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French real estate seen suffering supply shortage in 2017

Rents and capital values for French real estate are set to see upward pressure in 2017 as the country faces a supply shortage in both the rental and investment markets, according to industry observers.

Vacancy levels in the French office market in the second quarter of 2016 were at their lowest since the middle of 2012, with Paris seeing 4% vacancy, the Inner Suburbs 10% and the Western Crescent area 12%, a Cushman & Wakefield report found.

Meanwhile, a shrinking supply of commercial property for investors will see competition between local and international buyers intensify as they fight for ownership of France's prime real estate assets.

"I think the French market is [far] into the cycle," Iryna Pylypchuk, senior analyst at Fidelity International, said in an interview with S&P Global Market Intelligence. "We've seen a number of strong occupier years. The investment market is also starting to see constraints in terms of product availability and I think that has been or has become a little bit of a challenge in France in 2016 — lack of product and intense competition between local and international investors. And I think that's likely to accelerate even further into 2017."

There will be no new supply created in the next two years at Paris' main business district, La Defense, according to Raphael Treguier, CEO at CeGeREAL, a real estate investment trust specializing in offices. This should help further decrease vacancy rates at Europe's largest purpose-built business district to around 8% from their 14% peak a few years ago, he said.

"We see the same trends in other markets in Paris and the first ring around Paris where the new supply is not very generous,” said Treguier. "This should definitely help to let and to restructure the existing office stock, which definitely needs some investment from office owners."

CeGeREAL has seen a reduction in the time taken to let empty premises, along with a freeze on increases or reductions in the incentives offered to tenants. There have also been slight increases in rents in Paris and in the "first ring" around the city, Treguier said.

On the investment side, France — and particularly Paris — is continuing to attract a significant flow of international capital as low interest rates and global political uncertainty make European property a more lucrative and safer investment, according to Pylypchuk. International investors are continuing to plow capital into prime European real estate as they struggle to find better returns elsewhere due to interest rates around the world remaining at historically low levels, said Pylypchuk.

The level of investment capital from local and international buyers has seen capitalization rates in Paris pushed down in 2016 to 3%, Treguier said, a level he described as "historically low," surpassing those seen in 2007. "The investment market has been super active with a split even wider than in 2015 between the real core assets and the non-core assets," he said.

Treguier identified a hike in interest rates as the only major risk for the French real estate market in 2017. But he said his company could eventually benefit from any rise as competitors struggle with financing costs. "If the interest rates increase, for us there will be a short-term impact that will be slightly negative on the financing side," he said. "But there will be a positive impact because it will narrow the competition as the very long-term players cannot afford to pay such high prices any more."

The risk from April and May's presidential elections in France is minimal, Pylypchuk said. The far-right Front National is tipped to make it through to the second round of voting. But the high odds on a surprise win for the Nationalist Party, and the more powerful influence of other global economic and political forces driving international capital to European real estate, means the election is unlikely to have a major impact on the French economy and its real estate market, she said, adding that the outlook for 2017 was positive.

"In the context of real estate, considering that as an asset class it has learned a lot of lessons from the past, we have no over-leveraging as we have seen in previous financial crises or before it, we have very little development and very little of it which is speculative, so vacancy rates are very much at structural lows, and we still have a significant premium over bond yields, there is very little risk that I can highlight in the short term," Pylypchuk said.