Spotting Selective Real Estate Opportunities in France

Summary

1. Diversified property exposure provides an investment in income-yielding real assets with rental growth. This is attractive for long-term investment portfolios that are heavy weighted to financial asset classes, such as Equities and Bonds.
2. Commercial property has performed well: European commercial Real Estate funds have generated an average total return of 5.7% per year since 2002.
3. In the short term, both weak economic growth and higher interest rates are headwinds for commercial property. However, the worst economic effects are already being felt in property prices.
4. The above factors provide a better entry point for long-term investors in 2023 than in 2021 or 2022, given higher rental yields today.
5. BNP Paribas Real Estate forecast 5-year European commercial Real Estate returns in the 4-5% annual range out to 2026, well above current interest rates.
6. Offices: BNP Paribas Real Estate expect French regional cities (e.g. Lille and Bordeaux) to offer some of the highest five-year property returns in Europe.
7. Both Healthcare and Residential rental segments should offer rental growth prospectively of over 3% per year from 2023 to 2027 on strong rental demand.

Real Estate is the biggest asset class

Globally, Real Estate remains by far the largest asset class of all, dwarfing Equities and Bonds with an estimated value of USD327 trillion (as of 2020) according to Savills, a global real estate agency. By segment, residential dominates with 79% of all Real Estate by value, while commercial Real Estate (offices, warehouses, retail) represents around 10%.

Performance of commercial Real Estate investments has been relatively consistent – over the last 20 years, European commercial Real Estate funds have generated an average total return (capital growth plus income) of 5.7% per year, according to the INREV association of property funds. 

Key drivers of Real Estate

In basic terms, there are two main drivers of Real Estate returns over the long term, namely:

1.Economic growth and employment, and

2.Interest rates – the cost of borrowing

A combination of relatively steady economic and employment growth and low and falling interest rates up until 2021 has been positive motors for Real Estate demand and asset performance.

However in the near term, the global and regional economic outlook for Real Estate in European countries including France is more challenging, given the impact of the current energy crisis, translating into higher costs for companies and households. This factor weighs both on industrial activity and on consumption.

Secondly, both short- and long-term interest rates are rising as central banks, such as the European Central Bank, try to slow down current high inflation rates. Financing costs for Real Estate have thus increased from decade lows, representing a second near-term headwind for this asset class.

As a result, economic activity and employment growth will remain weak for the first few months of 2023 until energy prices ease further and inflation rates descend from decade-high levels.

Do not focus on the short term

We warn against focusing too much on short-term difficulties when considering an investment in Real Estate. Moreover, Real Estate remains a long-term investment within a diversified portfolio, suited to an investment horizon of several years, not months. Real Estate must be conceived as an asset in its own right in an investment portfolio. It is equally a real asset that provides an attractive return over time and is less volatile than financial assets.  Finally this asset class can provide an inflation hedge over time. In 2022, the indexation of rents partially offsets declines in capital values. This trend should continue in 2023 and 2024, given the typical lagged effect of inflation on rents. To note, commercial Real Estate rents continue to rise from +1% to +10% per annum in major European cities.

We believe that the bulk of the increases in interest rates have already been seen in Europe and elsewhere, with inflation rates already starting to decline and the global economy already slowing. We do not forecast further increases in long-term interest rates over the next 12 months, suggesting a stabilisation in Real Estate financing costs ahead. This should underpin commercial property values, at a time when rents continue to rise by +1% to +10% annually in major European cities.

As energy costs and inflation rates recede over time, we would expect economic growth to resume in Europe and beyond, acting as a renewed driver for demand for offices, warehouses and retail space.

Difficulties present opportunities

While the more difficult economic and financing climate is driving a period of adjustment at present, this will give rise to opportunities for new Real Estate investors. BNP Paribas Real Estate forecast future 5-year European commercial Real Estate returns in the 4-5% annual range out to 2026, well in excess of short- and long-term interest rates.

Commercial Real Estate driven by large long-term trends

Several trends have become key factors in determining the capital and rental values of commercial property today:

        - Location: a central location with easy access to public transport/parking is an asset.

        - Energy efficiency: buildings benefiting from the new energy efficiency standards now have greater market and rental value.

        - The adaptability of buildings: historically buildings were dedicated for office, residential or even business use. Today, they are built so that usage can evolve over time.

        - Demographic trends are indicative of greater needs in certain segments, such as healthcare or residential.

The ongoing industrial upheaval, including the relocation of industrial operations to Europe and the momentum of online sales, create opportunities. 

Adjustment is faster in Europe

Over Q3 2022, global Real Estate returns were flat according to MSCI Global, with capital values falling by 1% globally over the quarter, offsetting a 1% income yield.

European countries saw a greater adjustment in capital values, led by the UK with a 5% decline in Real Estate prices over Q3, while Germany saw a 3.5% price decline and France a 3% decline over the same period The best regional performance came from Central/Eastern Europe and Asia, where Real Estate prices continued to increase.

But office demand remains robust, especially in French regional cities

Despite growing economic weakness, Q3 remained a strong quarter for European office demand with continued recovery in office take-up after the COVID-affected years of 2020 and 2021. European prime office rental yields stand at 3.5%, while office rents have grown in 2022 so far everywhere except in London.

Regionally speaking, some of the strongest Real Estate returns have been observed in the French cities of Marseilles and Lille, where BNP Paribas Real Estate expect to see robust double-digit commercial property returns over this calendar year. Indeed, over the 2022-2026 forecast period, BNP Paribas Real Estate expect French regional cities, such as Lille and Bordeaux, to offer among the highest 5-year property returns in Europe.

Healthcare and Residential offer good rental growth prospects

According to BNP Paribas Real Estate Investment Management, both Healthcare and Residential rental segments offer annual rental growth prospectively of over 3% per year from 2023 to 2027. Rental demand in both segments remains high.

In particular, in Residential the combination of historically high residential selling prices and more expensive mortgage rates obliges households to continue to rent for longer. Rental of houses in big city suburbs remains in great demand following the COVID pandemic, as employees largely benefit from remote and hybrid work patterns and look for living spaces which can accommodate work-from home arrangements.

Hotels continue their recovery, especially in Paris

European hotels suffered heavily from the sudden halt in tourist activity on the back of COVID-19 lockdowns. This triggered a slowdown in hotel real estate investment. Recently, international tourists gradually returned to Paris, partly thanks to the weak euro. In the first half of 2022, the Paris and Ile-de-France region welcomed 7.4 million international tourists, 30% fewer than in 2019.

BNP Paribas Real Estate expects the recovery in tourism to continue over the next few months, with the return of business travellers and an increasing number of physical events to take place.

Hotels continue their recovery, especially in Paris

European hotels suffered heavily from the sudden halt in tourist activity on the back of COVID-19 lockdowns. This triggered a slowdown in hotel real estate investment. Recently, international tourists gradually returned to Paris, partly thanks to the weak euro. In the first half of 2022, the Paris and Ile-de-France region welcomed 7.4 million international tourists, 30% fewer than in 2019.

BNP Paribas Real Estate expects the recovery in tourism to continue over the next few months, with the return of business travellers and an increasing number of physical events to take place.