BKG Berkeley Group Holdings (the) Plc

CHIEF EXECUTIVE'S REVIEW

Purpose, Long-term Strategy and Capital Allocation

Berkeley's purpose is to build quality homes, strengthen communities and make a positive difference to people's lives, using our sustained commercial success to make valuable and enduring contributions to society, the economy and natural world.

We are the only large UK homebuilder to prioritise brownfield land, as we progress 32 of the country's most complex regeneration projects, 27 of which are in delivery.  Each of these neighbourhoods is uniquely designed in partnership with local councils and communities and includes valuable public amenities alongside tenure-blind private and affordable homes. 

Berkeley is a unique asset-focussed development business that seeks to manage risk and generate value through market cycles, with its inherent latent value rooted in its unrivalled land holdings.  The pace at which we deliver homes from our land holdings is determined by the prevailing operating environment and we will always adopt a long-term approach, prioritising financial strength above annual profit targets.

We seek to find the optimum development solution for each site in terms of the social, environmental and economic value for all stakeholders, and the returns we deliver to our shareholders.  We firmly believe these objectives are mutually compatible and reinforcing. Examples include Grand Union where our St George team is working in partnership with the London Borough of Brent to transform a derelict 22-acre industrial estate into a popular and productive part of Alperton with private and affordable homes, 10 acres of public open space, a community centre, shops, cafes, offices and an innovative multi-storey industrial workspace. And at Poplar Riverside our Berkeley Capital team is partnering with the London Borough of Tower Hamlets to turn a disused 20-acre gasworks into a sustainable riverside neighbourhood with private and affordable homes, parks, play-space, a secondary school, shops, cafes and flexible commercial and leisure space.

Our capital allocation policy is clear:  first, ensure financial strength reflects the cyclical nature and complexity of brownfield development and is appropriate for the prevailing operating environment; second, invest in the business (land and work-in-progress) at the right time; and third, make returns to shareholders through dividends and share buy-backs.

Planning and Regulatory Environment

The operating environment has become increasingly uncertain over recent years as a high number of well-intended regulatory and policy changes came into effect. This contributed to a marked decrease in private and affordable homebuilding activity, with SME developers and housing associations particularly impacted.

This significant decline in housing delivery has been acknowledged by policymakers at all levels and triggered a renewed focus on addressing barriers within the regulatory and planning system. This positive response has carried through to the General Election campaign and we are greatly encouraged by the tone and substance of manifesto commitments in support of homebuilding and urban regeneration.

Berkeley continues to work alongside industry partners, including other leading urban regeneration specialists and housing associations, to make the case for a stable and efficient regulatory environment which enables all parts of the market to invest with confidence.

Our core asks for the next Government include:

·    refraining from a further round of major reforms in favour of a focussed effort to resolve a number of relatively small operational challenges within the planning and regulatory system to make it faster and more predictable;

·   greater resources for severely overstretched local authorities and statutory bodies so they can operate the system more effectively;

·   stronger policy support for well-designed, high density neighbourhoods on sustainable brownfield sites close to transport and employment hubs;

·    replacing fixed CIL tariffs (which fund off-site infrastructure) with locally negotiated S106 agreements which prioritise on-site affordable housing and public amenities;

·   refinancing under pressure housing associations so they can get back into the market and perform their key role in driving housing delivery; and

·    simplify the complex Government grant funding regimes so they can become faster and more flexible.

Strategy Positioning and Establishment of Rental Fund

Core Business Strategy

In December, Berkeley set out a medium-term plan to respond to the extended period of volatility in the housing market, that began with the sharp increase in interest rates in September 2022, which also reflects the wider challenges presented by the planning and regulatory environment.  Despite this challenging backdrop, Berkeley's long-term business model continues to be resilient with good forward visibility:

Near-term (FY25 and FY26)

·    Having met its guidance for FY24, Berkeley is targeting at least £975 million of pre-tax profit across the next two years with the guidance for FY25 increased by 5% to £525 million.

·    Operating margins are expected to be within the long-term historical range (17.5% to 19%) following a 7.7% reduction in operating costs in FY24 and targeting no increase in FY25.

·   While the sales market remains subdued, cash due on private forward sales remains strong at £1.7 billion but will continue to moderate until transaction volumes recover. Consequently, Berkeley will carry higher completed stock levels than in recent years over this period.

·  Berkeley will continue to review the development solution on all its sites to achieve the optimum outcome for all stakeholders, including accommodating our best current assessment of the impact of evolving regulations, such as the requirements surrounding second staircases in buildings over 18 metres.

·    In the absence of material new land investment, the land holdings future gross margin will be targeted at around £6 billion at the end of this period.

·   Pre-tax ROE will be above 15% for the period as a whole but is likely to fall slightly below this for FY26.

Medium-term (FY27, FY28 and FY29)

·    Until the planning and regulatory environments unlock, alongside an inflection in the sales market, pre-tax profitability is anticipated to remain around the level to be delivered in FY26.

·   The focus will be on maintaining operating margin through our added-value approach to each site's development solution and ensuring our operating costs are aligned to the size of the business.

Capital allocation flexibility

·    We are on track to continue with the current shareholder returns programme into the future but remain agile and are ready to switch our capital allocation emphasis to invest in value accretive opportunities should these present themselves.

·    Berkeley's position has always been that, if it cannot deploy capital to deliver appropriate risk-adjusted returns, it will return surplus capital to shareholders. With the creation of the BTR platform, the surplus capital that we indicated in December would be available to make additional returns from 2027, should no new investment opportunities arise, will now be allocated to the development of the rental portfolio.

·    Berkeley sees this as an attractive opportunity to accelerate delivery of its existing assets by building a best-in-class London and South-East focused BTR residential portfolio and platform that will enable us to maximise value on our brownfield regeneration sites from this growing market segment to the benefit of both society and shareholders.

Establishment of Berkeley Build to Rent ("BTR") Platform

Recognising the severe shortage of high-quality rental accommodation, Berkeley is today announcing a natural extension of its strategy that will see the establishment of its own BTR platform, which will be developed over the next ten years, comprising some 4,000 new homes across 17 of the Group's well-connected, nature-rich, low-carbon brownfield urban regeneration developments.

This will represent additional delivery of around 10% of much needed new homes, when compared to the plan set out in December with the Company's interim results, along with the acceleration of place-making and affordable homes on these sites.

There is strong, unsatisfied demand for quality residential rental property built at scale in and around London, the country's most under-supplied market, from institutional capital which is attracted to its inflation-correlated attributes. Having sold over 1,000 homes across five sites in the last three years to institutional investors on a forward commitment basis, we now believe that adopting a more strategic route to this market will drive best value for these assets by creating a portfolio of scale, professionally managed, with proven income levels stabilised prior to disposal. 

With strong demand and a systemic under-supply of high-quality homes to rent in and around London, upward pressure on rents is forecast to remain. We will be locking in build costs early in the investment cycle and with yields linked to long-term interest rates, there is strong potential to drive value accretion over the next ten years, as well as incremental income while the properties in the portfolio remain owned by Berkeley.

Drawing on our experience in 2011-2014 when we developed and managed a portfolio of 900 homes, and utilising our ongoing site presence, we will create our own operating and management platform to provide tenants with the high levels of customer service experienced by our purchasers.

The establishment of the portfolio will be financed by a combination of internally generated funds (over and above annual scheduled shareholder returns), debt secured against rental properties once income generating, and the introduction of third-party capital at the appropriate time, thereby enhancing the efficiency of Berkeley's balance sheet and fully supporting the long-term 15% pre-tax ROE target.  It will not inhibit new land investment in the core business when appropriate opportunities arise.

The platform being established is flexible, ensuring Berkeley is able to dispose of the properties individually or in stand-alone blocks at any time should this become the more compelling exit route for any reason over the course of the next ten years.

Shareholder Returns

The current shareholder returns framework is based upon an annual return of £283 million through to September 2025 (as the shareholder returns year runs from 1 October to 30 September each year), which can be made through either dividends or share buy-backs, subject to a dividend underpin of 66 pence per share (approximately £70 million).

Shareholder returns during the financial year totalled £170.4 million:

Dividends paid during the financial year of £98.1 million comprised:

·        A £63.1 million dividend in September 2023 (59.30 pence per share) which completed the return of £283 million for the year ended 30 September 2023; and

·      A £35.0 million dividend in March 2024 (33.00 pence per share) representing half of the dividend underpin in respect of the scheduled return of £283 million for the year ending 30 September 2024.

The total amount returned via share buy-backs in the financial year was £72.3 million across 1.8 million shares at an average price of £39.62 per share. 

This includes £29.2 million in respect of the year annual return to 30 September 2024.  When combined with the £35.0 million dividend paid in March, there is currently £218.9 million still due for return by 30 September 2024.  This will be completed by:

·     A further £34.9 million (33.00 pence per share) interim dividend to be paid on 26 July 2024 to shareholders on the Company's register of members at close of business on 27 June 2024.  The ex-dividend date is 28 June 2024; and

·    A special dividend of £184.0 million (174 pence per share) to be paid in September 2024 accompanied by a share consolidation, subject to approval by shareholders at the September AGM.

Any further share buy-backs undertaken in the intervening period will therefore count towards the £283 million return for the year to 30 September 2025, which currently equates to £2.67 per share and compares to the initial £2.00 per share initiated in 2016.

Housing Market and Operations

Sales

Throughout the year, the value of underlying private reservations has been consistently around a third lower than FY23, reflecting the ongoing macroeconomic and geopolitical uncertainty and, in particular, the prolonged period of elevated interest rates. Sales prices have been largely stable across our sites and above business plan levels, with cancellation levels in the normal range.

Our core markets are underpinned by the systemic under-supply of new homes, the related strong rental growth of recent years and a supportive mortgage market.  Enquiry levels remain robust, with the slow-moving nature of the second-hand market impacting transaction timescales for sale-dependent owner-occupiers.  We anticipate sales reservations will remain around current levels until we see the first reduction in interest rates and customers have confidence in the trajectory for rates and the wider economy.

We continue to benefit from a strong order book. Cash due on exchanged private forward sales stands at £1.70 billion, down from £2.14 billion at the start of the year, with 80% of private sales for FY25 already secured.  This level will moderate over the course of the coming year while the prevailing sales rates continue. Equally, and as anticipated, Berkeley's completed stock has increased in this environment, providing readily available homes for those currently in the zone to move and for when the market conditions normalise.    

Positively, inflation is now abating, and the market expectation is for measured interest rate reductions over the near term against a backdrop of full employment levels and resilient wage growth which has improved affordability in real terms.  Nonetheless, Berkeley is mindful of the ongoing uncertainty on a number of macro fronts which weighs on market sentiment.  Berkeley is therefore positioned for sales rates to remain subdued for the near-term but is alert to the prospect of these responding decisively to evolving market conditions.  

More fundamentally, Berkeley's core markets in London and the South East are under-supplied.  Focussing on the capital, the latest DLUHC data is new-build starts for the 12 months to December 2023 of just under 17,000 (including private, PRS and affordable homes) below both the current London Plan target of 52,000 per annum and Government's identified local housing need of 94,000 per annum. 

Land and planning

Following extended planning processes and timescales, Berkeley has secured five new consents during the year:

·      199 homes in Spring Hill, Maidenhead;

·      470 homes in Guildford, Surrey (St Edward);

·      550 homes adjacent to West End Gate, Marylebone;

·      970 homes in Chalk Gardens, Sutton; and

·      2,150 homes at Syon Lane, Brentford (St Edward).

The sites in Maidenhead and Guildford have been added to the land holdings during the year, with the former a strategic land site and the latter transferred from the pipeline.  While consent was secured in December 2023 for the large-scale regeneration development in Brentford, the site will remain in the pipeline while Berkeley re-plans the development to reflect building regulation changes, notably to accommodate second staircases, that have arisen since the application was called-in by central Government in late 2021.  In addition, Berkeley has obtained some 30 amendments to planning consents on existing sites.

At 30 April 2024, Berkeley's land holdings comprise 54,081 plots across 70 developments (30 April 2023: 58,045 plots across 73 developments), including those in the St Edward joint venture.

The plots in the land holdings have an estimated future gross profit of £6.93 billion (30 April 2023: £7.63 billion), which includes the Group's 50% share of the anticipated profit on St Edward's joint venture developments. The net reduction in future gross profit of £0.70 billion principally arises through the gross profit taken through the Income Statement, with the two new sites added partly mitigating the impact of market movements and regulatory changes on the anticipated future gross profit in the land holdings.  Consequently, the estimated future gross margin is 25.1% (30 April 2023: 26.2%). 

The estimated future gross margin represents Management's risk-adjusted assessment of the potential gross profit for each site, taking account of a wide range of factors, including current sales and input prices; the political and economic backdrop; the planning regime; and other market forces; all of which could have a significant effect on the eventual outcome.

The pipeline comprises approximately 13,500 plots across 13 sites at 30 April 2024 (30 April 2023: 14,000 plots on 14 sites) following the transfer of the Guildford site to the land holdings.

Construction

For Berkeley, build cost inflation in today's market is at negligible levels apart from some isolated trades where demand is high, reflecting a combination of reduced energy prices, the reversal of the very high materials inflation of recent years and reduction in new homes starts and construction output more broadly.  For the early trades and those most impacted by the decline in orders we are already seeing some reductions in current tender pricing.  We expect these market-led dynamics to continue placing downward pressure on build costs, but this will continue to be balanced by the costs associated with ongoing regulatory change. These include the impacts of evolving building regulations, the introduction of the new building safety regime and the requirements for second staircases in buildings above 18 metres.

We continue to work with and support our established supply chain partners to ensure sustainability of the supply chain and delivery on our development sites as the market continues to adjust to these changing dynamics.

CMA investigation

Berkeley notes the outcome of the Competition and Markets Authority ("CMA") market study into house- building, which concluded on 26 February 2024 with the CMA's decision not to launch a market investigation at this time.  As one of the eight large housebuilders covered by the CMA's subsequent investigation into possible anti-competitive sharing of information in the housebuilding industry, we continue to cooperate with the CMA and their enquiries.

Self-Remediation Terms and Contract

On 13 March 2023 Berkeley entered into the Self-Remediation Terms and Contract with DLUHC, under which developers have responsibility for any life critical fire safety defects in buildings they have developed in the 30 year period to April 2022.

For the 820 relevant buildings Berkeley has developed over this period, we have third party assessments on over 95%. All of the remaining buildings are where Berkeley is not the freeholder and has not yet been provided access.  There are 40 buildings where works are still to be completed, 12 of which are buildings where Berkeley is reimbursing Government for the works under the Developer Remediation contract. Where works are required and yet to commence, Berkeley intends to begin works as soon as reasonably possible, subject to access being provided by the freeholder.

It is Berkeley's preference to take full responsibility for all its relevant buildings and to complete any required works itself as this will speed up the overall process of remediation.  We are seeking recoveries from the supply chain and insurers where appropriate.

Looking forward, Berkeley is ensuring its procedures are compliant with new legislation and is working closely with the new Building Safety Regulator which, together with the actions taken to date, should restore trust and confidence to the housing market, enabling it to operate efficiently, effectively and fairly for all.

Outlook

The last 12 months has seen a continuation of the volatile and uncertain operating environment for Berkeley.  However, while interest rates have stayed at elevated levels for longer than the market had anticipated, there are signs that the outlook is improving with inflation greatly reduced, the first interest rate cut expected later this year and a return to growth.

Housing is a central issue in the upcoming General Election and we are optimistic that the next Government will prioritise increasing housing supply of all tenures to deliver the homes the country badly needs where they are needed most. This is not straight-forward due to the multiple demands on development and the impact of policy and regulatory changes of recent years.  However, we look forward to working with all levels of Government to unlock development on brownfield sites which have a vital role to play in tackling the housing crisis and re-energising our towns and cities to meet the challenges of tomorrow.

Berkeley enters the coming year in a robust position with over £0.5 billion of net cash, £1.7 billion of cash due on exchanged private sales and £6.9 billion of future gross margin in our land holdings.

We have in place a clear strategy for capital allocation, maintaining our previously announced scheduled annual shareholder returns programme and investing surplus capital to increase delivery by around 10% to develop our own BTR platform to deliver much needed quality homes for the rental market on our well-connected, nature-rich regeneration sites.

Our focus for the next twelve months is to find the best development solution for each of our sites, adding value to maintain operating margins in the long-term historic range of 17.5% to 19.5%.  The challenge in the near-term is maintaining pre-tax return on equity above our 15% hurdle rate given the subdued sales market and the time required to achieve satisfactory planning consents in the current planning and regulatory environment.

We are delighted that over the last year our advocacy has helped the development of brownfield land to be recognised as the most sustainable way of solving the UK's housing crisis, and we will continue to fulfil our purpose and transform the most challenging sites into exceptional places with a real sense of community, yielding a long-term positive impact for society, the UK economy and natural world.

Rob Perrins

Chief Executive