BUSINESS REVIEW

In our last annual report, we reported that 2007 had been a tough year and that we did not anticipate life becoming much easier in 2008. Uncertainty remains, caused by recession in the markets in which we are active and the continuing lack of financial liquidity and lending capacity.

In 2008 we sold properties for gross proceeds of £421.5 million. This has had the effect of reducing our adjusted gearing from 131.7 per cent at 31 December 2007 to 102.6 per cent whilst increasing our cash from £122.0 million at 31 December 2007 to £195.3 million at 31 December 2008, after redeeming the loans relating to the properties sold in addition to servicing the ongoing loans. We have now completed our strategy of selling selected properties to enable the Group to be strongly positioned to take advantage of purchasing opportunities as they arise in the future.

At the beginning of the year the UK portfolio was valued at £485.8 million plus £112.8 million for the London Bridge Quarter (LBQ) and Fielden House joint ventures.

During the year, eleven investment properties were sold for gross proceeds of £113.3 million compared to a December 2007 carrying value of £105.2 million, a premium of 7.6 per cent. The buildings sold were Brent House, Conoco House, Coventry House, One Leicester Square, 22 Duke’s Road, 275/281 and London House King Street, Satellite House and Vista Centre. The sale of our interest in LBQ was also completed for £30 million including associated debt. The property at 86 Bondway that was previously included as an investment property has now been transferred to property, plant and equipment from the date that we occupied it as our head office. This property will be held at market value within property, plant & equipment until such time that it is returned to the investment portfolio or sold.

2008 proved to be a difficult year as the markets continued to feel the effects of the global credit crisis, with a further fall in transaction activity across Central London. Yields continued to move out as lack of demand was driven by the reduction of available finance and opportunistic buying.

The occupational market during the year remained strong with a number of new lettings completed, reducing the vacancy rate from 5.8 per cent at 31 December 2007 to 4.4 per cent by rental income at 31 December 2008.

New lettings were achieved at Cambridge House with existing tenants Prostate Cancer Charity and Open Society Foundation taking 320 sq m and 325 sq m respectively. Our subsidiary, Instant Office Limited, acquired a further 988 sq m at Great West House, expanding the business centre to 1,956 sq m. At Westminster Tower, 288 sq m was let to Trustwave Limited and further lettings were completed at Quayside and Ingram House. 86 Bondway was let to our subsidiary CLSH Management as the UK Head Office, assigning the lease on 26th Floor, Portland House, Victoria for a consideration of £0.2 million to Akzo Nobel Coatings (BLD) Limited with a guarantee from Akzo Nobel NV.

At Spring Gardens we achieved a significant increase at the June 2008 annual RPI rent review on units 3 to 5 and units 5 to 6. The index based review resulted in an increase of 4.9 per cent from £2.9 million to £3.1 million per annum in total. We completed the construction of the new on-site gymnasium and restaurant, which were extended to 939 sq m. This is let to the existing Government tenant of Spring Gardens until February 2026, in line with the expiry of all the leases on the estate.

Another significant rent review during the year was with Flight Centre on the 2nd and 6th floors of CI Tower where the rent increased by 20 per cent to £0.1 million p.a. on the 2nd floor and 8 per cent on the 6th floor to £0.1 million p.a. At Ingram House, a rent review was settled with GE Capital Europe on the 3rd floor increasing the rent by 89 per cent to £0.1 million pa.

Prior to the sale of Coventry House we completed the lease renewal on the restaurant over the lower ground, ground and 1st floors for a term of 25 years at a rent of £0.8 million pa, representing an increase of £0.1 million pa.

During 2008 we have been pro-active in seeking lease renewals and extensions to secure tenants and to maintain the income stream across the portfolio. This will remain the focus for 2009, together with reducing the vacancy rate further.

At 31 December 2008 the UK portfolio comprised 27 properties valued at £323.2 million including £2.3 million in respect of CLS’ share of the Fielden House joint venture. This reflects a decrease in the value of the current properties on a like for like basis of 15.8 per cent from December 2007.

We believe the biggest risks currently facing the property market is a deepening of the recession in the UK leading to increased vacancy and the lack of bank liquidity which will continue to affect the market. Since approximately 54 per cent of the portfolio is let to government or quasi-government tenants and the average lease period is 11.2 years, we anticipate that our UK property values will prove resilient compared to the wider market.

At 31 December 2007 the French portfolio was valued at £355.3 million (€482.2 million).

There was a significant portfolio sale of 29 companies owning 14 properties in May 2008. Consideration in respect of the properties was £110.3 million (€142.4 million) representing a 7.4 per cent premium on December 2007 valuations. Further to this sale, on 30 July the Group completed the corporate sale of three properties in a western suburb of Paris based on property values of £68.5 million (€87.0 million). These properties were valued at £69.5 million (€94.3 million) at 31 December 2007. As these were all corporate sales the purchasers also acquired the assets and liabilities of the companies, including certain loans secured on the properties which led to a book loss on disposals of £16.0 million (€19.7 million). Consequent to the sales however there was also a release of previously accrued potential deferred tax liabilities of £34.6 million (€43.6 million). The net result in the Income Statement for these disposals therefore was a gain of £18.6 million (€23.9 million – see Financial Review section in CLS annual report 2008).

A further property in Courbevoie was sold for £5.4 million (€7.0 million) compared to a December 2007 valuation of £5.0 million (€6.8 million). In addition, a deferred tax liability of £0.5 million (€0.6 million) relating to the property was released through the deferred tax line of the Income Statement.

We are pleased with the prices obtained for all of these properties, which have yielded good returns over our period of ownership.

In 2008, the French economy slowed down considerably, growing by only 0.9 per cent with the collapse of business activity in secondary and tertiary sectors. Business investment began to plunge due to deflationary expectations, blocked inter-bank lending and tougher credit conditions and the slow down of cash flows. The volume of investment represented only 12.5 billion euros, equalling 2004.

The volume of take-up in the Paris region in the year totalled almost 2.4 million sq m (a 14 per cent drop compared to 2007), whilst the immediate supply of office space saw a
13 per cent rise to reach 2.7 million sq m. The average vacancy rate in the Paris region at the end of the year increased to 5.4 per cent.

New leases were completed in respect of 13,385 sq m representing approximately 17 per cent of the portfolio and revenue of €3.0 million. The major re-lettings were located in Lyon with 6,407 sq m at Le Forum and 1,296 sq m at Front de Parc as well as in La Garenne Colombes with 2,385 sq m at Sigma. Additionally we negotiated lease extensions and renewals for 7,630 sq m producing revenue of €1.7 million including a new firm 6 year lease with GRTgaz over 3,170 sq m in Gennevilliers and a new firm 6 year lease with CAMFIL over 1,072 sq m in La Garenne Colombes.

Rents subject to indexation grew in the first half with annualised increases of 4.7 per cent in the first quarter and 4.5 per cent in the second quarter. These uplifts made an annual rent roll increase of approximately €0.6 million.

We continued renovation and refreshment of our buildings in order to offer the best office specifications to our tenants. In 2008 we have spent over €2.8 million including €1.9 million for complete renovation of the vacant premises (mainly at Sigma, Quatuor and Forum), €0.6 million for upgrading of air cooling systems, and €0.3 million for various improvement works in common parts.

At 31 December 2008 the portfolio comprised 25 properties (including 1 in Luxembourg) with a value of £223.4 million (€233.7 million), reflecting a fall in value of 7.4 per cent on a like for like basis during 2008.

The vacancy rate has increased to 4.2 per cent by rental income at the year end from 4.0 per cent at 31 December 2007, however negotiations are at an advanced stage for
re-letting part of the vacant areas and we have also launched renovation work for marketing purposes.

At 31 December 2007 the German portfolio was valued at £171.5 million (€233.2 million).

There were no acquisitions or disposals in the first half, but in December 2008 we completed the sale of the STEP 9 property for £11.4 million (€12.9 million) compared with a value at 31 December 2007 of £8.5 million (€11.6 million).

At 31 December 2008 the German portfolio comprised 17 properties with a value of £201.4 million (€210.7 million) reflecting a fall in value of 10.5 per cent on a like-for-like basis compared to 31 December 2007.

Our German operations have entered an exciting phase with approximately £24.6 million (€31 million) being spent on major redevelopments at the Rathaus Centre in the city of Bochum, and two new buildings that will form part of our existing property in Landshut, Munich over the next six months. Both of these properties have strong tenancy agreements in place with Bochum being let on a 30 year indexed lease to the City of Bochum, commencing May 2009, and the Landshut buildings on 10 year leases to E.ON Bayern AG with no breaks.

The German economy grew by 2.5 per cent in 2008 and GDP is expected to decrease by close to 3.0 per cent in 2009, the unemployment rate decreased to 7.2 per cent in 2008 but is expected to increase again to 8.0 per cent by the end of 2009.

The commercial investment market activity decreased dramatically by nearly 65 per cent, from €75.0 billion in 2007 down to €20.7 billion in 2008, due to the lack of financing. Nevertheless this is still 100 per cent above the 10-year-average transaction volume in Germany. Take-up in the office letting market decreased by 4 per cent in 2008 with 3.5 billion sq m which is the 3rd best result ever. We will keep looking for new development opportunities very selectively.

The vacancy rate across the German portfolio at the year end is 3.2 per cent by rental income compared with 2.4 per cent at December 2007.

The Swedish portfolio remains unchanged with the Vänerparken property in Vänersborg, near Gothenburg. The value of £50.8 million (SEK 581 million) has increased in Sterling terms from its valuation at 31 December 2007 of £49.6 million (SEK 635 million), but this is due to the fall in value of Sterling over the year. In local currency the value has fallen by 8.5 per cent, mostly due to a tenant surrendering space in exchange for a reverse premium amounting to £1.0 million.

The total transaction volume was predicted to decrease dramatically in Sweden during 2008, however, this projection was not fulfilled due to a few exceptionally large transactions. Vasakronan, owned by the Swedish government, was bought by AP Fastigheter in July 2008 at a purchase price of £3.4 billion (SEK 41.1 billion), which is the largest property transaction ever in Sweden. Including this deal, the total volume in Sweden last year amounted to £11.1 billion (SEK 132.8 billion), compared to £12.2 billion (SEK 145.8 billion) in 2007. International investors accounted for 25 per cent of the transaction volume in 2008, a decrease of 34 per cent compared to 2007.

The financial crisis is starting to impact the Swedish economy fully. Sweden’s GDP growth, which stagnated during the first half of 2008, is now expected to plunge into negative territory from the fourth quarter. The Swedish National Institute of Economic Research forecast in December that annual GDP growth will end at 0.8 per cent for 2008, compared to 2.5 per cent in 2007. Sweden’s unemployment rate was 6.4 per cent
in December of 2008 and is predicted to continue to rise.

After experiencing a few years of strong rental growth in Swedish property markets, rents now seem to be levelling out and are expecting to start falling in 2009.

Vänerparken consists of approximately 45,415 sq m and has a vacancy rate of 12.73 per cent, since the university vacated 11,783 sq m as they centralised their campuses in four towns into one. We have now let 6,001 sq m of that area to the local authorities and we are in final negotiations of signing new lease agreements for most of the remaining area with the local authority. Around 90 per cent of the rented area is let to Swedish government related tenants offering services such as healthcare, education, a leisure water park and restaurant facilities.

The vacancy rate at 31 December 2008 is 8.2 per cent by rental income compared with 0.8 per cent at December 2007, reflecting the surrender of space mentioned above. Negotiations are currently in progress that if successful will see the vacancy rate reduced to 1.9 per cent.

In June of this year the Lunarworks Group was re-branded as the Wyatt Media Group (Wyatt) to better reflect its developing identity as a multi stranded media group that provides effective advertising opportunities for its customers wishing to access the youth market. Wyatt now owns or is associated with seven websites (see wyatt.se) and is Sweden’s leading digital media house with 70 per cent of the youth market.

During the first half, the Wyatt Group exercised its option to acquire the remaining 60 per cent of Bilddagboken AB for consideration of SEK 25 million (£2.1 million) bringing its shareholding to 100 per cent. It also increased its shareholding in Internetami AB (Tyda) from 57 per cent to 82.3 per cent for consideration of SEK 5.4 million (£0.4 million) and acquired 40 per cent of blog collection site, Bloggkoll.com.

In May a new CEO joined Wyatt and a new strategy has been implemented that includes growth through both in-house development and acquisitions. As part of this, CLS Group has re-assessed the state of the market Wyatt operates in, the risks and uncertainties associated with that market and the business in its current state of development, the rate of growth that can be expected and the synergies that can be obtained from recent acquisitions within Wyatt. On the basis of this re-assessment the Board has decided to write off all goodwill on the acquisition of Wyatt of £22.0 million. The carrying amount of the Wyatt Group after this write-down is immaterial to the CLS group at 31 December 2008.

In the period from January 2001 to January 2008 the Group consistently outperformed both the FTSE all share and FTSE real estate indices, however in June 2007 share prices fell in anticipation of the downturn in the commercial property market which occurred in the second half of 2007. Since that time these indices have converged. The graph below, independently sourced by DataStream, includes conventional dividend payments but excludes the positive impact to CLS shareholders of substantial capital distributions through tender offer buy-backs.

In November 2008 and early January 2009 we distributed £58.9 million to shareholders by way of tender offer buy-backs of 16.3 million shares, equating to 94.8 pence per share.

3.7 million of our own shares were bought back from the market for cancellation at an average cost of 344.7 pence compared to a closing adjusted NAV per share of 647.2 pence.

During 2009 we intend to focus all of our energy and creativity on our core property operations. Our sales programme has now come to an end although our cost-cutting efforts continue. We will also concentrate on our letting activities and ensure that we retain our existing tenants in order to increase our cash flow.