High Rise and Fall

The Making of the European Real Estate Industry

Andrea Carpenter

• Publisher: Routledge
• Year: 2018
• eBook ISBN: 9780429877414
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

High Rise and Fall tells the story of how the European commercial property industry transformed from a local, small-scale business to an international, financially sophisticated, multi-billion-euro industry that was ultimately devastated by the 2008 crash.

Drawing on her experience as both former Editor of EuroProperty and Director at the European Association for Investors in Non-Listed Real Estate Vehicles (INREV), Andrea Carpenter explains how the mid-1990s saw the arrival of a new style of property investing in the European markets. Seeking high returns, impervious to risk and with a seeming indifference to the buildings at the heart of the deals, US players such as Morgan Stanley, Goldman Sachs and Lehman Brothers conquered the European property markets with an audacity that both repulsed and intoxicated the locals. Fuelled by improving economic conditions in the early 2000s, European investors were keen to emulate all or parts of the US investors' philosophy. Armed with a wall of capital, the industry expanded into the far reaches of Europe in search of returns, and piled on new risks that it did not completely understand.

In her highly readable style, Carpenter analyses the mistakes made by the industry in the run-up to the crash when billions were wiped off the value of property across the region, and it became clear that in the pursuit of high returns and a place in the wider financial world, the industry had turned its back on the basics – bricks and mortar. This book is aimed at students and younger professionals studying or working in the real estate industry who need to understand the events that shaped the world they are entering into, and the lessons that can be learned from them.

1

THE AMERICANS IN PARIS

When François Trausch tried to turn up for his first day in his new job in the summer of 1997, he had no idea that he was about to enter a market in mid-transformation.

As he headed to GE Capital’s offices in Paris, his mobile phone rang. At the end of the line was his new boss, who diverted him instead to an anonymous building in central Paris.

When the lift door opened, Trausch stepped into a data room. Inside there were close to 100 people sifting through dozens of boxes, taking out paper files and manually inputting the data from them into computers. They were analysts like him – a few French, but largely a team that was flown in from the US.

Each file held details of a broken property loan stretching back as far as 1990. Setting to work, Trausch could see exactly how banks overextended: the lending terms, the poor decisions, the bad borrowers, all the steps that led to the systemic scale of poor lending. One file at a time, Trausch relived the worst French property crash in history.

The story told in those files from the early 1990s used to be the ultimate cautionary tale for the industry. Paris was a city that found itself at the tail end of a zealous period of overbuilding. All in all, from 1986 to 1991, more than 12 million sq m of buildings rose from the ground, expanding office space in the city by 40%.

Collectively, the efforts of developers in Paris were historic, city-making, even. At one point, Paris marched past London to become Europe’s largest office market. A few years later, it surpassed even New York.

To have the Paris skyline packed with construction cranes in the late 1980s felt good for everyone; visible signs of the booming French economy, the property industry a driving force in progress, backing city growth to the hilt. Then, the world tuned into its televisions to watch live as fighter jets returned from sorties in Iraq, marking the beginning of the first Gulf War in 1991. The mood changed, as did the direction of the economy. France quickly slumped into recession and the same cranes soon became a shameful display of excess, a daily reminder of the hubris of business, and of the property industry.

The fallout for the property industry was devastating, but it could in no way be described as fast. No cranes creaked to a halt mid-development, no rents went into free fall overnight. This was an old-style property crash, and the end was dismal and protracted as the market dismantled itself over four long years.

At first, it was almost as if no one in the industry noticed. Developers finished up buildings into an expanding vacuum of demand from businesses. Others started new projects as the banks stayed firm on agreements to lend them the money. But not everyone remained so upbeat. With the growing burden of oversupply, investor confidence slipped, and values fell as the declining rents agreed for new space only confirmed the weakening market.

By 1995, the Paris property market had inched itself down to the bottom. Buildings were worth less than half of the FFr102,000 per sq m five years before. Rents too dropped from a peak of FFr5,000 in 1990 to just FFr3,000.¹

The same year the entire French property market bought and sold just FFr3 billion (EUR457 million) of property. Today, a single company somewhere in the world completes a deal of that size – or more – each and every week.

This stumbling pattern of decline was the quintessential property crash. This was how it worked in those days before the industry became so much more embedded into the financial landscape. Property was a business, local and clubby, slightly set back from the rest of the financial markets, the economy an engine running in the background. Property investment markets in Europe were all domestic, propped up by local money. There was no glut of global money queuing up to compete with the home players or plug the gap left by the locals if they got burnt in the downcycle.

For institutional investors – the pension funds and insurance companies – property was just property. That department down the end of the corridor, the one with the big headcount for the relatively small amount of money to invest compared to bonds and equities. That large team, however, earned its keep as when it came to performance, property always acted differently; a dependable counter-balance to the risk of equities, usually earning a bit more yield than bonds.

Today, as a truly global and financial industry, property works on much bigger levers. It is interest rates that steer the fortunes of property, acting as the valve to control how much money flows into the European industry from all parts of the globe. Its prospects are now as much about geopolitics as they are geography.

In today’s prolonged low interest rate environment, property is massively in favour. It has a new, more dynamic role in the portfolio alongside bonds, equities and other alternatives. Now, they call it a good fixed-income alternative in a world of low-yielding bonds.

This new set of clothes has come at a price. With the global financial crisis in 2008, the inevitable crash for property was not the usual slow disassembling of the markets. Instead, property fell off the cliff at exactly the same time as the rest of the asset classes. Unprecedented crash or not, property was hooked into the deepest reaches of the global financial system.

This makes the Paris crash sound nostalgic. It is unlikely that the industry will ever see a crash like that again, one where property was its own cycle, tangled up in its isolated out-of-kilter mess of demand and supply, and with only itself to blame when it all went wrong.

But that doesn’t mean to say Paris should be forgotten. In actual fact, it’s the first reference point of the modern market. As recent as the scars of the global financial crash still feel, the industry is where it is today not because of the global meltdown but because it changed so utterly in the preceding years. And all that started with Paris.

The Paris crash was so off-the-charts bad that the industry has never been the same again. In a business that is unfailingly cyclical, with generations of players programmed to repeat a suite of the same mistakes, Paris was the kink in the system that transformed the industry into the financial giant it is today.

Getting Coeur Défense off the ground

There were souvenirs from La Défense all around the room at Paul Raingold’s offices. Fixed to one wall were two giant pictorial maps of the business district to the north-west of Paris: a cheerful poster, with colourful 3D renditions of each building. The second, a sober out-sized version of today’s visitor’s map. In another part of the room, a small architect’s model encased in glass was perching awkwardly on the rim of the lower shelf of a hostess trolley. The gleaming high-rise tower trapped inside, a planned refurbishment on the second map.

For a man that is reluctant to be reminded about Coeur Défense, the lowest point of his career, Raingold finds himself in plain sight of this misfortune. Raingold is a successful man. For over 40 years, he has added and updated buildings to those maps. Not getting to build Coeur Défense hardly put a dent in his lifetime achievements, but he understandably remains unconvinced. “It’s something we have to live with,” he said. “We all made losses but c’est la vie, we did our best.”

It is difficult to believe that this doorstop of a building almost never happened. Coeur Défense is by no means the tallest building in Paris, and not the most elegant by a substantial margin. Its two 39-storey towers sit above three eight-storey groundscrapers, a bottom-heavy shape that had given it an air of sinking middle-age spread. Yet, it has always held a commanding presence at La Défense. In Paris, this is the place to which urban overachievers are banished, far far away from the city’s fairy-tale centre. There are at least 30 buildings over 100 metres high. Among them, Tour First, the country’s tallest at 231 metres. Grouped together in one tribe, they are impressive, but in reality, they all defer to Coeur Défense. It’s not just that they lack heft, they also lack history. When Coeur Défense was finally built, it became Europe’s largest single office building and still today, this heavyweight retains the title.

Raingold, with his development and investment company Générale Continentale Investissements (GCI), was on the front foot during this massive expansion of Paris in the late 1980s. Along with a partner, he had just sold six of a series of seven low-rise buildings each side of La Grande Arche, the triumphant arch that sits at the head of the La Défense estate. Those sales gave Raingold the equity for his greatest prize, Coeur Défense.

As a project, it was a gift, even Raingold acknowledged that. With La Défense centrally masterplanned and promoted by government quango Établissement public pour l’aménagement de la région de la Défense (EPAD), Coeur Défense came oven-ready. “It was 160,000 square metres of offices and it had planning permission, which was very unusual,” he said.

His company was part of an unwieldy group, its 11 investors making up the only consortium that bid for the site. Along with GCI, the group contained two other developers, one insurance company and seven banks. Unusually, the banks did not just agree to lend money but also took major stakes in the deal. The upgrade from lender to equity provider was already a sure sign that things were overheating in the city.

The deal included Tour Esso, the existing building on the site. Itself an artefact, it was nestled into a generous 2 hectare piece of land bought by oil company Esso back in the early 1960s. As the first office to have been built at La Défense, Esso’s first-mover advantage was lonely. For the next five years, its 1,500 employees practically trudged through mud each day to reach their desks. With only the newly built CNIT (Centre des Nouvelles Industries et Technologies) exhibition centre as a neighbour, and no public transport, Esso was ever-patient as the wasteland that surrounded it slowly transformed into a corporate city. At 11 storeys, Tour Esso was the site’s first “high-rise” building, but now in Coeur Défense’s new generation of skyscrapers, it was considered a waste of good airspace.

The group paid FFr2.9 billion (EUR442 million) to buy Tour Esso, the site and the development rights for the new tower.^2⁠ (A figure that amounted to the same volume as the entire industry bought in that record low five years later.) There was just one very large problem. If Coeur Défense had risen out of the ground, it would have sat on top of the other 4 million sq m of office space that already lay vacant in the city, most of it also newly built. One-tenth of all offices in Paris were completely empty, equivalent to another 25 record-breaking Coeur Défenses.

This growth in Paris was impressive, particularly as it was a defensive measure. Paris had been forced to soften its usually tight-fisted stance on agréments, the planning permissions needed for buildings over 1,000 sq m. In its race to attract major corporations, it was being sideswiped by the competition and – it couldn’t be worse – by London.

From across the Channel, Canary Wharf was winking at them. This was Prime Minister Margaret Thatcher’s era. She placed no restrictions on East London’s new masterplanned business district. Paris needed to retaliate.

Raingold and his fellow developers in Paris were the beneficiaries. From the mid-1980s, the agréments were lifted, and construction began. By the time the gate was lowered again in 1990, new buildings peaked at 2.5 million sq m a year.^3⁠ This was at a rate equivalent to adding 15 Coeur Défenses every 12 months. Most of this space was speculative – built with no guarantee of tenants – and the overwhelming proportion was in La Défense.

Alongside the ease of development, a second factor was in play: the banks. Bank financing was essential to get major projects such as Coeur Défense off the ground, and this development boom had corresponded with a time when bank lending – on favourable terms – was more than readily available.

In the three years to 1990, the debt outstanding to developers soared to a peak of FFr173 billion (EUR26.4 billion), more than ten times the average over the previous decade.⁴ In 1990 alone – the year before the consortium bought Coeur Défense – lending to developers added a further FFr35 billion (EUR 5.34 billion).^5⁠ Overall property lending, not just to developers, rose to a peak of FFr375 billion (EUR57.17 billion) in 1993.^6⁠

The figure was so high because banks were not just lending to developers. For a large part, their clients were marchands de biens, or traders. These unregulated, casual individuals often turned properties at a ridiculous pace, buying and selling them on for big profits within a matter of months (breakneck speed for bricks and mortar).

These traders had one major advantage. As long as they sold the building within four years, they weren’t required to pay an onerous 20% transfer tax on the sales price.

In the rising market, this propelled their rate of trading, leaving no time to make changes to the buildings and tenants to add value and justify the higher sales price. Instead, they traded on the positive sentiment in the market, cashing in on the rise in value of the building. With investment demand pushing prices up beyond the fundamentals, these marchands de biens sold buildings plus hot air, and that air quickly filled a classic property bubble.

Back in the data room

When Trausch entered that data room in Paris following the crash, it was clear amid the papers, files and spreadsheets, that nothing about this looked like a regular property deal. Trausch was working for one of the new US investors in town, and he soon found himself steeped in a brand-new way of thinking about property. “We all went to the ‘same school of the data room’,” he said. “The new generation of real estate in Europe, and in France, had all gone through these data room experiences. It was like a boot camp; an experience which people remember many years later.”

Trausch was helping his American employer prepare its bid for the FFr1 billion (EUR152 million) portfolio of broken property loans locked down in those files. They planned to buy the loans at a fraction of their original cost and work them out, negotiating new payments from defaulting owners or repossessing the property.

In a moribund market, the domestic players were perplexed as to why this was happening. “It was very new in Europe and so people had no idea that values would recover,” Trausch said. “Nobody believed in it. The only ones who believed in it were the American firms.”

It was this faith that property markets always rebounded which underscored this new American style of investing. With that knowledge, American investors hadn’t joined the crowds when the markets were booming. Instead, they set foot in Paris just as property hit its darkest moment. The crash pushed the city to the edge, and while that was painful for the locals, what the Americans saw – the mess, dysfunction and pain – was the perfect starting point.

The Americans were high-return investors, and their investing style was founded on unearthing value in distressed markets. In Paris, at the lowest point, they brought cash to capital-starved markets. When property rebounded, which they knew it would, the potential for returns over a short timeframe was stratospheric.

Landing in France was just the start. Buying up non-performing loans in Paris was the first demonstration of the transformative power of this type of capital. The American investors went on to spend EUR90 billion across the continent over the next decade.

Just as a powerhouse of investing, the Americans left an indelible mark, but the lasting legacy continues to be their methods. They introduced high-risk investing to Europe on an unprecedented scale – starting in the data rooms in Paris – bringing with it a new mindset that influenced a next generation of pan-European players.

Today, investing anti-cyclically is standard but to do that 20 years ago on such a scale and so systematically was groundbreaking. It is now unthinkable that there used to be periods in the market when there were no buyers. Today, high-return buyers are always poised, nimble and efficiently moving around the world’s markets anticipating the distress to come at the bottom of the cycle. “In the scheme of things,” Trausch told me, “even though the amounts were much smaller than today, it was a bold move.”

Denial in the banking markets

It was the stink of the debt that finally put the American investors onto the scent in Paris. The city’s property market had transformed into a textbook example of the pernicious nature of debt in property.

Excessive lending is nothing new. Debt has always had the power to be destructive on a systemic basis – not just for the property industry or banking, but for the whole economy. In a downturn, an overload of bad property loans will suffocate a bank’s ability to lend across all industries. Debt has been, and always will be, a driving factor in property crashes, and while Paris was no exception, it was a rare...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• Acknowledgements
• Notes
• Abbreviations
• Foreword
• Introduction
• 1. The Americans in Paris
• 2. Money coming out of boxes
• 3. For the love of property
• 4. The return of the Europeans
• 5. A rising risk in Europe
• 6. A new relationship with debt
• 7. Blurring the lines
• 8. Crisis hits Germany
• 9. The final party
• 10. Credit crunch, and denial
• 11. Life after Lehman
• 12. Bailouts and workouts
• 13. Revival and survival
• Bibliography
• Index