When it comes to commercial real estate, it looks pretty easy to see what is triggering investors' greed and fears today, write AtlantiStar's David Aubin and EAV Property Analysis' Eugene Agossou-Voyeme.

When it comes to commercial real estate, it looks pretty easy to see what is triggering investors' greed and fears today, write AtlantiStar's David Aubin and EAV Property Analysis' Eugene Agossou-Voyeme.

In 2013, the volume of investments into the UK and Germany real estate surged compared to previous years, reaching €55 bn in London and €30 bn in Germany. Meanwhile, the French market has remained steady, with €20 bn invested.

Unlike its major neighbours, France severely failed to attract higher streams of capital in 2013.

Whilst there is undoubtedly greed in London, with dealing prices of residential properties north of £5,000 per square foot, would that mean that Paris is feared? Not that simple.

The Paris market shows a paradox, with a historically high gap between CBD prime yields, and first ring prime yields. Let’s look at the figures: in the 'jobless growth' market of 2003, this gap was 0.75%, with first ring dealing at 6.50% whilst prime CBD was at 5.75%. In the distressed market of 2008 and 2009, massive job cuts pushed the gap up to almost double, at 1.35%. First string properties, suffering from a weak take-up, kept a slightly increased cap rate of 6.75%, whilst the safe haven of CBD saw cap rates contracting down close to 5.55%.

In 2013, the quasi-collapse of the subprime crisis and the nightmare of Eurozone sovereign debt subsided, paving the way for a new jobless growth (weak growth, admittedly) market. Has the gap gone tighter? No way.

To the contrary, it literally peaked at 1.60%, with first ring yields slightly down, around 6.10%, whilst prime CBD cap rates sharply compressed to 4.50%. Are Paris CBD prices unreasonably tight because of fearful investors having excess liquidity to deploy, and focusing on 'easy choices'? Are first ring cap rates too high because of a vacancy rate reaching 12% in some locations ? Is it right if first ring rewards 36% more than CBD, whereas is rewarded only 13% more in 2003? Difficult to say.

The correlation between GDP growth and office take-up is quite credible in Paris CBD, suggesting Paris cap rates would be priced correctly. Going one step further, the 6.10% cap rates in the first ring are far from homogeneous. In a city like Suresnes, at walking distance from Dassault Systèmes and Havas headquarters, a core-plus building struggled to attract investors at a cap rate sensibly above 7%. Even within Paris, near the peripheral road, efficient office properties in the 12th or 20th arrondissement fail to trigger interest in spite of a comfortable enough tenant schedule, and seven to 10 years unlevered IRRs approaching 9%.

Is the lack of appeal for first ring justified when so many groups among the CAC 40 have moved their headquarters in the first ring (Rueil - Malmaison, Boulogne - Billancourt, Montrouge, Charenton, ..), and some like Société Générale or GDF Suez have kept it in Paris CBD but are practically established in La Défense ?

We don’t believe this is the case. To the contrary, we see three key reasons why there are hidden gems around the mine in these secondary locations. First, the Paris region will remain the capital city for the second economy in the Eurozone and a worldwide tourist destination. The chances are therefore high that the Paris region will regain its strong appeal when growth picks up and job creation resumes.

Second, a gap of more than 1% between an average-looking but core asset in Paris' first ring and a prime asset in the same area is completely unreasonable, even if vacancy on obsolete assets around is high. At the end of the day, is there such a difference in the quality of building, in the tenant creditworthiness, or in weighted average lease terms?

In a variety of cases observed, this is not the case. The price gap is more due to fears than to actual factors. Third, rents have readjusted down to around €545 per m2 at the end of 2013 for Paris 1sr ring prime assets, showing a decrease of 7%. Given the evidence that substantial incentives are proposed to new tenants, the adjustment is probably much more pronounced in terms of triple net. Broadening the scope below the prime segment, CBRE’s figures show weighted average rents in the same areas falling sometimes below €200 per m2.

While there is no certainty that they have bottomed out, there seems to be much more upside potential than downside. We are like passengers of an A380 with three engines turning low-speed: far from being a nightmare
scenario, we have far more chances to feel the aircraft speeding up very substantially, rather than seeing it slow down further.

Once Paris regains investors' confidence, a significant yield contraction combined with a rise of rents could therefore offer bargains for those who are buying Paris first ring now. Perhaps it is the time to become fearful about the Central London crowded mine, and get greedy about hidden gems there?