 Tour de Force
[September/October 2008]
French REITs looking good heading into 2009
By Charles Keenan
While French REITs have hardly been immune to the decline in real estate values worldwide, they offer investors a good entrée into one of Europe's largest markets at a decent price.
SIICs, short for "sociétés d'investissements immobiliers cotées," offer exposure to Paris—Europe's biggest market in terms of office space, and perhaps its least volatile. Paris landlords are less dependent on financial companies, whose struggles have contributed to the precipitous decline of U.K. REITs in 2007 and 2008. Demand for office and retail space in France remains solid and supply remains tight.
"The French real estate market is very healthy," says Mark Inch, chairman of the Société de la Tour Eiffel (EPA: EIFF), a Paris-based SIIC that specializes in offices. "There is a balance between available space and tenant demand."
SIICs also offer access to a city with more than 3 million inhabitants, an advantage matched in Europe only by London and Moscow. "French REITs give access to the Paris market from a property market point of view," said Philippe Le Trung, a senior research analyst with Citi in London. "Its infrastructure may be one of the best."
The stocks of SIICs struggled during the worldwide decline of REIT stocks in 2007 and early 2008. Yet, they have fallen less than other groups, particularly U.K. REITs, which comprise somewhat less than 40 percent of the FTSE EPRA/NAREIT Index. The FTSE EPRA/NAREIT France index was declined 9.3 percent through the end of June over the trailing 12 months versus a loss of 27.3 percent for Europe and a 40.0 percent drop for the FTSE EPRA/NAREIT U.K. index.
Yet SIIC stocks have realized strong returns since their debut in 2003, and are worth about three times as much today, according to Institut de l'Epargne Immobilière et Foncière (IEIF), a Paris-based research firm. With stock declines in 2007 and 2008, SIICs were cheap on average. They traded at a 15 percent discount to net asset value in early June, according to IEIF.
"The French market has been safer in terms of underlying assets of property stocks," says Pierre Schoeffler, a senior advisor to IEIF. "France has not been as hurt by excessive speculation on property prices."
L'esprit de France
SIICs, armed with a tax-efficient make-up, were created five years ago in order to offer property owners a better way to compete against Dutch, Belgian and German funds. The creation of SIICs was also a way for the government to reduce its fiscal deficit, since existing property companies had to pay an exit tax in order to convert to the new approach.
However, SIICs are still in the early stages of developing as an investment regime. As of May, there were 49 SIICs with a combined market capitalization of $82 billion, according to IEIF. That compares with 20 SIICs with a market capitalization of approximately $46 billion two years ago.
The SIIC universe is also concentrated. The five largest SIICs represent more than 60 percent of the market cap of all SIICs, and mainly focus on retail, office and industrial space: Unibail-Rodamco, (EPA: UL), Gecina (EPA: GFC), Klepièrre (EPA: LI), Icade (EPA: ICAD) and Foncière des Régions (EPA: FDR).
These, and other SIICs, give investors access to the largest office market in Europe. Paris has roughly 540 million square feet, compared with 320 million square feet in London, according to IEIF. The office market in Paris is also less exposed than London to financial companies, making it more attractive at a time when many larger banks have lost billions of dollars and laid off thousands of employees worldwide. Financial institutions make up 26 percent of commercial space in Paris, compared with 35 percent in London, according to Atisreal, a real estate consulting firm and subsidiary of BNP Paribas, a French bank. The top five property sectors in London account for 71 percent of all space, versus 60 percent in Paris.
"Paris is a very sound market because the tenants are very diversified," said Jean-Paul Dumortier, president of Foncière Paris France (EPA: FPF), which focuses on office and industrial properties, and chairman of the Fédération des Sociétés Immobilières et Foncières (FSIF), an organization that represents SIICs.
Along with a more diversified market, demand in Paris and throughout France remains steady but not overheated. Companies throughout France are cautious about how much they will spend on new space, keeping rental prices in check. Meanwhile, the financial crisis has put a stop to any bidding wars and speculative development.
"No banks with any resources today are going to lend on speculative development, even if you have the land," Inch says. "Building costs and the difficulty of obtaining financing are such that there is no oversupply."
No Holds Barred
Like a U.S. REIT, a SIIC must distribute the majority of its income to shareholders—85 percent or more. But SIICs can keep the remaining 15 percent of income tax free, whereas U.S. REITs must pay corporate taxes on income they retain. SIICs pay out 50 percent of capital gains, but they also retain the other 50 percent tax free.
That gives SIICs more flexibility to pursue growth, notes Philip Charls, chief executive officer of the European Public Real Estate Association (EPRA). "SIICs can more easily retain funds for development or acquisitions and they can be somewhat less dependent on the capital market for funding," Charls said at a panel discussion at REITWeek 2008: NAREIT's Investor Forum® in June.
Further modifications to SIIC legislation have made it more attractive for various types of companies owning valuable real estate to sell off assets in order to put capital to better use. The French legislature passed an amendment to SIIC legislation in 2005 that allows companies a special tax rate when selling real estate assets to SIICs.
The amendment was made in order to remove a roadblock for sellers: in France, owners of real estate assets do not periodically mark them to market, which made for onerous tax bills for companies that have held real estate for decades or more. The amendment halves the corporate capital gains tax rate to 16.5 percent. The tax break is due to expire at the end of this year, but experts expect an extension in some form.
As a result, SIICs stand poised in the coming years to continue to amass portfolios as French corporations dispose of real estate assets. Everything from government offices to state railways to old industrial companies add up to vast amounts of real estate with the potential of being monetized. Shareholders in many instances are pushing for sales. For example, Carrefour Group, a French discount retailer, has been pressured by shareholders to sell off its real estate in order to put the capital to better use.
Investors in office properties can expect total returns annually in the 10 percent to 12 percent range, says Inch of Société de la Tour Eiffel. The SIIC, with a portfolio of $1.9 billion at the end of 2007, focuses mainly on office buildings, business parks and industrial buildings outside of central Paris. Like Société de la Tour Eiffel, many smaller REITs, such as Foncière Paris France and Affine (EPA: IML), follow a similar strategy, because buying property outside of central Paris offers higher yields. These properties have lower rent rolls and offer yields in the 8 percent range, versus 4 percent to 5 percent in Paris's expensive business districts.
"We have a specific appetite for investments in those medium-size regional towns in which the market is more stable," says Alain Chaussard, co-chairman of Affine. "You have those international funds coming in with suitcases full of money. You can't compete with them. You get much better yields and much more regular rents in those medium-sized cities."
World Market
The larger SIICs have embarked on international expansion (SIICs with international subsidiaries are subject to the tax laws of each country where they do business). "One of the key elements for the growth of the sector will be the extension of portfolios all over Europe," Dumortier says.
Unibail last year merged with Dutch-based Rodamco, making it the largest REIT in Europe, spanning 14 countries. The majority of its portfolio is in retail, with a property portfolio worth $39 billion at the end of 2007. The company's office portfolio is mainly located in Paris' central business district and western fringes. The retail portfolio is spread across Europe. Vacancy rates are less than 1 percent at its shopping centers, with 80 percent of its development platform designated for cities of 1 million inhabitants or more. "We see opportunities in big city centers," says Peter van Rossum, chief financial officer of Unibail-Rodamco. "We are a big city player."
Larger companies like Unibail-Rodamco offer investors diversification either by geography or sector type. For example, last year Foncière des Régions, with a portfolio of $28 billion in assets, purchased a 68 percent share of Beni Stabili (BIT: BNS), an Italian real estate investment company. The SIIC also has assets in countries such as Belgium and Germany. The company owns a majority stake of Foncière des Murs, (EPA: FMU), which invests in a range of assets such as hotels, restaurants and medical clinics, and Foncière Développement Logements (EPA: FDL), which specializes in residential, in addition to owning a company that focuses on parking facilities.
The structure of Foncière des Régions allows investors to either develop a pure play or go with the umbrella stock, says Yan Perchet, chairman and chief executive of Foncière des Murs and board member of Foncière des Régions. "Each investor can play with the sector he wants," Perchet says. "If he wants to be invested in one of the sectors, he can be a shareholder in one of the companies or the top level if he wants diversification."
Even smaller players are expanding internationally: for example, in 2006 Affine, based in Paris with $2.2 billion in assets at the end of last year, purchased Banimmo Real Estate (EBR: BANI), a Belgian real estate company that repositions properties. The company also is diversified by sector type in offices, warehouses and retail.
"Affine relies heavily on diversification for the sake of long term security," Chaussard says. "We are risk averse. Diversification is key to ensure for the shareholders long-term optimum balance between risk and profitability."
While consolidation is expected to pick up as the industry matures in the coming years, all eyes are on France's largest SIICs, some of which are owned by highly leveraged Spanish companies feeling the effects of Spain's real estate downturn.
Spanish companies bought several SIICs in recent years, aided by a tax planning strategy that gave them a competitive advantage over French buyers. However, Inmobiliaria Colonial (MCE:L1CAR), based in Barcelona, Spain, has put its French SIIC Société Foncière Lyonnaise (EPA: FLY) up for sale. Gecina may also be sold by Metrovacesa (MCE: MVC), a real estate company based in Madrid.
In fact, in order to curb further foreign ownership, the French legislature has amended SIIC legislation by prohibiting one shareholder from owning more than 60 percent, effective January 2009. SIICs also must have a free float of shares of at least 15 percent.
Overall, experts say SIICs offer an easy way to gain access to a young market for the REIT approach to real estate investment. "The real interest in going forward is to provide an entrée into the French market with local expertise and with people who have the ability to identify in which sectors to invest," Inch says. "The tax-free nature makes it attractive."
Charles Keenan is a contributor to Portfolio.
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