Contents
Summary 1
Investment case 4
French real estate landscape 14
Listed companies in this report 19
French office market: return to 2004 27
Retail real estate assets: still a gold mine? 39
Warehousing: a risky sector 51
Residential market: downward cycle starting 57
Company profiles 61
Foncière des Régions .............................................................................................63
Gécina .....................................................................................................................77
Klépierre ..................................................................................................................87
Mercialys .................................................................................................................97
Unibail-Rodamco...................................................................................................109
Disclosures Appendix 118

Summary
The subprime crisis and the impact it has had on the real economy have hit the French
real estate market hard. With more difficult access to credit and higher credit margins,
asset prices have declined significantly, even if rental income is holding up reasonably
well. In the short term, the contraction in asset values is putting companies’ covenants
in danger, especially related to loan-to-value (LTV) ratios.
The pressure is general: this is not a purely French crisis but a European one. In fact,
compared with other countries, the French market has proven relatively resilient.
However, what began as a dramatic deterioration in financing conditions has developed
into a lasting recession, which seems now to be jeopardising more fundamentally the
businesses model in quoted real estate, combining significant further risks to both asset
values and rental incomes. Delinquency and vacancy rates are likely to grow, while
asset values should fall. As a result of both financial constraints, asset devaluation and
the cyclical deterioration in income, investment pipelines – a driver of sector growth in
recent years – are being scaled back in most of the companies under our coverage.
These cyclical and structural challenges are well reflected in European real estate
equity values. The Stoxx 600 real estate index has fallen 80% since its 1Q07 peak, and
trades at absolute historical lows. Quoted real estate in Europe has underperformed the
wider market by 50% over the same period, and by 38% since the end of 2Q07 and
28% since the wider equity market collapse from the end of 3Q08. The sector is
currently trading at 0.53x stated 2008 NAV. The five French real estate stock under our
coverage have behaved no differently, down between 44% and 82% from their share
price peaks, trading in a range of 0.27-0.79x NAV. The question we are addressing in
this report is: does the sector now offer an attractive risk/reward profile?
Our answer is ‘yes’ – selectively and cautiously. In our view, despite declining asset
portfolio values, we believe now is a good time to begin looking at selective exposure to
French real estate. We continue to consider the relative bias in the French real estate
portfolio mix towards resilient retail income as a very positive asset to the sector.
Tougher and more costly financing conditions are partly being offset by flexibility, with
the scaling-back of investment portfolios. In addition, we see some reasons to be
optimistic as we approach more stabilised market conditions. We are closer to that
point than six months ago, and we identify certain preconditions that could bring
attractive investment opportunities and a return to cash flow growth.
In this context, our real estate stock-selection criteria are as follows: (1) focus on
segments such as malls, premium offices and healthcare assets at which rental income
should prove resilient, if declining; (2) avoid low-quality office assets and logistics
businesses, which are too cyclical, in our view; (3) avoid companies with fragile
business models in terms of debt management; (4) favour companies with proven lease
management capabilities, able to increase rental incomes even in difficult conditions;
and (5) avoid companies with aggressively valued asset portfolios, which imply
potential value losses.