Gains in the pipeline for Land Securities

Land Securities, Britain's largest property company, comes with psychological and physical baggage. Psychological because it was in the eye of the financial storm and in 2009 had to resort to a rights issue and ill-timed asset sales to keep afloat. Physical because it is still letting out much of its property at pre-crisis rents - 'over-renting' in industry jargon. That means management has to fight a corrosive tide of lease expiries to grow profits and dividends.

Yet, if investors can look past the trauma of 2007-09, shares in Land Securities look a solid bet. Management increased the dividend for the first time since the crisis in May, and the dividend yield, though hardly princely, is above the FTSE 100 average. But the big reason to buy the shares is the pipeline of property developments that Land Securities has in London. These should raise the value of its portfolio, pulling up the share price.

Commercial property is valued by taking the total of the contracted rents in a building and applying an appropriate multiple, which is conventionally expressed in terms of its inverse, the yield. In the crisis, capital values took a double hit as rents fell and yields rose. Yields have since dropped back for prime London properties - such as Land Securities owns - partly thanks to the pound's weakness, which has made sterling-valued real estate look cheap to overseas buyers. That factor accounts for the bounce in the group's net asset value (NAV) since the rights issue, but it's unlikely to provide further gains.

Meanwhile, the recovery in London office rents has only just begun. Development schemes were frozen as rents plummeted in 2008 and banks are still reluctant to increase their exposure to property, so only the best-capitalised property companies can afford to re-start them. That means new office space will be scarce from mid 2012 - just as a wave of leases signed in the late 1980s boom expire. This imbalance between demand and supply should underpin strong rental growth over the next few years.

Land Securities does not automatically benefit from this recovery because of the over-renting problem - market rents will merely be catching up with contracts written before the crisis. That's why the development pipeline is so important. By delivering brand new space to the market in an environment of strong rental growth, Land Securities can increase its income and the value of its properties even as it struggles to extract growth from existing leases.

Chief executive Francis Salway was quick to realise this and pushed the button on three West End schemes in January 2010, just as the UK economy was spluttering back into life. The group also has projects in the City, most notably a skyscraper in Fenchurch Street. Nicknamed the 'Walkie Talkie', the planned tower has an oddly bulbous top to maximise space in the more valuable upper floors. But it won't be ready until 2014, so less grandiose projects, such as the refurbishment of 110 Cannon Street, which is due for completion next spring, are more immediately relevant.

Property development is highly capital intensive. Land Securities is only able to finance its programme because its emergency rights issue in 2009 left its balance sheet in good shape. But the lack of bank finance for big schemes is good news for the major listed players as it makes it all but impossible that the rental boom will be doused by a flood of rival projects.

The property market outside London is less buoyant, with a patchy outlook for retail - the only sector in which Land Securities operates in the provinces. Fortunately, the group is heavily skewed towards London, which accounts for 61 per cent of its portfolio. Moreover, its regional assets tend to sit at the prime end of the market and only 4.5 per cent of its retail portfolio (including London shops) was empty at the year-end - compared with double-digit vacancy rates in many regional high streets. And its only major retail development scheme, in Leeds, is already 53 per cent pre-let.