comprise:

a)    A Structured Note is an investment whose return is linked to the value of an asset at the end of a specified term.  The notes entitle the Company to benefit from the rise in the value of the asset, whilst also being exposed to any potential decrease in the value of the asset and are designated at fair value through profit or loss.  The underlying financial assets of the notes are equity investments held by the note issuer.  The fair value assessment of each note is determined by the valuation agent which is the board of directors of the issuer by reference to the net asset values of each share on each reporting date.  The notes have a five year maturity after which the notes can be renewed or repaid by mutual consent.  Repayment proceeds would come from the sale of the underlying shares.

b)    A currency hedge contract.

11.    Taxation

The rate of tax in Jersey applicable to the Company and the group is 0%.  No tax therefore arises on the results of the Company.

Taxes on profits of the Group arising in Germany are computed using the tax rate of 15.83% (2012: 15.83%), both for current and deferred tax. Taxable income arising in Cyprus is taxed at 12.5% (2012: 11%).

All taxation charges and credits are recognised in the statement of comprehensive income. The total tax credit for the year is detailed below:

The following are the major deferred tax assets and liabilities recognised by the Group and the Company, with movements thereon during the year. Deferred tax assets and liabilities are shown gross and then offset against one another where both assets and liabilities arise within individual taxable entities to the extent that only overall amounts payable or recoverable are carried in the statement of financial position.