This article examines the opportunities in the Paris residential market, which, in our view, are particularly concentrated in the north east of the city where new vibrant neighbourhoods are emerging. This is driven by a combination of an improved economic outlook for France and the city's urban dynamics. Economic growth accelerating, rising disposable incomes and a shortage of new supply should support continued house price growth in Paris over coming years. As newly emerging neighbourhoods such as the 10th and 11th Arrondissements become more established, property values for both residents and local businesses will become less affordable, triggering a spillover in demand to the neighbouring lower-cost locations in the north east.
French economy expected to receive a boost
Improving confidence expected to boost sluggish economic recovery. Emmanuel Macron's victories in both the French presidential and legislative elections were greeted with relief by investors, ending a prolonged period of uncertainty. As a result, household confidence improved markedly in June 2017 reaching the highest level since 2007. Mr Macron will be faced with the challenging task of reuniting a divided country and adding some much-needed momentum to France's hitherto sluggish economic recovery.
Paris will be at the forefront of future investment.
With the mood in France now improving, the outlook for Paris investment remains positive. Indeed, despite several years of subdued national growth, Paris has remained a key city for international and domestic investors, with total real estate investment exceeding €23bn in 2016 (2nd in Europe behind London and 7th globally). We think that investor demand will be supported by several strong fundamentals:
Paris is the only truly global city in Europe outside of London, ranking inside the top five for most global city indices. It houses a mature financial sector and 35% of Fortune 500 companies have a presence in the city. It is a centre for innovation and has a rapidly expanding technology sector, particularly in vibrant areas such as the 2nd and 10th Arrondissement. As a result, the Paris region is the main economic driver in France, comprising around a third of national output, with GDP growth around 2.0% p.a. compared to 1.3% p.a. for other French cities.
From a cultural perspective, Paris is an iconic city with enduring global appeal. The Paris region is the second most popular European destination for tourists after London, attracting 16 million visitors per year and the city is recognised as a global fashion capital.
New infrastructure projects, such as Le Grand Paris project (a public transport network that will connect the suburbs around the city of Paris) will develop new public transport and new residential areas outside of the city centre over the next 20 years. These projects are set to reinforce the region's economic dominance and will offer opportunities to developers looking to undertake large-scale residential development.
Paris could also benefit from Brexit-related relocations.
Although the outcome of the UK's Brexit process remains highly uncertain, there are already signs that the potential loss of passporting rights for the UK financial industry is leading some London-based financial firms to consider relocating parts of their operations to Continental Europe. With no obvious single alternative to London, the arising demand for office space would most likely be distributed across several cities. At the top of the list is Paris, due to its global status and the depth of its office market. Its main drawback, the relative inflexibility of the French labour law, might improve in the course of Macron's presidency, but the language barrier could still pose some challenges.
While the positive impact on the Paris office market has received most attention, relocated staff will also create additional residential demand. The absolute numbers of individuals involved are too small to boost residential prices, however we expect them to create distortions in selected Paris neighbourhoods typically favoured by white collar foreign workers. In Paris, non-French nationals and white collar workers overlap in the outer Arrondissements within the city boundaries, particularly in the north-eastern part of the city (the 9th-11th and 18th - 19th Arrondissements).
Paris residential at a turning point in the cycle
The Paris housing market is at an early stage in its cycle.
Despite outperforming the national housing market, Paris house prices are highly correlated with fluctuations in the national economy and in Paris demographic trends. A multivariate regression of French real GDP growth and Paris population on the house price index over a period of 37 years (1980-2016) indicates that both variables have a very significant impact on house prices and jointly explain over 65% of the house price variation (Chart 1).
Not surprisingly, returns have moderated in recent years as economic growth stalled, triggering a deceleration in capital value growth. With economic growth now improving, rising disposable incomes should support continued house price growth in Paris over coming years. We believe that Paris house prices have indeed reached a turning point. Average annual house price growth was 3.1% in 2016 following several years of stagnation. The rate of growth accelerated to 5.5% y-o-y in the opening quarter of 2017, providing further evidence that growth is gathering momentum. Interestingly, Chart 2 shows that other Paris real estate sectors, such as retail and offices, have seen uninterrupted capital growth since the low point in the cycle in 2009, indicating that residential is at an earlier point in the cycle. It also suggests that the residential sector has delivered more stable returns than other sectors through this period.
Low interest rates to support residential price growth.
Encouragingly, the volume of new lending for house purchases in France reached a 13 year high in 2016, supported by historically low mortgage rates, which currently stand at just 1.57%. This has resulted in a sharp uptick in transactional activity in Paris, filtering through to price growth in 2016 and at the start of 2017. Furthermore, Paris remains well positioned to continue to grow even as interest rates begin to rise. Unlike other European countries, such as the Netherlands and the Nordic countries, French households are not encumbered by significant debt and typically take on fixed-rate mortgages, providing a buffer for when interest rates eventually move out. Against this positive market backdrop, we also expect certain neighbourhoods to outperform.
The areas that will outperform will offer a combination of value and vibrancy
The highest residential values are found in the core.
The city of Paris has the highest average population density in Europe, with 23,000 inhabitants per km2, compared with 8,100 people per km2 in inner London, the second densest city. As a result, the highest values are located in the city core, most notably in prestigious, high income, neighbourhoods in the 6th and 7th Arrondissement where median values reach c. €12,500 per m2. This compares with c. €7,000 per m2 in fringe markets in the north east of the city (18th-19th), which have traditionally been perceived as being less desirable (Map 1). However, our analysis suggests that perceptions of these mid-priced areas are beginning to change.
Strongest growth observed in young and vibrant areas.
Over the past 25 years, district-level house prices have closely tracked the wider Paris trend, allowing for some dispersion across submarkets. In determining what drives growth at a local level, our analysis highlighted a number of key factors. The first is that the fastest growing areas have been in locations with a high concentration of young professionals, as illustrated in Chart 3. Secondly, we observe that high-earning young people tend to actively seek vibrant areas with a wide selection of amenities, often close to their place of work. In London, the tech sector has been instrumental in establishing previously fringe locations, such as Shoreditch, as highly sought after areas where inhabitants live, work and play. In Paris, the highest densities of white collar workers, tech start-ups and new restaurant openings (a useful indicator of vibrancy) are in the 2nd and 9th-11th Arrondissements (Map 2). This has driven the strongest annualised price growth in the city (c. 5.0% p.a. vs. the Paris average of 3.5% p.a.).
Search for value to drive relocations. While population growth was a significant factor driving residential values in the past, it will play a much smaller role going forward. Limited new supply means that population growth in the city of Paris is forecast to stabilise, increasing by just 0.1% p.a. over the next 10 years. The majority of the population growth in the Paris Metropolitan Area will be focused in the Paris suburbs, particularly in the poorer Seine-Saint-Denis (in the north) and affluent Hauts-de-Seine (to the west), where property values are lower, new development is less restricted and new infrastructure projects will improve connectivity to the centre.
Instead, we believe that intra-city relocations of high income households will be an important driver of neighbourhood house price growth over the next 10 years. The latest migration data shows that 51% of intra-city relocations involved individuals moving to lower-cost neighbourhoods. This trend is particularly strong in the north-eastern districts where, on average, 71% of relocations are driven by individuals seeking value.
As trendy, newly emerging neighbourhoods such as the 10th and 11th Arrondissement become more established, property values for both residents and local businesses will become less affordable, triggering a spillover in demand to lower-cost locations. The majority of historic value-driven intra-city relocations are to neighbouring districts. The logical conclusion, therefore, is that districts such as the 18th-20th Arrondissement will continue to be beneficiaries of this trend, leading to outperformance in these areas in the future.
After several years of sluggish growth, the French economy is now improving. This has translated into renewed growth in the Paris residential market. We expect this trend to continue in the medium-term as rising incomes and favourable lending conditions support house purchases, driving capital growth. Within the market we expect to see the strongest house price growth in the rapidly gentrifying neighbourhoods in the north-east of the city, which stand to benefit the most from the spillover in demand from higher-cost locations.