JLL dismisses bubble fears as Paris yields spiral downwards

The Paris real estate sector is not heading for another bubble even though prime yields are edging closer to the 2006-2007 low-point seen before the subprime crisis, JLL has said.

The prime Paris yield has fallen by an estimated 50 basis points over the past 12 months, from 4.50-5.00% to 4.00-4.5% and current transactions are being seen at even lower yields. At this level, yields are close to the 2006-2007 low-point from before the subprime crisis.

According to JLL, legitimate questions are being asked as to whether yields at this level are sustainable or if there is another real estate bubble in the making given the flat economic climate and the difficult rental market.

CHACTERISTICS OF A BUBBLE
According to JLL, a real estate bubble forms when there is a rapid increase in prices with no link to the fundamentals of asset value. The formation of a bubble is often due to the combination of a number of factors: excessively optimistic expectations, planned short-term ownership while speculating on rapid capital gains.

Another bubble characteristic is that after having inflated, it bursts (crash) or deflates leading to a fall in prices with a lesser or greater degree of severity and over a varying period of time.

Based on a comparison of market conditions now with those prevailing in 2007, JLL concludes that the French capital is not on course for another bubble.

The reasoning behind this position is based on several factors. Firstly, there has been no reversal in the spread between real estate yields and the French risk-free rate (OAT) in 2014 - in fact the situation has been quite the opposite. Historically, real estate has always presented a risk premium over the 10-year OAT (150-250 points for the prime references). 'Between 2006 and 2007, the investment market moved away from this historic rule with a "negative risk premium” or reverse yield gap for prime Parisian assets - which had yields below that of the OAT,' according to JLL research director Virginie Houzé.

Since then, the difference has been restored and the French OAT has fallen to a very low level; this has maintained a comfortable level of risk premium for investors, currently at around 200 basis points. Recent ECB decisions are unlikely to reverse this trend in the short term, she said.

EQUITY TRUMPS DEBT
There is little or no speculation on financing in contrast to 2006-2007 where the abundance of debt and commercial mortgage-backed securities (CMBS) contributed to the market overheating. At present, investors’ recourse to financial leverage is limited, Houzé said. 'In recent years, 80% of investments in the Greater Paris Region for assets over €30 mln were not subject to financing and LTV levels remain reasonable (at an average of 63% in 2013).'

Whilst the availability of debt in the market is very high, a significant number of investors (sovereign wealth funds, insurance companies) invest almost exclusively using their own equity and therefore bring a higher level of stability to the market.

And, investors remain selective. Unlike the 2006-2007 period with its abundance of capital and debt, the current situation has not (yet) attracted unexperienced investors in the French market. Stephan von Barczy, head of investment for JLL: 'This is also illustrated by the fact that not everything sells and that some marketing programmes are unsuccessful either due to the asset’s characteristics, location or the price expected by the vendor. Market segmentation remains a reality.'