Will the Paris Office Market Escape the Slump?

Your scribe is a real old throwback; our lunch on 19^th March was on a lovely sunny spring day, overlooking Hyde Park and to also have a young lady talking about Paris made remembering to keep notes a bit tricky.

Fortunately, Catherine Kervennic, Partner at Property Market Analysis gave us a very engaging talk, with lively questions afterwards. Her answer to the question set was simple – ‘no’. After a period of denial last year, reality has struck; vacancies are rising, investment yields are rising and rents are falling. However, in Catherine’s view, whilst Paris will have its ‘slump’, it will not be as deep as those in London, the US and Germany for example. She gave four reasons for this. First, there is less over-supply. Secondly, investment yields had not fallen to such low levels, nor rents risen to such heights; there is therefore not so much ‘unwinding’ to be done. Thirdly, because rents are more modest, tenants, whilst shedding staff (this is, of course, less easy than in the UK), are not so keen to shed the accommodation as well; keeping it until better times return is more affordable. Finally, in response to a question, there is not likely to be much distress-selling. Banks in France are better-placed than in the UK or US and will not be so keen to pull the plug, and anyway office properties are less geared-up, with much being owned by secure overseas sources.

The Paris office market is divided into three very distinct markets: the Central Business District, La Defense and the various inner Business Districts. Each of these has its particular dynamics because each tends to have its own tenant base – La Defense with the large space-users for example. This will lead to some variance. La Defense is likely to have over-supply problems because development is still occurring. By contrast, the Western Business District, with its particular and attractive ambience is proving more resilient. Nevertheless, across the board rents are falling, and Catherine found it indicative that landlords are now less forthcoming on discussing any incentives that they have given.

The decline in rents is having an interesting side effect. In France, in broad terms rents are generally linked, at review, to the building cost index. At most times, this has favoured tenants, but it now works against them. There is a further statutory provision that, if the index has risen by more than 25%, the tenant may opt to use a market comparison, which many are now doing. She wondered if, after this experience, tenants will be so keen to use the building cost index.

As to eventual recovery, Catherine considers that, as Paris entered its decline later, it is likely to start its recovery later. She does not see the ‘busted flush’ of London’s financial ‘expertise’ as an opportunity for Paris to gain competitive edge – London still has a unique advantage. There are also issues about France’s political direction. Whilst the present government was elected on a platform of reform, and has taken some major steps, there are signs, if not yet of reverse, of a certain slowing. This will not assist the present lack of confidence amongst employers.

Despite that, Catherine pointed out that Paris bears a different relationship to France as a whole from London to Britain. Paris is the place to be for many businesses, are there are no equivalent alternatives such as Bristol, Leeds, Edinburgh etc. This dominance must underpin its long term strength.

To me, the image Catherine gave was of a temporary market decline such as those we have experienced several times during my career, declines that, whilst awkward at the time, pass without serious damage. One wonders if that is quite what is happening in London.

Michael Mallinson

What is Jessica?

Chapter members who attended the lunch on 19^th January heard our speaker Paul Aldridge reference 'Jessica’ and might have wondered what that meant.  Here is a more complete explanation from Paul.

"For those keen and hardy souls, I'm afraid to be the bearer of disappointing news - there are not yet any academic papers to hand that I am aware of for circulation."

"Jessica stands for 'Joint European Support for Sustainable Investment in City Areas,' and the essence of the position is shifting public sector funding towards a position of recoverability. In other words, it is proposed that Jessica stand as a 'loan,' but it doesn't have first charge over land in the manner that you'd expect with commercial debt finance."

"Exactly how this works in a tiered hierarchy of returns remains to be seen. A cynic could say if it's not first charge on the asset then it's pretty unlikely to be recovered, but it's just too early to see how it works. I hope that it moves us to a position of more economically sustainable development where the principles of equitable return on traditionally grant funded schemes are accepted, accepting that the risk profile for the parties may have to change to effect this shift. There are working papers in hand with WAG and NWDA, but the nuts and bolts of the project funding approach just aren't there yet."

See the Jessica information at the European Investment Bank web site: 

http://www.eib.org/projects/publications/jessica.htm.

"Jessica: A new way of using EU funding to promote sustainable investments and growth in urban areas." (Date: 05/09/2008)

A 6 page PDF file describing Jessica is viewable from the above site in several languages, with the English version here:

http://www.eib.org/attachments/thematic/jessica_2008_en.pdf

Delivering Regeneration - The Role of Local Asset-Backed Vehicles

How does a landowner without access to finance secure development of his land without either selling it or losing all control via a lease? This conundrum has been with us throughout my career and Local Asset-Backed Vehicles are the latest solution offered. Paul Aldridge and his firm, King Sturge,  are at the forefront of the initiative, and he came to our Lunch on 29th January 2009 to explain what they are up to; starting with a single project in 2002, they now have 30 or so in various stages of progress.

The idea is straightforward. The land is placed in a ‘vehicle’, usually a limited liability company in which the shareholders comprise the landowner, one or more development partners, who would be expected to bring substantial ‘seed’ capital, and perhaps a bank or other financier. The company follows proper corporate practice, with regular board meetings attended by directors nominated by the parties who bring expertise as well as exercising corporate responsibility. The vehicle is given a limited life, usually around 15 years. At the end of that period, the company is wound up, profits are taken and the land reverts to the landowner. During the development period the land is ‘drawn down’ by the developer in accordance with demand at a formula-driven price, developed and let.

As Paul emphasised, one of the keys to success will lie in getting the Memorandum and Articles in a shape that properly represents the wishes and interests of each party. There is usually a lock-in period of around 10 years, but thereafter interests can be sold, albeit that they may not be that liquid.

These arrangements are, in Paul’s view, particularly suited to public bodies with extensive or critical land holdings where they wish to bring about development in the interests of regeneration but they have neither the skills nor the financial backing to carry out development themselves; he illustrated this with the projects already under his belt. The general structure is flexible enough to allow for development elements of a ‘social’ or below-market nature, but, of course these must be counter-balanced by sufficient market development to meet the finance costs and the profit expected by each partner. The structure provides an entity that is generally eligible for grants, should these be available, and also wider public sector support; we talked of ‘Jessica’ and ‘Jeremy’, cash streams from the EU that are currently being rolled out for just such vehicles.

In answers to questions, particularly from members who were a little chary of public sector ‘partners’, Paul said that his experience was that their input was generally good. However, as well as getting the structure of the company right, it was also necessary to reach prior agreement on a proper business plan that the board could exercise its corporate responsibility in delivering. The timing of agreement on these matters was often politically sensitive, but in electorally ‘fallow’ times many authorities are quite capable of being business-like.

At the outset, the public body must, of course, select its partner or partners in a transparent and open manner that meets public sector ‘best value’ standards. If this is done properly, there is no difficulty in the chosen developer having exclusive access to the land covered by the vehicle throughout the period of the agreement.

Paul displayed not only mastery of his subject, but also considerable enthusiasm for the general concept. Whilst it is, primarily, a development tool, he is of the view that the content of that development was capable of considerable extension.

With the benefit of hindsight, I think that we did not question him quite strongly enough about the end of the agreement; that tends to be the time when chickens come home to roost. However, we all found the ideas Paul provided both interesting and potentially stimulating.

Michael Mallinson

[Ed. note: see the blog entry, below, for a link to the academic article referenced in Paul's presentation.]

LABVs: Grace & Ludiman Academic Article

Andrew Ludiman, AMWL Head of Consultancy at King Sturge, at our January 29, 2009 LAI London Chapter luncheon, referenced the following article, which is available for viewing at our web site, in the PUBLICATIONS section.

Title/Citation:

“Local asset backed vehicles: The potential for exponential growth as the delivery vehicle of choice for physical regeneration” by George Grace and Andrew M. W. Ludiman, partners at King Sturge LLP, Journal of Urban Regeneration and Renewal, Vol. 1, 4, 341–353 (Henry Stewart Publications: 2008).

Abstract:

“Nearly half the Regional Development Agencies (RDAs) in England have now adopted the use of local asset backed vehicles (LABVs) as a means to manage and/or develop their property holdings. In doing so, they have collectively invested over £400m of property in 50/50 partnerships with leading private sector regeneration experts such as Igloo Regeneration Ltd. Given the RDAs property holdings represent less than half a per cent of those held by local authorities (£1bn compared with £230bn), the potential impact on the regeneration sector if local authorities embraced this new approach to regeneration could be enormous in terms of leveraging in private sector finance, heralding a new culture of genuine partnership between the public and private sectors and catalysing a paradigm shift in the quantum and quality of physical regeneration in the UK.”

 

Where From Here?

"Where do the property markets go from here?" was the topic of discussion at the LAI London Chapter luncheon, November 20, 2008, presented by guest speaker Ed Stansfield, head of property research at Capital Economics, an independent macroeconomics research consultancy based in London.

If it hadn’t been for the good company and excellent food, our Lunch on 20th November would have been a depressing affair. Our President had chosen for our speaker one of the more bearish commentators, and Ed did not disappoint!

His answer to the question set was simple: down -– considerably down. Our commercial property market has fallen an average of 30% and he could see this extending to 40/45% in fairly short order, where it would remain for 2 years or more. Residential will be no better; he pointed out that the earnings/house price ratio still remains high by historical standards and he argued for a further fall of 20% before a floor might be found.

Unfortunately, as well as bringing such a depressing message, Ed was able to convey his views with demonstrable skill and logical support; few would have left unconvinced.

The core of Ed’s rationale lay in his, now universally held, belief that the world, and particularly the UK and US are faced with a deep and extended recession. In response to a question, he suggested that the Euro-zone problems may be less, but he was sceptical of their ability to agree on and organise effective and timely counter-measures, thus making a manageable crisis worse than it need be. In a bid to limit the degree of recession, central bank interest rates could well be brought down close to zero, but Ed argued that this may have only a limited effect. Whilst the banking crisis may have been contained for the present, he thinks that further failures remain more likely than not. Whilst that is the case, the appetite for lending by banks will be very constrained and low central bank lending rates will not transfer to the real world. Further, the prudential barriers to lending will remain high. On the other side of the equation, the appetite of businesses to borrow will be pretty weak. Tumbling profit (?) margins will threaten business viability and discourage new investment. There are bound to be extensive worker lay-offs (perhaps 3.3m unemployed in the UK). Ed therefore painted a gloomy downward economic spiral as a virtual certainty.

This basic scenario had inevitable financial investment consequences. Equity dividends would be extensively threatened, making a mockery of backward-measured dividend yields. In a similar manner, effective economic demand for commercial property will evaporate across the board, if it has not already done so. He argued for falls of around 25% in rental values. Such a view of rents would undermine any view that property yields looked cheap compared to Government bonds of 3%, or perhaps less. Ed argued that this depressing property picture would extend across sectors and geography; there will be no safe niches!

On BBC TV there is a brilliant, but gloomy, current dramatisation of Little Dorritt. Ed would have fitted in well, save that he offered no Amie to make things right. However, he did just manage to squeeze out three positive thoughts. He had kind economic words for Finland andGreece. He doubted if the UK Government’s likely borrowing and spending spree would be inflationary even in the long term; any borrowing would be a tiny proportion of the wealth destroyed. And, when asked how we would repay those debts, he reminded us that, although the reputation of many parts of the City was in tatters, the UK offered wider and still valuable financial skills.

Michael Mallinson, Scribe

 

Who is going to go bust?

was the topic of our LAI London Chapter's luncheon presentation (Thursday, October  9, 2008) by Héléne Demay, Head of Rental Information Service at IPD (Investment Property Databank), the world leader in performance analysis for the owners, investors, managers and occupiers of real estate.

Timing is all! If she had given her talk two or three days earlier the answer might have been easy – almost anyone. Fortunately, by our Lunch on 9th October 2008 the British financial situation seemed to have stabilised somewhat and Héléne was able to focus on her original ideas.

Her task within IPD is to identify and track, over time, the financial resilience of around 60,000 commercial tenants in the UK. Her target audience is largely institutional landlords who, in today’s more difficult times, have come to realise that they have a vested interest in understanding the status of their tenants, and that such understanding can be a crucial element of their investment decisions. The core of her work derives from close study and analysis of the product of credit agencies, particularly, in her case, Dun and Bradstreet. This data is supplemented by also looking at IPD data on rent payment history, by study of County Court judgements and other, more local data. The interest lies, of course, not in the snapshot images, but by the patterns that emerge over time.

As with all such endeavours, the quality of product depends upon the quality of inputs. Héléne admitted, for example, that her data would have offered no insight to the fall of Lehmanns. There is inevitable degradation of input where published accounting allows significant ‘off-balance sheet’ activity (the author wonders if the days of this are numbered). Nevertheless, her time series do give valuable insights that can assist landlords by giving early warning of impending trouble, and perhaps the chance to take ameliorating action.

In the current market there are clear signs of distress. For example rent unpaid after 30 days has doubled over the last year as has the level of default. However, Héléne was keen to emphasise that, given the severity of the ‘credit crunch’, default rates for investment grade commercial property were still extremely low.

Some discussion of names took place, but, under the ‘Chatham House’ convention of Lambda Alpha, these have been censored from my notes. Nevertheless two detailed comments might be appropriate. On the positive side, Héléne had noted the positive performance in her regime of retail warehouses. On the negative, there was some discussion of whether we should be watching more closely some semi-governmental and local government tenants.

Discussion also took place about how her data related to and impacted upon valuers. Whilst warnings from her data are clearly relevant to valuers as well as to landlords, there was some concern that, in difficult times such as the present, valuers might be over-defensive, over-cautious.

Ending on a positive note, a note that might have been more jarring a few days ago, Héléne argued that her data did not show the world to be ending next Friday, or even shortly after.

Michael Mallinson

Emerging Real Estate Markets

At our Lunch on 11^th September 2008 Mark Charlton, Director and Head of Research at Colliers International, gave us a fascinating insight into the course that many property markets follow as local economies mature towards the Western capitalist model. He used his personal experiences in the Balkans, Ukraine, Georgia and Kazakhstan to illustrate his points in a presentation entitled: "Emerging Real Estate Markets -- Obscurity to Maturity; Emergence to Convergence."

We talk of ‘globalisation’, but sophisticated property markets in the terms of long-term investors really only exist in North America, Western Europe and South-East Asia. As other countries seek to emulate the economic success of these areas, they must develop property markets to match. Most, at present, are moving from command (often communist) economies to free markets.

Mark identified a sort of typical evolutionary path. This starts with political instability and inherited low quality (but often highly priced) built stock. Governments kick-start the process by taking initiatives to enhance the investment quality, and thus the price, of their own debt to invest in infrastructure, and, by extension, the debt of international companies they seek to attract. Success in this vastly expands occupier demand and, with limited supply, rents soar to premium levels. Mortgage market principles will also be established. As a facet of this, nuclear families start to break and migration to cities accelerates, raising the demand for housing. This triggers a first response from local developers, often to low standards and, on their back, international developers follow. Over-supply commonly arises, and rents fall. The increasing presence of international companies forces improvements in building standards, and better space can be afforded as local wealth, often in limited hands, makes demands on retail and logistics for example. With such increases in building quality and robust renting arrangements international investors are attracted, albeit at yields higher than advanced economies. From this point on, convergence increases. Increased political and legal stability, greater transparency and increased data gradually reduce perceived business risk.

Not surprisingly, property market convergence runs in parallel with economic convergence, and also with social convergence. In the early phases, growing wealth will be in few hands, but the genesis of a burgeoning ‘middle class’, even if it is not as extensive as in the Western world, is a key component.

This ‘model’ is, in almost all cases, interrupted by over-ambition, and by political setbacks. It may also be retarded by local practices of ‘corruption’. This makes investment early in the cycle suitable only for those willing to accept high risk, but Mark sees the overall direction of progress as generally being strongly driven by local wishes, and eventual acceptance that the Western model will deliver. He gave as an example a 400 hectare site in Belgrade that is slowly emerging from political deadlock as realisation dawns of what must be done if its potential is to be delivered.

Mark emphasised that, whilst his model is robust, each country will have its own quirks. These may be quirks of history, or even quirks of ambition; not all countries wish to mimic the West entirely. Understanding how those quirks might distort the model, and particularly understanding where a country has got to on its journey requires extensive research and good local contacts if risk is to be managed.

As subsequent discussion brought out, the implication of Mark’s paper was that property markets presently off the radar of investors might merit consideration rather earlier. With care, and understanding of his model, rational investment was feasible. There would be risks, not least of liquidity and valuation, but higher returns and risk-spreading techniques are natural bed-fellows.

Michael Mallinson,  CBE FRICS (Scribe, London Chapter, LAI)