At a macroeconomic level, the renewed growth that all observers glimpsed at the end of 2004, which was expected to be ‘weak’ in any case, has stalled during this quarter as a result of a bout of low confidence affecting businesses and, to a lesser extent, households. The business and consumption atmosphere was probably affected by the negative results of European Union referendum campaigns in France and the Netherlands as well as disappointing unemployment figures.
This immediately resulted in the principal economic institutions revising their growth forecasts downwards. In western Europe, only two countries have escaped this downward trend – Spain and the UK. As an illustration, whereas in October 2004 almost 80% of Consensus Forecast economists predicted GDP growth at over 2.1% for France in 2005, in May 2005 only 35% of the economists held that view.
This economic slowdown should be looked at in conjunction with a global financial environment deeply characterised by a great abundance of
liquidity. Indeed, world monetary base has almost doubled since the second half of 2000, reaching $5,250bn in May 2005. This mass of liquidity, fuelled mainly by Japan and increasingly by China, instead of bringing much feared inflationary pressure, has prompted a generalised increase in asset prices, particularly in the case of property prices (residential as well as commercial).
Focusing more specifically on the situation in France, one should distinguish between the service sector, where the national CEO confidence index has bounced back to regain its January 2004 level, and the confidence of managers of industrial companies, which has recorded a further decline. This has had an immediate impact on net job creation, which has turned resolutely positive in the service sector, but remains negative in industry. The bad news this quarter is the downward revision of growth forecasts for business investment and industrial production for 2005.
For all that, if we extend the forecast horizon, prospects become favourable once more, particularly when one factors in the fact that French firms need to invest in to remain competitive on the international scene. Decision makers are acutely aware of this but lack the confidence to make the step.
At a European level, according to Cambridge Econometrics, growth of the large regional cities are expected to be mainly fuelled by market services, with non-marketed services (public administration, public services) and energy & industry coming second. In this context, France’s main cities are expected to grow at a moderate level (2.3% per annum on average for the 2005-2008 period) as compared with their main European comparables, with Paris and Lyon at the forefront, followed by Marseilles and Strasbourg, and Lille coming last (see right).
Let us now focus on the four main sectors in relation to property investment and management in France.

Stabilising vacancy rates
As far as the market in offices in France is concerned, the level of activity in the rental market and investment market has remained high and has continued the trend observed over the last two years. In France and in some European cities the decline in office construction since 2002 has made it possible to “control” new supply, and thus vacancy. Vacancy rates in Europe’s main cities are stabilising. The Ile-de-France Region has seen a slight decrease in its vacancy rate – 6.1% in April 2005 compared with 6.4% in January, according to Immostat. The Paris region continues to enjoy a relatively favourable situation in the wider European context – 19.6% vacancy rate in Frankfurt and Amsterdam and 4.6% in Rome (source: PMA).
More specifically, the northern sector (Clichy/Saint-Denis/Saint-Ouen) has a relatively high (but declining) vacancy rate compared with other sectors in Ile-de-France (more than 15% in April 2005, according to CBRE). On the other hand, Paris central business district (CBD0 and the western business district (excluding La Défense) are enjoying vacancy rates of below 7%. We have seen a smaller decrease in rental values for new refurbished/renovated offices in most Parisian markets (see right). However, it is to be emphasised that incentives still make up a significant fraction of headline rents (we estimate these incentives to be in the range of 10-20% when rent-free periods, fitting-in costs and other costs are included. A drop in incentives will signal the upturn of the market.
Most observers recall that the investment market was particularly dynamic in 2004 (e12.2bn in France) and it is to be said that this has remained so in Q1 2005 (€2.13bn – source : Immostat). With the 10-year bond yield losing ground (-30bp), the stability of prime Paris CBD office yields at 5.3% still looks attractive. Posting an overall total return of 8.0%, the IPD performance for the office sector in France was satisfactory for 2004 (see right), but we must remain prudent and be aware that reversionary potential has been eroded to some extent and is increasingly less frequent in institutional investor portfolios. On the whole, we expect that given the economic outlook depicted above and the current supply/demand relationship, the upturn will be slow, but without any major crisis. In fact, it is as if most market participants await an upturn in rents which is rather slow in coming, but is still forecast for 2006.
The retail markets are chiefly characterised by: a slight downturn in consumption; active repositioning of different distribution formats on the part of the major operators; and a climate of increasing price competition. For all that, the rental market remains active and is standing up relatively well due to constrained supply and increased activity on the part of corporate names looking to renew some of their retailing concepts and to rethink their positioning and geographical networks.
One of the most significant aspects of these last few quarters is the rise of retail parks in France, which are seen to be increasingly positioning themselves as a market sector in their own right. Investors’ appetite has not dimmed and has led here again to the pursuit of yield compression. On the whole, the ability of the French retail sector to hold its own in the economic climate is still very good (it is true that household consumption has slowed in France, but by much less than has been the case for its main neighbours, and it is therefore still the main driving force for GDP growth). In the longer term, demographic change and changing consumption patterns should lead the investors in the retail sector to adjust their strategies and diversify among various retailing formats. This may be a safe way to continue benefiting from the very attractive returns reaped from retail investments in France (14.1%, according to IPD).
The logistics/warehousing market is bearing up as far as leased volumes are concerned, but the quarters go by and each is different from the last for all the sub-sectors. Nevertheless, a general rate decline is apparent. A closer look, region by region, shows that the trend has reversed in Lyon and this quarter was characterised by low leasing activity. Nord-Pas-de-Calais’s status as an attractive logistics region gained strength this quarter, while Marseilles is the theatre of fierce competition between various sites in a context of relatively weak demand. Finally, it should be noted that other French regions do present favourable logistics characteristics and opportunities.
Overall the logistics market in France remains characterised by more active search for flexibility on the part of the operators, which aim to optimise their logistics chain (floor space, price, dedicated facilities and so on). Looking forward, we may reiterate our opinion that cities located at centres of trade, notably with South East Asia, should continue to benefit from the increase in international trade.
Finally, the residential market is still reaping the full benefits of the interest rate level and downward trend and the structural imbalance between housing supply and demand. We would nevertheless wish to point out that there are clear signs of an ebbing in the rents and price-growth pattern. Indeed, the housing market is subject to opposing forces, with, on the one hand, household confidence still low, although it is recovering, and a relatively “still” employment market and, on the other hand, easy access to mortgage credit at interest rates that remain on a declining trend in the Eurozone. The impact on total return is immediate: IPD reported a hefty 11.6% total return in 2004 for residential investments in France, fuelled mainly by a 7.1% capital growth.
A large majority of observers now believe that interest rates in the Euro zone are set to continue to decline until at least the end of next year. Overall, at the present time, the housing supply-demand imbalance and the continuing decline in the supply of private lets are protecting the existing housing market from a sharp fall in prices.
Mahdi Mokrane is head of research and strategy at IXIS AEW Europe

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