COMMENT: The French connection

In spite of the country’s dire growth prospects, opportunity funds are moving into France.

Last year, France saw a 77 percent collapse in foreign investment into the country– its lowest level in 27 years. Indeed, just €4.2 billion of foreign capital went into France’s economy, according to a report by the United Nations, and unemployment stands at 11.1 percent, having risen by 5.7 percent in 2013.

Yet, this week, Lone Star Funds agreed to buy the Cœur Défense office complex in Paris for €1.35 billion via its latest opportunity fund, Lone Star Real Estate Fund III. Blackstone, perhaps its closest rival these days, has been making investments in the country for the past 12 months. So, why have these firms been active when most economic indicators for the country are so negative?

Indeed, there are many reasons to stay away, as PERE’s roundtable discussion in Paris last week highlighted. Socialist France is behind major European countries such as Germany, the UK and even Spain and Italy in terms of structural reform, and that is impeding economic growth. With tough economic conditions, French companies are looking less at relocating and that in turn is subduing the lettings market.

At 4.25 percent, yield compression probably has gone as far as its going to go for prime core Paris offices as French and international buyers cram into a limited marketplace to fulfill their quotas for real estate. Meanwhile, the rest of Paris’ office stock is becoming increasingly obsolete, given much of it was created between 1960 and 1990 and now lacks requisite green credentials. In addition, anyone wanting to develop new offices will find construction costs very high.

Still, France is predicted to receive more opportunistic money in the coming months. This is no re-run of 1997, when French real estate was really distressed and values collapsed completely. There has not been that much activity yet, and experts say that, of the €15.5 billion transacted in 2013, maybe 10 percent or 15 percent could be classified as opportunistic. Furthermore, no one is factoring in any economic growth.

However, several situations have been brewing for ages – Cœur Défense being one example – that are now coming to a head. Lone Star has gained access to the building at an attractive discount via its securitized debt. In another example last year, Blackstone purchased two offices – Colisée III and IV in Paris – for less than the debt attached to them and was able to factor in lower rental targets as a result.

There are very few assets of the size of Cœur Défense coming available, but those on the ground say there nevertheless are plenty of smaller but similar opportunities to come. Beyond overleveraged investments, opportunity stems from French companies needing to sell property they occupy in order to raise capital in the face of the country’s poor growth prospects. Crédit Agricole, for example, sold and leased back for four years its Paris investment banking headquarters, Paul Doumer, at a cap rate of 9 percent. You can guess which firm acquired it – Blackstone.

PERE’s roundtable revealed that opportunity funds are picking submarkets in Paris where the dynamics actually look quite good. For instance, in some cases, buildings are not over-rented and there is no oversupply. The funds are willing to take a risk on shorter leases and undertake some capital expenditure if the rents look cheap compared to neighboring properties.

Lone Star and other opportunistic entrants still will need to be cautious in France, even if it is buying an iconic office complex at an attractive price. The Cœur Défense has some vacancy, there is some new supply of offices nearby and tenant demand is soft. However, a country that might frighten off foreign investment in other industries won’t dissuade opportunity real estate funds from carrying on.