Domestic factors are positive for investors in France, but international issues remain a concern. Nicol Dynes reports.
The French commercial real estate market is in a strong position due to domestic factors, but international issues are a concern. “The situation is favourable, with positive growth forecasts, lower unemployment, strong business sentiment and political uncertainty gone after the recent presidential election,” says Rory Sheard, international director, Paris office investment, at BNP Paribas Real Estate.
Emmanuel Macron was re-elected president for a second time but in June his coalition, Ensemble, lost its absolute majority in the National Assembly. Having reforms approved might prove to be more difficult in future, and there are now question marks over imported inflation as well as geopolitical concerns.
“New uncertainties have crept into the market over the last few months,” says Simon Wallace, head of research, alternatives, Europe, at asset manager DWS. “There’s inflation, higher construction costs, rising interest rates and general investor uneasiness. But these are global issues, not French problems so we’ll absolutely continue to invest in France.”
Investments in commercial real estate in France were €27.4 billion last year, slightly down from €29 billion in 2020. This year is seeing an improving trend, with €5.3 billion invested in Q1, a 2% increase on the same quarter of 2021.
The traditionally dominant Île-de-France region accounted for €3.1 billion or 59%, while the regions performed better than in past years, attracting €2.1 billion, or 41% of the total in Q1.
Offices, accounting for 48% of investments, continue to be the main magnet for capital, but there has been a slowdown this year compared with 58% for 2021. Retail is the next largest sector in terms of investment, with 26% (compared with 12% in 2021), and logistics & industrial follows with 18% (20% in 2021).
Retail’s strong performance
“Retail really punched above its weight in Q1 this year because of a very large shopping centre transaction,” says Sheard, referring to Unibail-Rodamco-Westfield’s sale of a 45% stake in the €1 billion Westfield Carré Sénart shopping centre in Paris in February this year. So logistics is likely to regain second place later this year.
Bond yields are being watched closely as the spread is reducing fast, but offices continue to be attractive due to rental growth fuelled by low supply. “We expect rental growth to be around 2.4%, which means there is a healthy buffer of 1.5% before total returns would be affected,” adds Sheard. “Rents are indexed in France, so real estate does provide protection from inflation.”
‘We are financing conversions rather than new buildings. It’s a fabulous way to support the fight against climate change.’
Benjamin Cartier-Bresson, Berlin Hyp
According to BNP Paribas Real Estate figures, Asian investments fell from 12% of the total in 2019 to zero in 2020 and last year crept back to 5%, while the combined share of UK and US investments has steadily increased from 17% in 2019 to 25% last year. French domestic capital accounted for 59% of investments in 2021, but in Q1 this year its share had increased to 74%.
“French players remain dominant in the market, but they are being increasingly challenged by German investors, who are very active, and Anglo-Saxon capital, which tends to be higher on the risk curve,” explains Sheard. “Korean investors, who had been present before the pandemic, have been replaced by Singaporean capital, with GIC taking up big positions in La Défense.”
Investors move away from core
High demand and lack of supply in the Paris office market are leading institutional investors to move up the risk curve, experts agree. “We are seeing a change in investment strategies, away from core and up the risk curve,” says Wallace. “Taking on redevelopment risk doesn’t seem so risky in Paris, as we still see high occupier demand and rental growth, especially for quality space that is ESG-compliant.”
In Q1 this year there was a significant reduction in the share of core assets being traded, accelerating a trend that has become increasingly visible in the last few years. The share of core investments in the office sector in Paris has declined from 69% in 2019, to 62% in 2020, to 50% in 2021, to a mere 34% in Q1 this year, according to BNP Paribas Real Estate figures. Value-add strategies, by contrast, rose from 13% in 2019 to 25% in the first three months of 2022.
It is the same upward trajectory for speculative investments, which have risen from 5% of the total in 2019 to 16% in Q1 2022, while core+ strategies, which accounted for 10% in 2020 and 17% in 2021, this year are up to 25%.
“We’ve seen significant rental growth and low supply, so traditional core buyers are taking risks in Paris now,” says Sheard. “ESG factors are becoming key in investors’ decisions, and this is contributing to lack of product.”
As investors become more selective, the number of attractive properties is shrinking while the potential for stranded assets increases. “There is a definite split between ‘bad’ assets and ESG-friendly assets,” notes Raphael Tréguier, founder and managing partner of Kareg Investment Management. “Older buildings are not interesting and there are a lot of empty assets, even fully-let offices that are empty. We’re in a transition phase but there are still opportunities for agile players.”
Market polarisation is becoming a feature of the Paris office market. “The good offices of tomorrow are better than those of yesterday, so some assets are inevitably left stranded,” adds Sheard. “Distressed office properties are being reinvented as mixed-use assets, student housing or even last-mile logistics and people are seeing this as an opportunity.”
The problem is that, however willing and creative investors are prepared to be, they have to deal with the authorities’ slow-moving practices. “Repositioning and change of use is on a 5-to-10-year time scale in Paris while the investment time frame is a few months, so clearly there is an issue,” says Tréguier. “It is difficult to assess administrative risk because investors are not familiar with it.”
Another issue is rising material and labour costs. “There are question marks over redevelopment risks now, as construction costs are going up,” says Wallace. “As projects are delayed or cancelled outright, supply will inevitably be further curtailed. Lack of supply will translate into higher rents, which is why we see the medium-term opportunities rather than focus on the short-term risk.”
ESG issues have come to the fore post-pandemic and this is changing the Paris market. “The ESG aspect has become a priority in the last 12 months,” says Benjamin Cartier-Bresson, head of Paris office at Berlin Hyp. “We have to look at the future performance of an asset we are financing, and if the location is good and the property is ESG-compliant or can be made so with capex then we are in a safe haven.”
Another change has been the difficulties in demolishing existing buildings, which is leading to a sustainability-driven shift towards repurposing. “We are financing conversions rather than new buildings and I am sure we’ll do more and more of that,” adds Cartier-Bresson. “It’s a fabulous way to support the fight against climate change.”
The need to reposition and repurpose buildings, usually old office assets, has led to a willingness to diversify into other sectors. “Asset repositioning reduces the carbon footprint and gives a second lease of life to buildings,” explains Tréguier. “Every year 50 million sq m in Paris becomes obsolete. Around a third of that will be restructured as offices, because the office sector will stay strong, but the key question is what to do with the rest?”
Financing for fast-growing resi
More and more investors and lenders are waking up to the huge opportunity to turn existing buildings into something else, be it mixed-use, residential or logistics. “Investors have changed their positions on asset classes and so have we,” says Cartier-Bresson. “We’ve started to finance resi in France, which is new for us, including operational resi like student housing and senior housing, which is a fast-growing sector.”
The focus on residential allows investors to look beyond Paris to France’s regional cities. “We are very positive on the French market and outside the capital resi is a big focus for us,” says Wallace. “Long-term demographic plays mean there are interesting opportunities in build-to-rent in fast-growing cities like Toulouse or Bordeaux.”
‘Older buildings are not interesting and there are a lot of empty assets, even fully-let offices that are empty.’
Raphael Tréguier, Kareg Investment Management
Investors are looking beyond residential and financing requests are becoming more and more varied, adds Cartier-Bresson: “Every other week we’re asked to finance an interesting life sciences project, or urban logistics, usually conversions from car parks. We’ve even been asked about landing pads for drones.”
As EU taxonomy is changing and evolving, lenders as well as investors and asset managers must keep up with developments. “EU taxonomy will have a huge impact on our segment in the next five-to-10 years,” says Tréguier. “There’s been an important change in mindset, going beyond ‘do no harm’ to actually making a positive contribution. A lot of capital will be redirected to funds that have a positive impact on the planet.”