Traditionally offices have formed the backbone of many portfolios, but as France recovers from the pandemic, investors are casting their net wider. Nicol Dynes reports.
The French market is becoming more competitive as institutional players move up the risk curve. Everyone has been looking for resilient assets, especially in logistics and residential, but the big players have cast their net wider and that is changing the market.
“Before the crisis we just focused on core but now we’re keen to take on additional development and operational risk,” says Tania Concejo-Bontemps, president of Union Investment Real Estate. “It’s been a big change for us, but everyone has to move, find new ways of doing business and diversify in terms of sectors as well as geographies.”
Guillaume Turcas, managing partner of Faro Capital Partners, adds: “Before only opportunistic players took risks, but now everyone looks at any asset class that’s interesting and the buyer is the winner. It is difficult to get the product and to shape a proper business plan to get value out of an asset and long-term buyers are ruling the market.”
‘France is a deep market that is not dependent on any one sector, so it’s very resilient. Our well-located assets in Paris have performed very well during the crisis.’
Tania Concejo-Bontemps, Union Investment
The next few quarters will be critical in showing how the market is going, but players may have to accept lower returns for a while yet, he adds.
“The biggest question for us is whether we can use leverage in today’s market and get some arbitrage,” says Edward Bates, president & CEO of Stam Europe. “It is hard for us to compete with the likes of Union Investment and that is the biggest challenge we face.”
In the current low-yield market the interest rate environment is crucial to allow companies to hedge, says Daniel While, head of research, strategy & sustainable development at Primonial REIM. “Historically low yields make it very hard for value-add or opportunistic strategies,” he says. “A large proportion of the equity invested comes from French insurance companies, who are active in direct real estate investments as well as funds and they’re income driven as they need regular revenue.”
Overseas investors still active
Domestic players dominate the French market, but overseas investors have also remained active throughout the crisis. “Asian capital has disappeared in the last year but European and US capital has kept investing in offices and logistics,” says Union’s Concejo-Bontemps. “France is a deep market that is not dependent on any one sector, so it’s very resilient. Our well-located assets in Paris have performed very well during the crisis and capital has continued to flow.”
France had very severe restrictions in place during the pandemic and suffered the deepest recession in Continental Europe, but it has come out of the crisis well, with strong GDP growth and lower unemployment.
“This has been a transition year from the lows of 2020 to the expected highs of 2022, but we still don’t know what we are transitioning to,” says While. “However, France has managed the health crisis very well and the rebound effect has been strong, with the lowest rate of company insolvencies ever in 2021.”
Residential is in great demand in France, but building a portfolio is hard work, say experts. “Resi today is the only asset class with upside in terms of capital gains – it has replaced offices,” says While. “Capital flows to the sector have increased: it used to be a €2 billion market, but last year it grew to €5 billion.”
Growth will continue but the French market is unlikely to reach the scale of the €15 billion German market, he adds.
“The beds sector is very granular and very competitive, it is difficult to deploy large amounts of capital,” adds Stam Europe’s Bates. “It takes a lot of work to build up a portfolio. As a value-add player we’re taking on more risk like permitting risk and by moving up the risk curve we’ll get the returns we need as long-term holders.”
‘The beds sector is very granular and very competitive, it is difficult to deploy large amounts of capital. It takes a lot of work to build up a portfolio.’
Edward Bates, Stam Europe
Residential has always been a big part of investors’ portfolios as it provides risk-adjusted returns, but it has become more attractive during the Covid-19 crisis.
“Offices have always been the backbone of our business, but now we are looking at resi as well with great interest,” notes Concejo-Bontemps. “It is an extremely resilient asset class and it has proved
to be one of the winners of the pandemic. But in France there are very few opportunities, volumes are low and there are strong established alliances between developers and institutions, so it’s not easy for a new player to enter the market.”
Institutional investors need critical mass as they seek to buy hundreds of apartments to create an efficient structure that will allow operational platforms. “We have 90 flats in our portfolio so far but we need hundreds more to have a competitive structure,” says Concejo-Bontemps.
The difficulties in creating a substantial portfolio are just one of the reasons why the build-to-rent (BTR) sector in France is still at the starting blocks.
“France is not culturally ready for BTR strategies, as people prefer to buy their home,” says Primonial’s While. “But operators are getting better and capital is ready to take on more risk. The future is quite bright for resi in France and indeed in Europe in general.”
In the next few years the sector in Paris will benefit not just from economic and demographic growth but also from the largest urban transport project in Europe, the Grand Paris Express, which is set to deliver 200km of metro lines and 68 new stations (see below).
According to a recent research report published by Primonial, “future creation of value in real estate will be largely dependent on the delivery of stations”.
Experts are predicting a wave of opportunities in the Paris office market as many buildings will be put on sale. “Most commercial real estate is owned by large institutions and around 60% of that is offices,” says Faro’s Turcas. “Now they seem willing to reshuffle their portfolios and a lot of office buildings will come to the market.”
Most of those portfolios have secondary offices that can be repurposed into residential or refurbished and made ESG-compliant. New ‘green’ requirements are driving sales, as the new energy efficiency regulations are difficult to price in and institutions don’t want to be landed with stranded assets.
“We have been looking at our portfolio to include more green assets and that is going to continue,” explains Serge Bacconnier, deputy head, Paris office, at Berlin Hyp. “In La Défense in particular there are many assets that need to be refurbished and a lot of capital needs to be deployed there.”
Local authority power
It will not be smooth sailing because local authorities hold great power in France and getting the necessary permits can be difficult and time-consuming.
“Conversions are never easy and municipalities hold as much power as Louis XIV the Sun King did,” says Turcas. “Even if the zoning plan authorises you, the head of the municipality can still say no and block everything. That needs to change.”
‘We have been looking at our portfolio to include more green assets and that is going to continue. In La Défense in particular there are many assets that need to be refurbished.’
Serge Bacconnier, Berlin Hyp
If sales are set to take off, the lettings market is still slow, however. “Big occupiers are hesitant and it’s been a struggle to get them to take substantial leases for large offices,” says Concejo-Bontemps. “The pandemic has had an impact and companies have been rethinking their real estate strategies,
so there have been very few big transactions in the lettings market.”
In future companies are likely to demand shorter leases and more flexibility as the market adapts to the new post-pandemic hybrid model. “We don’t expect a great difference in office take-up, as meeting and conference rooms will still be needed,” says While. “It is likely to fall by 10-15%, from the current annual take-up to 2 million sq m to 1.8-1.9 million sq m. It will be an adaptation rather than a massive disruption.”
Less work from home
Another factor that works in favour of offices is that remote working has not taken off in the French capital to the same extent that it has in London or Frankfurt. “There’s been much less work from home in France than in the UK or Germany,” says While. “It’s partly for cultural reasons and partly because people live in smaller flats in Paris and there is less incentive to work from home.”
At the top end of the market shiny prime headquarters in the CBD will continue to be in demand for company image and culture purposes as well as places in which to hold meetings, while other companies will opt for secondary offices and more peripheral areas to avoid paying the €900-plus per sq m rent in central Paris.
“Offices are still seen as a necessity and a more productive environment to work in”, says Bates. “For investors it will continue to be a key market, because there’s a limit to how much money you can deploy in resi and logistics.”
The rise and rise of residential
The title says it all: the new research report by Primonial REIM on the European residential sector is called The Great Acceleration. Residential is in great demand across Europe and it has emerged as one of the winners of the pandemic.
While the GFC and the European sovereign debt crisis both led to a drop in house prices in many countries, the health crisis of 2020/21 has had the opposite effect. Prices and demand in the European residential sector have accelerated and institutions are increasing their exposure.
The rise of institutional investment in block housing goes hand-in-hand with these developments. Since 2018, residential real estate has overtaken retail to become the second most invested in sector behind offices.
The same pattern is visible in many European cities, the report explains: construction volumes never fully recovered from the GFC, leading to a wide and growing gap between ever-increasing demand and limited supply.
“Confounding some predictions made during the first lockdown, we are not seeing an urban exodus towards smaller towns but rather a reorganisation within major urban centres,” says Henry-Aurélien Natter, head of research at Primonial REIM.
‘Residential valuations are not irrational but instead offer the prospect of stable growth, assuming an unchanged interest rate environment.’
Henry-Aurélien Natter, Primonial REIM
The city of today and tomorrow is inter-generational, hosting several age groups with different needs. This will lead to the further growth of residential models, from co-living to build-to-rent and student accommodation to senior housing.
Demand for rented homes has risen in the Eurozone as house prices have risen, making it more difficult for people to get on the housing ladder. This shift to renting has been particularly noticeable in Spain and Portugal.
Differences in rental trends
On average three out of 10 residents rent in Europe, but there are huge differences between countries. In Romania and Hungary owner-occupiers are the majority, while in Switzerland, Germany, Austria and Denmark renters are the majority. France, Belgium, the Netherlands, Sweden and Ireland are in line with the European average.
European residential markets will see positive total returns between now and 2023, Primonial REIM believes, thanks to the economic recovery, economic activity that is likely to be stimulated by the European recovery package, the shortage of supply and attractive mortgage rates.
“Residential real estate currently offers a risk premium of between 200bps and 600bps, with prime yields close to those on prime office assets,” says Natter. “Residential valuations are not irrational but instead offer the prospect of stable growth, assuming an unchanged interest rate environment.”
For investors, linking residential real estate to stages of life can offer attractive diversification as well as ticking the impact investing box. “Such investments can provide social advantages, thus allowing investors to meet their ESG and/or SRI targets,” adds Natter. “Moreover, in recent years residential real estate has demonstrated its ability to offer regular and stable revenue flows whilst also providing attractive capital returns.”