eco TV

The Paris office market: a matter of yield

6/17/2020

As commercial real estate can be seen as a financial asset, analysing spreads between property and government bond yields is a proper way to better forecast price levels.

TRANSCRIPT // The Paris office market: a matter of yield : June 2020

FOCUS

FRANÇOIS DOUX

In our Focus, we will look at the office real estate market in France to get a better picture of the recovery -- or at least growth -- in France.

We are here with Richard Malle, Director of Real Estate Research at BNP Paribas Real Estate.

Hello, Richard.

RICHARD MALLE

Hello.

FRANÇOIS DOUX

Commercial real estate is the biggest asset category for institutional investors, with assets of EUR 250 billion. That’s why this segment is so important for understanding the real estate market. Could you review the pricing fundamentals of this market in France?

RICHARD MALLE

As you pointed out, it is primarily an investment category for professionals, for investors. Instead of looking directly at prices, we are mainly interested in the difference between the property’s rental value and yield.

That is what is shown in this chart, which shows the initial yield of the so-called “high-end” real estate segment in Paris. It is the main benchmark used for international comparisons. We can see that the return has declined rather significantly since the early 2000s before hitting an all-time low of only 2.8% at the end of 2019.

FRANÇOIS DOUX

Indeed, 2.8% is not very high. Are investors willing to settle for that? Why?

RICHARD MALLE

It is very low, a record low. One explanation is provided by a comparison between the risk-free bond yield, notably 10-year government bonds in France, which is one of the main benchmarks, and the real-estate yield. These two yields are often compared.

And what do we see? Government bond yields have also fallen sharply. From 5% in the early 2000s, they are now fluctuating more or less around 0% in late 2019 and early 2020. Over the same period, the real-estate yield has also fallen by virtually half, dropping from 6% in the early 2000s to 3% at present.

FRANÇOIS DOUX

This is the famous yield spread I mentioned during the introduction to this edition of EcoTV. How do prospects look now, Richard?

RICHARD MALLE

We use this type of chart and analysis to help us make forecasts. We were already using them before the lockdown, and they are still pertinent today. We can look at what happened during the previous crisis – the global financial crisis of 2007-09 – and compare it with what is happening today. It is worth comparing these prospects, because today’s situation is totally different.

This is what we saw in 2007, just prior to the outbreak of the global financial crisis. The spread – i.e. the difference between the real-estate yield and the risk-free bond yield – was negative by 50 basis points. Why? Because there was a lot of speculation in the office real-estate market. Investors were seeking capital gains that failed to materialise in 2008-2009. Today, the situation is totally different. The spread is historically high at about 280 basis points. What does that mean? It means that the real estate yield is high enough now to accept all the risk and uncertainty in the quarters ahead, even without a significant increase in the real-estate yield in 2020-2021, unlike in 2009 when the yield rose very significantly.

FRANÇOIS DOUX

There is a lot of talk about working from home, which seems to be a widespread trend. Could this have an impact on rent?

RICHARD MALLE

Not really. The crisis began with a very significant shortage of office space, notably in Paris proper. Currently the vacancy rate ranges between 2% and 3%, which indicates a real shortage. Historically, the average vacancy rate for the past 15 years has been 4%. The economic crisis has inevitably had an impact on jobs and could lead to new ways of working, which means there could be an increase in office capacity in the quarters ahead. Yet this trend is likely to remain mild, below the breakeven point. That is why rent is likely to decline, but only mildly, notably in Paris proper.

Similar observations can be made in most of France’s main regional metropolitan areas, including Lyons, Lille and Marseilles as well as Bordeaux on the Atlantic coast.

FRANÇOIS DOUX

To conclude, we should not expect to see many price corrections in the office property market due to a shortage of office space.

RICHARD MALLE

That is correct.

FRANÇOIS DOUX

Thank you, Richard Malle, for this update on the specific workings of the office real-estate segment. We will be back in a moment to continue talking spreads with William De Vijlder. This time, our Chart of the Month will compare the yields on German and US 10-year government bonds. Stay tuned.

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