Flagship offices in central locations continue to entice investors across Europe; over in Paris, a new urban masterplan is set to change the face of the city and its office market.
“A major game changer for the Paris office market will be the PLU bioclimatique, the new urban plan which is currently undergoing public consultation and is expected to come into effect in 2025,” says Martin Schellein, Head of Investment Management Europe at Union Investment. With this new urban masterplan, Paris’s city council aims to speed up the ecological transformation of the French capital and to provide more affordable housing in central locations, which will cut existing office stock in favour of a more diverse urban mix, Schellein adds.
According to the current draft, the PLU bioclimatique will require the transformation of office space into residential accommodation. This will apply to new construction projects and major refurbishments exceeding a floor area of 5,000 square metres – more than 10 percent of the office space in such buildings will need to be transformed into residential use, notes Schellein. “On top of that, close to 1,000 commercial buildings in the wider Paris CBD have been earmarked by the city council to be partly converted into residential. Due to the regulated residential rents in Paris, the resulting capital value of this transformed space will be lower compared to its original use as offices,” he says.
More affordable housing could restrict the supply of office space
While this clearly spells good news for the city, it is understandably difficult for investors: “This is an obvious concern for many investors, as they will have to compensate for this potential downside with even higher rents and capital values for the remaining office areas,” Schellein warns. “Occupier demand is focused more than ever on centrally located office buildings in Paris’s CBD. Therefore, the implementation of the PLU bioclimatique will likely lead to a significant supply-demand imbalance and put further upward pressure on office rents.”
The PLU bioclimatique has been adopted by the Paris city council, it’s a big thing for the market. There will be important constraints on landlords, especially in the west of the city.
Martin Schellein nonetheless remains confident: “All in all, it’s a challenging environment for investors, but it will also have its rewards for those who have taken strategic positions in this highly soughtafter market.” David Bourla, Partner, Chief Economist and Head of Research at Knight Frank in Paris, agrees: “The PLU bioclimatique has been adopted by the Paris city council, it’s a big thing for the market,” he says. “There will be important constraints on landlords, especially in the west of the city.” Referred to as the “servitude de mixité fonctionelle”, there is a lot of uncertainty surrounding it, according to Bourla. “Fewer investors are likely to take on redevelopment projects to which the 10 percent component applies. With parts of some offices reconverted to resi and landlords reluctant to launch office redevelopment projects, there will be fewer Grade A office rents,” he adds.
In the first half of the year, there were €2.7 billion in office deals transacted in Paris, just half of the volume of the same period last year, according to Knight Frank. Last year, there were €27 billion of deals across all asset classes in Paris, according to Bourla. “This year, I’m expecting it to be between €12 and €15 billion, of which €5 billion to €6 billion could be offices,” he says. “The third quarter will be very quiet, even quieter than the second quarter, because several deals have been withdrawn from the market due to the difference in seller/buyer expectations. It won’t be a good year but I think things could improve by mid-2024.”
Investors are recalibrating strategies according to property size, purchase price and financing
And the CBD is attracting the lion’s share of investment, according to Delphine Mahé, Head of Market Research at JLL in Paris, who notes that the best investment opportunities are offices in the CBD, amongst others, as very high-quality assets that improve portfolio quality are the most likely to be approved by committees, but they shouldn’t be “too expensive”: “Offices that cost €150 million are too big, investors have difficulty getting financing for deals of that size,” she says. As the cost of financing increases, many investors are changing tactic, according to Mahé: “Office buildings in the CBD costing less than €50 million are the most sought-after assets, accounting for 74 percent of transactions,” she says. The market is very muted at the moment; owners prefer to keep their buildings and allocate their capital to enable them to meet environmental requirements, according to Mahé: “We don’t expect the market to come back until 2024, when interest rates are expected to stabilise. That would lead to more clarity for vendors in terms of potential market values.”
Schellein agrees: “Liquidity for larger lot sizes is restricted. Several investment opportunities exceeding €200 million have already been pulled off the market because target pricing could not be achieved.” Nonetheless, he points out that some larger deals have been concluded in the first half of 2023, with luxury companies such as Kering and LVMH acquiring mixed-use properties for their own use. “The average deal size has fallen, however, and most transactions now are between €50 million and €100 million, with insurance companies and pension funds appearing as selective buyers,” he adds.
Office buildings in the CBD costing less than €50 million are the most sought-after assets, accounting for 74 percent of transactions.
There was a 26 percent drop in investment for lot sizes under €50 million and a drop of 36 percent with regard to those from €50 to €100 million. Most of these medium-sized transactions were recorded in Paris, such as Banque Delubac & Cie’s sale and leaseback of 10 Rue Roquépine with OREIMA.
“Investors and tenants want green, very efficient buildings in Paris but there aren’t many on the market,” Bourla says. “In the suburbs, the situation is more challenging, especially in the northern and eastern suburbs, where there’s sometimes a bad image and less good transport links.”
Union Investment is creating high-quality offices behind historic façades
Since the start of 2021, Union Investment Real Estate has made four acquisitions in Paris, totalling more than €400 million, all of which are in the CBD, apart from a property in the 11th arrondissement. Last year, the investment management company entered the market in Lyon with the acquisition of a €100 million office project in Part Dieu. In Paris, Union Investment mainly invested in value-add opportunities that the company has acquired either in vacant possession or on short unexpired lease terms, to create sustainable office properties behind historic façades and to significantly increase rent levels.
Even historic buildings can now be refurbished with a target EPC rating of B, according to Schellein: “Our goal is to have a carbon-neutral portfolio by 2050. To that end, we are spending significant amounts of money on our existing holdings.” Recently, Union Investment has improved its second largest business centre, Quartier d’Affaires Paris Victoire, in the 9th arrondissement, with €46 million of capex, in order to re-let the majority of the office space to CIC. At present, Union Investment is working on three office refurbishment projects in Paris with the intention of spending more than €90 million to achieve top rent levels.
Union Investment intends to continue to invest in the best locations in Paris, such as the Etoile and Opéra CBDs, or in upcoming locations, according to Schellein. The 11th arrondissement is not yet an established office location but Union Investment has recently acquired an office project there which is pre-let to the Institut Français on a long lease, and there is clearly a future upside in the rent.
Strong demand in the CBD is driving prime rents to unprecedented levels
“The vacancy rate in the CBD of Paris is around 2 percent compared to 8 percent in the Île-de-France, where rents are moving sideways in peripheral locations and tenant incentives are rising,” he says. “At the same time, prime rents in the CBD have increased by more than 5 percent year-on-year for the best locations and in some cases have now reached levels above €1,000 per square metre/year. The spread between prime rents and secondary rents will continue to widen.”
Appetite for the most established markets is maintaining upward pressure on rental values in the CBD, where unprecedented levels have been reached with a prime rent of €950 per square metre/year, €432 for second-hand space and an annual average of €426 for new space, according to JLL (see chart).
Some companies are taking advantage of the downsizing potential to move from the suburbs into the city centre, according to Bourla: “We’re seeing more companies downsize from the suburbs to take smaller spaces in the city centre, even though rents are higher, because it’s easier to attract new workers. In the longer term, we’ll see whether CBD rents will soften a bit because the economy and the job market might deteriorate.”
Caution is also driving pockets of the rental market, with take-up down this year. “Since the beginning of the year, corporations are moving less because of rising costs,” Mahé says. There was 600,000 square metres of office take-up in Paris in the first five months of this year, according to JLL. Rents are very high currently; they are at historic highs and inflation and the ECB rise in interest rates spell higher financing and operational costs, so there is a lot of rental renegotiation, although it’s difficult to know by how much rents are being cut. “We see a real dichotomy between Paris, where demand for offices is very strong, and the rest of the region, but the lack of supply in Paris could lead to a higher level of activity in the suburbs,” she says.
However, some tenants are pre-empting future demand in a bid to rent the best properties, according to Martin Schellein: “We’re seeing a big difference in demand between prime and secondary assets, with tenants demanding less, but better, space in central, well-connected locations.” Central Paris is clearly outperforming the peripheral submarkets in the Île-de-France. “In general, the rental market is slowing down, but tenants looking for best-in-class space have to start searching for new premises a few years ahead of their lease expirations to secure pre-lets. We are already seeing interest from prospective tenants for some of our recent office acquisitions, even though the properties still need to be refurbished.”
Office take-up down 22 percent compared with the prior-year period
There was 816,200 square metres of office take-up recorded in the Greater Paris region in the first half of 2023, according to JLL, which equates to a drop of 22 percent year-on-year. Reduced activity was seen across all office segments, with 17 percent less take-up in the medium space segment, 15 percent less in the small space segment and 34 percent less in the largest properties. Predictably, this is having a knock-on effect on the development market. Just 700,000 square metres of office stock is expected to be completed in Paris this year, down from 1.2 million in 2021, according to JLL.
In general, the rental market is slowing down, but tenants looking for best-in-class space have to start searching for new premises a few years ahead of their lease expirations.
Union Investment will continue to focus on Paris as its most important investment destination outside Germany, to grow the existing portfolio and expand into other asset classes, most importantly residential. Over the past few years, the company has made an in-depth analysis of the residential markets in the Île-de-France region, namely the immediate suburbs of Paris like Boulogne-Billancourt, Issy-les-Moulineaux, Neuilly and Levallois-Perret.
“For our residential investment strategy, we will concentrate on newly built properties and projects which already match our environmental requirements and require no further capex,” Schellein says.
Going for Gold
Paris is witnessing a veritable building boom in the run-up to the Summer Olympics in 2024. The Clichy-Batignolles eco-district is being developed on a 54-hectare site with the aim of meeting ambitious climate and biodiversity objectives.
Built on the former SNCF rail yard in the north of the Batignolles neighbourhood in the 17th arrondissement, this is the most ambitious project of its kind in the city. As such, it is becoming a world-leading example of how to construct a sustainable, net-zero carbon city with Passivhaus, environmentally designed buildings, renewables, biodiversity improvement, water sensitive urban design and smart waste practices.
Once completed, it will include 200,000 square metres of housing, of which half is social housing, 30 percent is owner-occupied, and 20 percent intermediate, as well as 105,210 square metres of offices, 28,000 square metres of public facilities and 25,000 square metres of shops. At its heart is the 40,000-square-metre Martin Luther King Park. In the north sector of the site, the ring road is being reduced to make way for a new metropolitan hub centred on the emblematic 160-metre-high Paris Courthouse designed by architect Renzo Piano.
Work on the new urban masterplan started in 2001 and is due for completion by the end of 2023
The district was awarded an EcoQuartier label by the French Ministry of Housing and Sustainable Housing in 2016 and won the Sustainable City Grand Prize in the international Green City Solutions Awards. It also received European funding for the creation of the first smart grid in Paris. The development of the Clichy-Batignolles eco-quartier has been planned since 2001, integrating the Olympic Village as part of Paris’s bid for the 2012 Games: “Office rents there are around €330 per square metre/year, which makes it much more affordable than city centre Paris rents of €950,” Delphine Mahé from JLL says. Saint-Denis, which will be at the heart of it, is only about 20 minutes away from the city centre by train, and the metro and train lines to service it are being extended. The T3B tramway extension from Porte de la Chapelle to Porte d’Asnières took place in 2017 and the extension of metro line 14 in 2020.
Mahé describes it as a good development that will improve the city: “It includes the relocation of the Paris Courthouse, known as the Cité judiciaire de Paris, and Le Bastion to the north of the ZAC. It will become home to 7,500 new inhabitants and create around 12,700 new jobs. Launched in 2002, the redevelopment will be completed by the end of 2023,” she says.
By Sara Seddon Kilbinger