Country Report: France – In search of value

In the French market, a chronic deal shortage is driving strategic moves beyond core Paris. Lauren Parr reports.

It won’t be long before Paris sees prime, core transactions trade at below three percent net initial yields, market spectators believe (see chart showing prime yields). Right now, prime office yields in Paris’s CBD stand at three percent exactly, tighter than London’s expensive West End.

“There has been a lot of interest on behalf of equity investors pushing pricing high,” Marco Rampin, head of EMEA debt & structured finance at CBRE, explains. This is a result of chronic lack of supply in Paris, making core deals hard to source for both investors and lenders.

In a bid to get deals done and find returns, investors are moving into the core plus and value add part of the market (see panel). The first French investment made by Natixis Asset Management and AEW’s new pan-European core fund, Senior European Loan Fund II (SELF II), financed a portfolio of 13 offices based in the Paris region, four of which are undergoing repositioning and one of which is vacant. SELF II bought a €20 million position in what was a €400 million loan facility supplied by a French and a US bank in April.

French market remains liquid

The underlying real estate market is pretty active even though, like other European markets, it is expected that transaction volumes will be lower compared with 2015. Relative to other markets it remains at a high level, CBRE shows. Turnover of more than €15.3 billion was recorded in the year to 30 September, which was three percent higher than the same period in 2015.

Bertrand Carrez
Bertrand Carrez

“There is more capital available to be invested in CRE loans than assets to be bought,” observes Bertrand Carrez, global head of real estate at Acofi. The French asset management company secured €420 million of equity at the latest closing of its (fourth) commercial real estate debt fund in October and will have deployed 80 percent of capital in senior loan investments across asset types and risk profiles by the end of 2016 – half in France. “Our domestic market remains competitive; there is still more money to be lent than borrowing needs despite the dynamism of the direct real estate market,” Carrez says.

The current lending opportunity stems from an “interesting point in the property cycle” whereby rents have been stabilising and, in some sub-markets, rising, meaning take up is positive, says Roland Fuchs, head of European real estate finance at Allianz. “Real estate fundamentals are looking quite good at the moment, especially in Paris CBD and the La Defense office market,” he notes.

Allianz provided a €225 million long-term loan to French listed property firm Icade, backed by the Pont de Flandre office park on the outskirts of Paris in June.

Most French investments are made by local investors (up to 75 percent, according to CBRE); the likes of big REITs and insurance companies looking for a long-term play.

On the core side leverage is typically low, between 20 and 40 percent loan-to-value, with some deals not leveraged at all.

“The biggest competition for banks at the moment is equity buyers,” in Fuchs’s view.

Shift towards value add

Even with the low interest rate environment putting some debt on, returns are low: single to mid digit IRRs. “This attracts a drift towards value add and repositioning assets,” says Rampin. He points to the Dutch market where there has been “a complete boom for that”. The result is that “the value add side has topped out with little more growth expected because demand for the space available has dried up”.

“Now France is at the beginning of that race; it needs strong signals from the economy though to boost demand,” he says.

Continues Rampin: “Secondary locations and the value add opportunistic market only works well in a growing economy. Post-GFC, when things began to get back in shape, demand for secondary product was still very limited because occupiers’ demand did not follow through.”

Investors are waiting for visibility on what Brexit will mean. Meanwhile, political instability tied to the French presidential election next year could pose near-term risk.

With potential volatility on the horizon pbb Deutsche Pfandbriefbank is concentrating harder on quality, says Norbert Müller, pbb’s head of real estate finance in Western Europe. The bank’s speculative development financing of an office project in Paris is protected by the fact it is “a fantastic scheme in the heart of the CBD. If properties compete with each other, the newest buildings in the best locations will always win in an upturn and especially a downturn,” Müller believes.

Like most European countries the French economy is on a moderate growth path. It is still waiting to see the first positive indicators on employment for a sustained period. “It is not on a downward angle though,” insists Fuchs. “More important is that real estate fundamentals look quite healthy at the moment.”

Allianz sees a continuation of lending activity in the office and retail sectors, with potential for greater activity in the logistics sector (see panel). Core investors are also expected to return to the city housing market in the coming years, with German lenders starting to look at the residential sector on a long-term financing basis.

Demand from equity investors remains strong, sustaining a supply shortage in the Paris market and driving expansion beyond core. “Investors aren’t buying to make a quick buck; they’re medium- to long-term holders and senior lenders are comfortable lending to larger, well-known borrowers in this space,” says Rampin, with the caveat that activity will likely slow down in the run up to the election next spring.

Looking outside of the core

With limited core stock available in Paris and returns low, investors are moving into alternative and operating asset classes.

“People are trying to diversify into hotels, senior and student housing and medical care,” says Cyril Hoyaux, head of debt funds management at AEW Europe. A club of French banks financed the purchase by Primonial of Gecimed, Gecina’s subsidiary dedicated to clinics and healthcare housing, before the summer.

Logistics is a stand out financing opportunity, even though investments have become expensive at a day one yield of around 6 percent. “With increasing ecommerce activity the logistics market in general and especially in France, which is the axis between anything that goes from Germany and further east, to the southern hemisphere, will benefit,” explains Allianz’s Fuchs.

pbb Deutsche Pfandbriefbank financed the €100 million purchase of the Wolf portfolio of 19 logistics assets located within the French logistics corridor from Lille to Marseille at 70 percent LTV. Müller stresses it is important to back the right asset manager as logistics portfolios often contain hundreds of leases.

Lenders are supportive of certain regional retail although, warns Hoyaux, with purchasing power diminishing they should be careful to back dominant schemes. AEW is about to close a €25 million participation in a circa €350 million financing facility issued by a French bank for a portfolio of high street retail assets in “the best locations in the best cities”, namely Paris, Lyon and Marseille.

Key players and typical terms

Cooperation between banks and insurance companies including Allianz, AXA, Predica, CNP, Scor and Credit Agricole has become an established business model when it comes to larger transactions. Allianz recently concluded a large refinancing of a pan-European portfolio for a French REIT arranged by French banks.

French banks like SocGen and German banks including pbb Deutsche Pfandbriefbank and Helaba dominate the lending market, with a total of about ten institutions active in the arrangement of big-ticket finance. Among the line-up is Aareal Bank, which acted as underwriter and arranger for a €215 million loan to Tishman Speyer for its acquisition of Tour CBX in La Défense in October. It subsequently syndicated 25 percent of the deal to French asset manager La Banque Postale (LBPAM).

“Next to Germany, France represents one of the largest investment markets and, accordingly, Paris is the most liquid and transparent real estate finance market in continental Europe,” says pbb’s Müller. “Access to the market is offered by French banks, which are deep into the market, serving clients’ other business, not just real estate, inviting German banks into clubs or syndications.”

Balance sheet lenders or banks that distribute part of the risk to insurance companies or funds like Acofi, AEW and LBPAM comprise the most active players, over and above a handful of investment banks including Bank of America Merrill Lynch, Morgan Stanley and Goldman Sachs, whose presence has declined in the past year or two in line with yield compression.

Margins are under pressure, with spreads against well-let core assets in Paris’s CBD now around 100 bps mainly owing to competition driven by French banks and German pfandbrief lenders. That’s still 20-30 basis points higher than the equivalent deals in Germany (70-80 bps lower than in the UK). For assets with a core plus or value add risk profile, pricing has remained more consistent at no less than circa 130 bps.

“Banks know they have to find liquidity with people like us and we couldn’t buy their loans if they don’t offer a minimum return so the market has been quite resistant to the pressure on spreads,” says Acofi’s Carrez, adding that he doesn’t see too much flex from the arranging banks in terms of structure and financial covenants. For core deals LTVs don’t typically exceed 65 percent; maximum 60 percent for value add.

Decent margins of up to 200 bps are available on the development side, Müller points out. pbb recently funded the redevelopment of the Centre Marine Pépinière in Paris’s CBD into a 18,500 square metre flagship office development with a circa €150 million loan. It is working on several development opportunities with some of the best capitalised French sponsors.