In a nutshell

With the rise of teleworking, thousands of square meters of office space, which the Grand Paris Express rapid transit lines were supposed to fill, remain empty in the inner suburbs. Investors, developers, along with banks, are trying to negotiate with the public authorities but are struggling to come up with solutions, foreshadowing a deep crisis. This is what Antonia Raccat, partner at August Debouzy’s Real Estate and Construction department, observes.

More than twice as many offices than before the pandemic now lie empty in in the Greater Paris Area (Île-de-France): 4.5 million square meters are looking for takers, with some industry players even projecting that total vacant space will reach 10 million square meters within the next three years. An old pipedream has come true, at least in the outskirts of Paris. In the central business district (the west and center of the capital), the vacancy rate in the first quarter of 2023 was in fact only 2.9%, a frictional rate due to the fact that there is always a lag between the departure of a previous tenant and the arrival of the new one. It rises to 20% in municipalities such as Colombes, Issy-les-Moulineaux, or Saint-Denis, compared to 8% in Boulogne-Billancourt, Rueil Centre, or Saint-Cloud. La Défense business district itself is not immune, with a measured rate of 16.2%.
A growth in the office property market was expected, particularly around the future stations of the Grand Paris Express, but a number of buildings, some of them completely new, remain empty. And emptiness attracts emptiness: if no company is present, there's no incentive for others to move in, because unless they want to occupy all the space, no one wants to move into a deserted building. On the other hand, if just one organization decides to move in, this can set off a positive spiral.

Since the coronavirus pandemic, business districts have been deserted as teleworking has developed. Companies have discovered a number of ways of working, whereas previously flex-office models had struggled to gain a foothold. At the same time, they have noticed that they had a lot of space that was not essential, and are now making different calls. The budget that is no longer spent on additional square meters will be spent on choosing a prime location, in the center of Paris, close to transport hubs. One of the aims is to attract young talent who want to get around by bike or on foot. The same trend can be seen across the Channel, where HSBC has announced that it will be leaving its Canary Wharf headquarters for a building in central London that is half the size. The trend is even more pronounced in the United States, where whole districts of certain cities like New York, San Francisco and Boston, for example have been deserted, leaving ghost neighborhoods with vacant offices and declining shops and businesses.
It was anticipated that there would be a necessary adaptation of the office real estate market, involving in particular the conversion of certain spaces, with an emphasis on increasing coworking areas. A number of companies had initiated this process and, through their disruptive models, had forced investors to rethink their office assets in a different way. However, no one could have anticipated the scope of the current crisis, which is also a debt crisis, and the way out for office property and its conversion will depend to a large extent on public decision-makers.

The debt wall

Empty buildings pose real problems. Property tax, insurance, maintenance, security, their carrying costs remain enormous. These were already issues last year but have further intensified this year with the rise in interest rates and inflation. The former has strongly impacted the volume of transaction, which, for buyers, are based on the hope that they will benefit from the full effect of leveraging: taking on debt must be the guarantee of strong future profitability. Until recently, low or negative rates made this possible. With borrowing now more expensive and the valuation of the investments they finance more uncertain, the market has entered a form of paralysis.

In addition to the issues raised by vacancies, these buildings also generate debt problems. Many of the loans previously contracted for them are reaching maturity. These are often "bullet" or "in fine" loans, i.e., you pay only the interest during the term of the loan, and repay it only at maturity. There are two ways to go about that: either sell the asset or find someone to refinance you and take out a new loan. This second option is a thorny one today due to high interest rates and the reluctance by banks to finance operations. But the first is even thornier due to the lack of buyers. A debt wall is thus looming in the horizon.

In French law, debtors have a number of ways they can protect themselves from their bankers, and in this respect we have recently been recommending ‘conciliation’, a confidential procedure that enables a balance to be struck between the interests of all parties. It also offers the advantage of having a coercive aspect that is not present in case of proceedings where an ad hoc representative is appointed. However, this presupposes financial viability either way.

But could this just be a passing crisis? Can you ask your banker to give you two or three more years in the hope that the economy will have turned around by then? This is a real concern for investors who are dealing with banks that are deeply worried about defaults by borrowers, who are starting to hand back the keys, while some banks are preparing to sell off new portfolios of non-performing loans. Compounding this issue are the recent announcements by major office property investment funds (SCPIs) concerning the drop in the value of their shares. This has prompted a movement, the extent of which is not yet known, among savers to withdraw their funds.

Reconvert to break the deadlock?

The fate of many buildings hangs in question. The beginnings of a solution seem to lie in conversions. We recently supported a fundraiser by a company specializing in this field, and there is every reason to believe that it has a bright future ahead of it. Legal tools are also beginning to take into account potential changes in building function for new building projects.

Most buyers are in line with this reconversion approach: some are looking to buy up buildings on the cheap and convert them into something some. There are opportunities to be seized here. Some may be tempted to take the gamble of buying property at a low price in order to raze it to the ground, thinking that land, which is increasingly scarce the closer you get to Paris, is already worth more than what has been invested. In any case, this will require administrative authorizations, but which will be very difficult to obtain.


For the conversion strategy to pay off, however, the housing market would have to be in better shape, but its turnaround is far from certain. Besides inflation and rising interest rates, households seem to place diminishing social value on home ownership, which is retreating in the face of uncertainties about the economic future. Banks are also looking more closely at loan applications. Reservations for new-build properties are plummeting: some developers are even registering more cancellations than new-build orders, and others are finding themselves in such dire straits that they have no choice but to seek the protection of the courts or implement massive redundancy plans.

Conversions also take time, sometimes up to four years, which means three or four years of asset carrying and a definite impact in terms of shareholders' equity.

What to expect from the public authorities?

Such long timeframes are mainly due to administrative formalities, as transforming an office into a home is not necessarily easy: it involves modifying local town planning schemes, and therefore having the town hall on your side. But a town hall that converts property zoned for office use into residential use will lose out in terms of the revenues brought in by the tax on office space. This shortfall is not made up by the property tax which was scrapped during Emmanuel Macron’s first term of office. Housing also means the need to provide infrastructure, such as day care centers and schools, which will have to be financed.

With an operation that generates fewer revenues and more expenses, few municipalities are inclined to give their green light, unless perhaps the developer finances these facilities themselves, thus making the investment less profitable. Between 2020 and 2022, permits authorizing office space to be used for another purpose were down on average by 20% compared to the 2015-2019 period, and construction starts by 15%.

Should we then expect a response from the higher echelons and the government on this subject? Recent announcements from the Conseil national de la refondation (an exercise in participatory democracy bringing together political, economic, social and civic actors, elected representatives and randomly selected citizens) have largely disappointed industry professionals, from major developers to the Fondation Abbé Pierre, an NGO investing in housing. The paradox is that, at the same time, we are going through a major social housing crisis. For this reason, tax incentives or measures aimed at municipalities would have been welcome.

Deceptive valuations?

So what’s going to happen to these buildings? We risk seeing ghost towns appear in the inner suburbs, similar to what can be observed in Midtown Manhattan, where offices have emptied due to remote work, where small businesses at the base of buildings have closed, and where investors will have to grapple with the dilemma of converting or rebuilding.

A real crisis is to be feared, deeper than the one at the end of the 2010s, which for many was a liquidity crisis. Either there will be a real discount, attracting its share of opportunistic investors, or there will be a cascade of loan defaults leading to forced market placements or disposals of portfolios of non-performing loans (NPL). The debt risks precipitating the devaluation of the market, but there is no guarantee that buyers will show interest in these assets, whose future remains uncertain.

Looking at this pattern, one might also consider that valuations as of June 30, 2023 appear not to have fully reflected this phenomenon. Investors seem to have taken shelter in a 'there are no comparables' stance to assign a high value to the assets they own. However, if there is an absence of comparables it is precisely because there are few transactions, and therein lies the crux of the matter as recent flagship transactions in the luxury market (LVMH, Kering) are not representative of the office market. However, following the AMF's request for valuations to be filed by September 15th at the latest, a number of SCPIs were forced to post decreases in their valuations ranging from 8% to 18%, prompting a withdrawal by savers who are seeing an erosion of the value of their investments in real estate. There's a good chance that this will lead to the need to put certain assets in SCPI portfolios on the market, and consequently to a price correction. But it will also create opportunities for funds to look at buildings and even acquire stakes in smaller SCPIs that have demonstrated their resilience to the office market crisis.