Posted On Sunday, 25th March 2012
French real estate sector ended 2011 on a dynamic note
In a break from the financial and macroeconomic environment, the French real estate sector ended 2011 on a dynamic note, with total commitments bouncing back to a respectable €16.1 billion, up from €9 billion in 2009. Various supporting factors will, however, be missing from the market in 2012, according to the latest research from La Française AM.
Continuing high risk aversion
For investors, the market is limited to the most secure and most recent assets in the best locations. The few unsecured developments remained marginal in 2011, and are likely to become even more scarce. The search for defensive assets and regular returns is winning the day over value creation strategies.
The end of Article 210E
While it is difficult to estimate how many sales were brought forward to 2011 in order to be eligible for reduced capital gains tax, there is no doubt that the deadweight effect provided a stimulus that will not be repeated in 2012.
The credit freeze and the prospect of the “debt wall”
Following a fairly buoyant first half of 2011, many banks announced that they were cutting back or halting financing of real estate purchases. Furthermore, increases in the cost of funds for various lenders, together with an increase in the margins on offer to customers, led to a considerable rise in financing costs for investors. Finally, uncertainty over the refinancing of leveraged portfolios acquired between 2006 and 2008 will unavoidably act as a brake on the market.
A downgraded macroeconomic outlook
Following the decline in macroeconomic expectations from September 2011 onwards, many operators are factoring in the prospect of a correction in rentals and lower occupancy levels, leading to a corresponding rise in risk aversion and buyer selectivity.
However, in an environment in which the decline has mainly been driven by exogenous trends, our assessment of the real estate sector and its intrinsic characteristics remains positive.
No crisis of overproduction
The French real estate sector is protected by a Malthusian approach whereby the only properties constructed are those that have already been let or are virtually sure of being let. In the absence of growth, this approach of managing scarcity protects occupancy levels, rental values and yields, though at the expense of modernising the country’s stock of real estate.
A diversified and highly adaptable underlying economy
France’s economic fabric has shown itself to be highly adaptable in the face of lacklustre conditions: businesses are reluctant to take risks, are seeking to protect their margins and are only taking on moderate debt. In this environment, arrears and tenant defaults remain the exception.
Consumption is holding firm
Although it is constantly changing, commercial real estate in France can also rely on a level of consumption which, while it might slow down, will never really contract violently, as has happened in some developed countries hit by recession.
Areas in which market inefficiencies create opportunities
The withdrawal of risk-averse investors creates potentially attractive market segments which should benefit from a return to a more favourable economic environment. This makes it possible to entertain alternative investment strategies based on “sustainable” renovation of office properties in prime locations, the development of SME and SMI premises in view of industrial redevelopment, long-term holding of residential portfolios, etc.
Economic environment: a lacklustre outlook
In 2011, France and a large part of the eurozone succumbed to an economic climate characterised by slow growth and uncertainty. A return to rising unemployment, the weak export competitiveness of French industry (with the trade balance reaching a record level of around €70 billion in 2011), government austerity measures and the rising price of imported commodities all combine to slow activity.
The medium-term outlook points to sluggish growth in the the first half of 2012, followed by a slight economic recovery in the second half of the year. Potential good news stories in 2012 might include an economic recovery in the United States, containment of the latent credit crunch by the ECB and a fall in commodity prices. However, any recovery will still be restrained by austerity measures that have now become part of the long-term landscape, weak household spending and, above all, the high level of ambient uncertainty over the eurozone’s financial future and the 2012 elections. Any economic recovery in France is not expected to happen before the second half of 2012, or possibly even 2013.
Financial environment: latent credit crunch
The financial environment for investment real estate at the end of 2011 was characterised by a particularly high level of market uncertainty caused by the prospect of a European recession, the delicate financial position of eurozone countries and the slowdown in emerging countries. In response to the situation and the inability of European governments to restore confidence, the ECB finally intervened by lowering its key policy rates and offering unlimited cheap liquidity to Europe’s banks.
At the beginning of 2012, then, investment real estate faces a very real threat: weakened European banks need to deleverage and are therefore relatively unlikely to want to finance - or refinance - real estate assets. On the other hand, the safest segments in the real estate market continue to play their role as alternative defensive investments for long-term investors mainly looking to invest cash.
Corporate real estate: a buoyant end to the year
In a tricky economic environment, the French market for office space paradoxically had a dynamic year in 2011, with prerented office space in the Ile-de-France region growing 14% year on year to around 2.4 million square metres. However, these positive indicators cannot hide the deterioration in the rental market, which began in the summer of 2011, or, in particular, the persistent and marked downward pressure on real rents. In fact, while the level of activity - the gross demand for rental property - may be strong as a result of natural turnover among lessees, this often comes at the expense of used properties, thus accelerating the obsolescence of the real estate stock, and always at the cost of a drop in rents.
Economic growth, the office space market has managed to maintain its stability and a 7% vacancy rate thanks to the construction freeze and movements by companies seeking to lower their costs within a fixed stock of properties. On the investment market, in spite of a delicate economic and financial environment, total investments amounted to almost €16 billion in the year, thanks to a very dynamic fourth quarter of 2011 (though this was, admittedly, stimulated by the withdrawal on 31 December of tax benefits offered by “SIIC” status). Yields held steady in the fourth quarter of 2011, with a prime yield of 4.5% in Paris, 5.50% in the inner suburbs and around 6% in the regions. However, the premium on these yields is liable to increase significantly in line with rental risk and the technical standard of buildings.
Residential real estate: running out of steam
In the third quarter of 2011, the French residential property market was still giving out positive signals: transaction volumes were continuing to rise, equalling their 2007 record, with 826,000 housing units sold in a year (up 6% year on year, compared with a 32% rise in 2010). Prices continued to rise (up +6.7% year on year), though this trend appeared to slow towards the end of the year. Region, it reached only 4.3% year on year in the regions, with certain market segments even posting declines.
French real estate sector ended 2011 on a dynamic note
In fact, the residential market has for the past few quarters been signalling a reversal caused by the fact that virtually all its drivers have run out of steam: housing loans have shrunk drastically, fiscal policy has been reversed, there has been a widespread feeling that the cycle has peaked, etc. Nevertheless, there are still strong forces pushing back against this trend, including in particular a relative, localised shortage of residential property, especially in the Ile-de-France region.
In this environment in which opposing forces are at play, the 2012 correction should therefore prove relatively limited. According to various market observers, the average correction in existing property prices across the whole country should be between 0% and 7%. In fact, the markets in which demand is highest could be immune to this correction.
Solid and diversified economic fundamentals
The French hotel sector is built on solid and diversified fundamentals, and in particular on a dynamic foreign tourist trade: France is the world’s number one tourist destination, with 77 million visitors in 2010 and tourist revenue of $46.3 billion (number three in the world). The years between now and 2020 will see the development of a new clientele from emerging countries, growing at more than 7% a year. A proportion of activity in the hotel sector, however, relies on domestic demand (domestic and business tourism), which is currently experiencing a slowdown. On the supply side, available hotel space in France fell by 5% between 2006 and 2010, enabling occupancy rates to recover after bottoming out at around 63% in 2009.
A positive year in 2011
In this environment, although it did not return to 2007 levels, the French hotel sector posted growth in activity in 2011, mainly thanks to a dynamic first half in terms of both occupancy rates (65%) and revenue per available room (RevPAR). However, performance continued to diverge between categories:
• Budget and two-star hotels, which are mainly exposed to domestic demand, saw visitor numbers stagnate (up +0.8%), though this was offset by rising room rates (up +2.1%).
• The three-star segment, which saw RevPAR increase by 6%, was supported by a slight economic recovery in the first half of the year and a calendar of events that brought in business customers.
• Benefiting from international tourism, RevPAR in the four-star and luxury segment outperformed the market in 2011 (up more than 10%), particularly in Paris and the Provence-Alpes-Côtes d’Azur region.
Real estate investors make a comeback
Against the backdrop of a recovery, there was a pronounced upturn in investment in hotel real estate (with €1.6 billion invested in 2011 - see graph opposite). In particular, this uplift in commitments was driven by emblematic acquisitions of luxury assets by foreign, and particularly Middle Eastern, investors.
In spite of the gloomy economic environment, the sector should continue to recover in 2012, albeit at a less sustained pace. The higher-end categories should once again keep their heads above water, driven by an international clientele. For investors, investment opportunities will arise in particular from sale and leaseback transactions, which are likely to be on the increase.
For example, the Accor group has announced a €1 billion increase in its 2010- 2015 disposals programme, bringing it to €2.2 billion. A B&B portfolio is also currently on the market for around €500 million. Furthermore, various groups, like Starwood, are likely to continue unloading “trophy” assets.