France’s buoyant investment market contrasts with its struggling economy and the cool winds blowing through the office leasing markets. Growing apprehension regarding the economy has intensified investors’ focus on income security and location; Paris and the surrounding districts attracted over 70% of the total investment volumes in the first half of the year, with the CBD alone accounting for one-third of the spoils. According to CBRE, while cross-border investors accounted for a respectable 38% of total France investment, they represented just 28% of inflows into Paris region offices, reflecting keen pricing and, arguably, fewer opportunities to acquire long income assets after the frenetic trading of recent years.
Data from RCA suggests cross-border investors continue to view the liquidity and depth of the Paris region as an attractive proposition. Norges Bank’s purchase of the Prologis logistics portfolio demonstrates continued commitment, following their acquisition of Generali’s office portfolio in 2012. US investors also remain firmly committed, while UK and Italian investors have returned to the office market after a notable absence in 2012. German investors are still at large in the market, albeit less active than last year. Deka’s big ticket purchase of rue La Fayette from Ivanhoe Cambridge helped to improve an otherwise weak showing. Middle Eastern interest also seems to have waned after the strong showing in 2012 from the Qataris and the U.A.E.
The intense focus on Paris suggests pricing will remain resilient. As for London and Germany’s core office markets, a flavor of the 2007 bull market resonates across Paris at present where successful acquirers of prime assets offer tomorrow’s price to secure the deal. The prime CBD yield is currently c.50 bps higher than its level at the height of the previous cycle. While this might set alarm bells ringing, there are notable differences:
Keen real estate pricing today partly results from central bank asset purchases, which have depressed bond yields and lowered the required return on real estate.
Short term rental growth expectations are much weaker today compared with those during the previous cycle, partly explaining the willingness to over-pay for long income in the hope the economy and rents eventually play catch up.
Prime-secondary yield spreads are nowhere near as compressed as they were in 2007, demonstrating elevated risk aversion rather than risk-taking.
Equity forms a much higher component of deal finance than debt (although there is recent evidence that the banks are allowing LTV creep for secure assets)
The lack of debt finance for speculative projects in recent years should be good for rental growth when France’s occupier markets recover.
Despite these differences, buyers of prime assets could face challenges as interest rates normalize. Central banks will pare back asset purchases when they see signs of a strengthening economy and they will adjust short term interest rates as emerging economic growth looks sustainable, even if not for a few years. Real estate performance will suffer unless improving rental growth expectations offset the rise in the bond yield. Current real estate yields imply France’s economy will be in rude health by the time the ECB moves on interest rates.
Andy Schofield: Director of Research, Property