French returns hold firms as residential sell-off
In May, Investment Property Databank released its annual performance figures for the French property market for 2003. At the end of 2003, the databank comprised 4,743 properties, valued at e57bn – around 62% of property assets owned by institutions and quoted property companies in France.
2003 saw a further gradual deterioration in the performance of the French property market. All property returns slipped to 8% in 2003 from 8.7% in 2002. This decline came as the rate of capital growth slowed from 2.3% in 2002 to 1.6%, while income return remained static at 6.4%. After a poor year in 2002, when returns fell to –31.9%, equities rallied to achieve an annual return of 19.9% in 2003. Meanwhile bonds, the top-performing asset in 2002, saw returns more than halve to 3.8%.
However, over the medium term, property has delivered superior returns in France, as shown in Figure 1. Over the past six years, property has achieved total returns of 9.9% a year, against equity returns of 5.2% and bond returns of 5.9%.
The commercial property market in France is made up largely of three sectors. At the end of 2003 the office sector accounted for around 55% by value of the total investment market. Residential made up 22%, retail a further 12%, with the remaining 11% or so held in industrial and mixed use/other properties.
As can be seen in Figure 2, retail has been the star performer of the French property market over the past six years, delivering total returns of 15.4% a year. Offices, at 11.2%, have marginally outperformed industrial, at 11%, while residential has managed just 6.7% a year. The driver of retail outperformance has been strong capital growth of almost 8% a year. Strict planning controls mean that there is a tightly limited supply of retail stock; however, demand from investors has become increasingly fierce, pushing yields down and capital values up. The rate of increase in office capital values, at 4.4% a year, has been double that on residential, while office income return, at 6.8% a year, has exceeded that on residential by 2.5 percentage points a year.
Poor residential returns have come about as a result of higher unemployment in France. Housing booms in the UK, Netherlands and much of Scandinavia have been fuelled by a combination of low interest rates (a common factor across Europe) and low unemployment, providing a large pool of would-be purchasers. But as Figure 3 shows, in countries like France, Germany and Finland where unemployment has remained fairly high, returns have not taken off.
Residential has also proved unattractive as a result of the high costs associated with this type of investment. Figure 4 shows the net income received and operating costs incurred on French property by sector at the end of 2003 – the figure after the sector describes the percentage of income lost as costs. Residential easily incurs the highest proportion of costs of all the sectors, at 24.9% of gross income, against 11.5% and 8.8% respectively in the retail and office sectors.
Another negative factor associated with the sector is the age of stock. As shown in Table 1, 70% of residential stock was built before 1986, compared with just 33% of office stock.
Taking into account residential’s weak performance history and relatively poor income and age profile, it might be expected that investors in France would have moved to decrease their exposure to the sector relative to the office and retail sectors. Figure 5 shows that this has been the case.
Figure 5 unbundles the changes in portfolio weights since 1998 into ‘active’ changes resulting from investors’ deliberate asset allocation decisions (termed net investment shift) and ‘passive’ changes (caused by variations in the rate of capital growth or the addition of funds to the databank) across segments. At a sector level, the analysis reveals that investors have sought to decrease their exposure to residential property by almost 12.5 percentage points over the past six years. Conversely, investors have attempted to increase exposure to the office sector by 10.7 percentage points and to the retail and industrial sectors by around 1.5 percentage points each. At a segment level, investors have largely looked to increase their exposure to Paris offices outside the core central business district and to shopping centres.
Residentials recorded a net withdrawal for the sixth year in succession of –e2.3 billion, or 17.3% of existing holdings. This shows that the trend of part sales of apartments, often to current tenants, that has accounted for much of the institutional withdrawal from the sector has quickened significantly. Going forward it is difficult to see a change in attitude from investors, and it must be anticipated that ‘easy sales’ will continue to be made by institutions keen to exit the residential sector in favour of investing in larger office and retail schemes.
Dominic Smith is a senior researcher at Investment Property Databank (IPD). Email firstname.lastname@example.org