OUTLOOK PARIS Imbalances increase in prime office market under weight of capital

The investible prime office property market in Europe will continue to shrink and yields will continue to compress as institutional capital opts to hold onto assets in core locations for longer periods of time.

That was one of the key conclusions drawn at PropertyEU’s Outlook Investment Briefing held on Thursday at the Paris office of law firm Taylor Wessing.

The bond market may not be as deep as it was a few years ago, encouraging more investors into real estate, but the same holds true for prime property on core locations, according to Marcus Cieleback, head of research at German investment company Patrizia. ‘Sovereign wealth funds and German institutional capital are holding on to property for 10, 15 years or even longer. That means an ever smaller part of the market is being traded.’

As a result, it will become increasingly challenging to get deals going, he said. ‘There’s not as much going on… the market is declining and we will have to live with lower liquidity and greater volatility.'

Record-high risk premium
At the same time, investors are paying a stiff premium for liquidity which may not always be justified by the market fundamentals, Cieleback warned. The risk premium is at an all time high and it shouldn’t be, he added.

‘Until the millennium there was quite a strong relationship between vacancy rates and prime rents in the office market. But that relationship has broken down to a large extent. Prime rents are going up despite vacancy levels remaining high or even rising. That is not a typical text book assumption. Going forward prime yields are set to compress further in all markets so investors must be careful of what they are moving into.’

As prime yields compress further, investors are being increasingly challenged to make returns and are attracted towards products being labelled as ‘develop, manage or built to core, Cieleback said. ‘Investors want core products, but I would argue they are not going up the risk curve, they are going up the return curve. They need value-add returns because they were core returns six or eight years ago, but some of these products won’t be core in the long run. You need to understand what you’re buying and whether it really is prime.’

Some investors are possibly buying into secondary assets at a prime price, he argued. ‘The yields may be more attractive, but the fundamentals could be missing.’ Notable exceptions, he added, were Italy – which is still in catch-up mode – and some Dutch cities like Rotterdam.

Disconnect in Paris
Commenting on current pricing in France, Philip la Pierre, head of investment management Europe at Union Investment, agreed that prime office yields in Paris in particular were extremely tight. In terms of transparency and stability, the Paris market is ‘fantastic’, he said. ‘The regions are a lot less liquid and transparent.’

But there is a disconnect in Paris, he added. ‘There is a risk in the leasing market and that is creating challenges on the office side.’

While the French government has so far failed to take the steps to achieve the necessary economic restructuring, market conditions are more favourable in the French retail and logistics sectors, he said. Yields have come down in both these sectors in Germany but there is still a big gap between logistics and retail yields in France. ‘This surprises me. There appears to be a disconnect which may be an opportunity.’

Didier Unglik, president of L’Etoile Properties, has even greater reservations about the French market. Asian investors are keen to enter France, he said. ‘They have tried, we have taken them here but in the end they don’t want to buy anything…They’re not on the market for two reasons. The competition is very heavy and they can’t compete on the pricing levels.’

Germany is a more popular destination, he added. ‘They all want to go there. The market is more diversified in geographic terms but also on the yield side. The economic fundamentals are strong…Germany offers only pluses.’