Looking to Lyon
Key Messages
Regional offices will achieve the best total returns, where the potential yield compression is still high. In Lyon, we are still expecting a yield compression of -30 bps for prime by 2021
Some yield compression may occur in the Paris office market, mostly for secondary assets
The strongest rental growth is likely to be in Paris CBD, where the available supply is low (1.3% at the end of 2019)
2019 was the year all the records for the French market were broken: highest investment volume, prime yields at historical lows (in each asset class) and strong rental growth. With good fundamentals in the market, the next two years are promising.
Offices remain the preferred asset class for investors accounting for 62% of the total investment in France. Prime yields compressed in most markets (except for La Défense and Lille) in 2019, Prime yields may continue to decrease across the front part of the forecast period of 2020-2024, but at a slower pace. Major yield movements may occur in average properties with increased competition from investors.
Market fundamentals have momentum. In the Parisian region, we think sustained take-up will ensure positive net absorption over the forecast period. Vacant space will increase over the front part of forecast (with new deliveries) but remain under its natural rate (estimated at +7.7%). It implies we can expect prime rental growth of around 1% on average over the forecast period. The whole market rental growth will be stronger at around 1.5% over 2020 to 2024.
In the regional cities, 2019 witnessed record highs in take-up and investment volume, reflecting increasing attraction prime offices with higher yields. It is cheaper way to diversify portfolios. Consequently, market total returns may be very strong in 2020 (11.3% for Lyon and 11.9% for Marseille) before falling to near half by 2024. With a strong demand and good fundamental, we are expecting a positive capital growth in 2020 and for the years to come in France.
With a fall in the prime yield of 75 bps and an increase of investment volume of +76%, logistics was clearly the best performing asset in 2019.
The Parisian region, with its catchment of almost 12 million people, is still the most desired location. The questions of environmental impact and “last mile” deliveries are directing logistics companies to urban locations. Land scarcity in these areas are pushing prices up and decreasing yields. For the whole market though, we do not expect further yield compression.
The prime total return of +22.8% in 2019 is set to decrease sharply in 2020 to around 6%. Reduction is mainly a result of yield stabilisation as income will mostly drive returns. Capital growth may be mostly negative over 2020-2024. Rental values are steady and with the increase of tenant demand, we expect low rental growth of under 1% over the forecast period. Lack of product and demand for custom-made warehouses may create difficulties for investors sourcing property.
Performance of French retail varies depending on the sector. Shopping centres and retail parks are struggling but core retail in the city centre is holding up. Our forecasts look at city centre prime the best of which is in Paris. Here we see the lowest yields for commercial real estate in France at 2.4% in 2019. We think this yield level may maintain over the front part of the forecast before decompression occurs from 2022 onwards. Correspondingly, we anticipate mostly negative capital growth in the sector over the forecast, reflecting the uncertainties attached to value.
Although the retail here is among the best, rental growth across 2020-2024 will be mostly zero. The rental situation along with negative capital growth may result in total returns fading to around and finally turning negative in 2024.
Risk to the Forecast
In an environment where demand is strong and supply not overreacting, we can identify two risks to the forecast.
Increase in construction cost. Developers may be more cautious about committing if it becomes too costly. Reductions in new supply could change the rental dynamic
Strategic refocusing of companies. A prolonged economic slowdown implies space reduction may occur for companies to reduce costs.
Benoit Lefebvre