The french real estate market
The Replacement Value of Paris
Much of Paris was rennovated to an unsurpassed standard in the late nineteen century. This period referred to as "Hausmanian" corresponds to an era of unprecedented architectural accomplishment and prosperity from the second half of the 19th century up to 1914. Bourgeois buildings would be built in a style that shows well applied craftsmanship and discerning taste. The bourgeois buildings integrate well in their surrounding. Their sober sculptural ornamentation let public buildings more extensive statuary stand out.
After the first world war, French people never had the resources to build with such a quality again. Many breadwinners died (and many of these fine stone workers), and so many families were ruined by the destruction of the war and its political consequences that rent control had to be introduced. It never made economic sense anymore to build like this.
Paris is a world city with a unique heritage, but rental income is far too low compared to the replacement cost of its many excellent buildings. When compared to other world cities such as New York or London, Building quality and taste is more refined, but building prices have stagnated for the last 100 years, with no chance for a property developer to build at such specifications again. Still, this city is with Rome arguably one of the most beautiful in the world, and will likely stay so for a few hundreds of years more.
A typical flat in a well-built stone Hausmanian in a prime area now costs above EUR10000 per square meter. A typical example can be found here.
Typical Rural Deal
For our typical middle of nowhere deal, I'll use the picturesque village of Meyrueis.
Fully renovated village houses usually cost 60,000 to 80,000 euros. However, these houses are generally too small and not well adapted to a modern lifestyle. As gainful employment is hard to get in these communities, the village house prices can be predicted to remain stagnant while the general price levels increase through inflation. More recent villas built outside the village can be found for 200,000 to 300,000 euros, but those are not built using traditional materials and lack personality,
Another possibility is to purchase a ruined stone house for 50,000 to 100,000 euros and renovate it for 300,000 euros. The result is a beautiful house with character in a very picturesque setting that should appreciate over the coming decades, as their value can stand the test of centuries.
Real estate prices are traditionally more volatile in Paris, and more stable in provincial cities. While the real estate crisis of 1992-2000 saw gross rental yields culminate at 10%, prices more than doubled while rents did not move much, gross yields in Paris have now gone between 3% and 5%, and it is not clear that real estate investment can be net positive given the cost of upkeep. Houses in a rural setting that look outstanding are harder to rent all year at an economic level. A better yield can be obtained as a vacation rental. Given the cyclicality in yield, It could be projected that prices in France will stagnate until rents catch up with prices. So prospects over the next 10 years are poor.
Confiscation of Profits
confiscate (v.): 1550s, originally, "to appropriate for the treasury," from Latin confiscatus, past participle of confiscare.
Any real estate transaction involves costs of around 10% of the property value. These taxes are levied to discourage speculation. Any new building or improvement is subject to a 20% VAT. Repairs are subject to 10% VAT.
There are recent changes that made the fiscal situation more paroxysmal: taxation for resident is at marginal rate which caps at 45%, to which 15% of social contribution is added, resulting in a 60% effective rate, for non resident the income tax rate was 20% flat but rose to 35% in 2012 due to the adjunction of social contribution, this high tax rate for non resident is based on net income from the first euro. This means that taxation is becoming comparable to that of real estate purchased through a company that pays its own tax and pays taxed dividends. Given the benefit that the latter solution brings for estate transmission, this solution makes sense in most cases except for the main residence.
Update 2018: Local taxes, HOA charges, and small improvements and most importantly, depreciation cannot be deducted from unfurnished rental income. This contrasts with furnished rentals which allow all these deductions. We give more information in this blog post on furnished rentals.
Capital gains for primary residence are exonerated. For secondary residence, they are taxed at a maximal effective rate of 40.5%, and while capital gains basis used to be exonerated after 15 years, this period has been changed to 30 years in 2012. The headline rate is only 19% but an extra 15% of social contribution and an extra 6% for gains above 260,000 have been added in recent years.
French tax residents are subject to a wealth tax on their worldwide asset at an annual rate of 1.5%. A five million dollar bonds and stocks portfolio and a five million dollar home in New York would generate 100,000 dollars of annual wealth tax. This tax was introduced in 1981 at a time when government bonds yielded 15%, but the wealth tax yield has not been revised down and would bear ominously on any asset unless it is exonerated for being art or one's company, A question would be whether non residents would also be made subject of this tax if their real estate holding is valuable, this has become law for residents of Andorra, a tiny state in the mountains between France and Spain, but there is currently no plan to extend it to further countries.
While headline tax rate is apparently only 20% on capital gains and 45% on income that bears international comparison, there is a 15% add-on of social contribution, 20% of VAT, and 10% of transaction cost.
Origins of the redistributive agenda
Paris as a city can boast having had in 1848 the earliest worker's movement with red flags overthrowing the government. This did not last, but the class consciousness was there for generations of leftist politicians to develop. The left organized itself in international movements. After the Second Internationale, a schism occurred between communist in favor of revolution and expropriation and socialist in favor of reform and taxation of profit. While revolutionaries won in the developing world, France, Germany, and England developed a tradition of social reform. Few in France want to expropriate owners, the general agenda is to fully redistribute profits.
In appearance, the politician rhetoric and population sentiment are adverse to the capitalist. In practice, the policies implemented correspond to the new deal and the Keynesian policies of the US in the '30s to '70s. The capital accumulation through the private ownership of a corporation ends up ironically being the only sheltered from redistributive pressure. That is because profitable companies are needed to pay workers in the long run, and French made the choice of keeping private owners.
While the social value of entrepreneurship is recognized and the word investment is viewed very favorably, words such as profit or capital are only ever mentioned as public enemies. The word rentier is most reviled, as deriving income from one's savings is construed as parasitic. Excess personal income and savings are the primary targets of the government policies, the government ingenuity is applied to more efficiently taxing the middle savers to fund its comprehensive system of social security entitlements.
To illustrate the difference, an individual salary, rents, or dividend revenue and capital gains are taxed between 20% and 60%. the companies are allowed to compound their profit with lower corporate tax, and dividends they receive from majority owned company (subsidiaries) are exonerated. Inheritance tax is also skewed to allow heirs to keep their parent's company whereas any other asset is taxed at 50% above a few 100,000 threshold.
So by setting yourself up as a landlord, you become a prime target, It is imperative to talk with a fiscal specialist before buying in France, consider ownership through a company, and understand the difference between furnished rental and long-term rental regulations.
It is symptomatic that any public debate on tax reform centers on how tax can be used to redistribute wealth, rather than on how to keep people motivated to grow their earnings. It is as if Ronald Reagan had not been elected president in the '80s.
Update 2018: the Macron government suppressed last year the ISF on companies and maintained it on real estate, however, these measures might be reverted due to popular protest. The constant political agitation and controversy around French fiscal rules do not help investment over long periods such as real estate.
Pro-Tenant Measures and Rent Control
French law is strongly pro-tenant, its laws are designed to protect the widows of world war I. Eviction normally takes more than a year. The allowable rent increase is regulated.
The authorities are now concerned that the landlord is transferring their cost to their tenants. So, while the treasury is concerned with maximizing tax income, other authorities are concerned with regulating away gross income.
One year after systematically gathering rent levels and occupancy data through mandatory reporting to the newly instituted government agency called Paris Rent Observatory (OLAP), the administration started to impose relatively wide bands for rents. Some worry that the authorities are setting up an Orwellian infrastructure that enables populist politicians to more finely control how the landlords will bear the economic hardship, and claimed that this may discourage investment. The reported approval ratings for these measures, however, is 80%. While respondents admit not knowing the intricacies of the plan, they support its purported aim, which is that rent increase should not follow price increases.
This is another risk larger than that confiscation of rental profits: the risk that income is regulated away. Price controls resulted in French utility companies failing and being nationalized after the war. The government does certainly not want to micromanage rentals, but politicians do not want costs to be passed to their clients.
High transaction taxes of 10% can be seen as rules signaling to investors that the real estate game can only be played over many years. Over the last five years, the rules have been changed faster than the players were allowed to move. This measure has been introduced in 2015, the authorities have thoughtfully put in place in 2012 a double capital gains tax, lest owners would take their gain and exit. While French civil servants are not ill-intentioned, they do follow orders: first, you put barriers to exit, then you introduce mandatory reporting requirement, then you can implement whatever solution the politicians devise.
Update 2018: the 'zone tendue' (tense zone) regime which controls rent increase to a politically controlled real estate cost index has been extended to most of the cities with dynamic economic growth that are suitable for furnished rentals. We review these cities in this blog article article. The stronger rent control rules put in place in 2015 which would force 1/4 of the landlords to reduce the rents to comply with the bands have been suspended in 2017 by an administrative court decision, but local city politicians are working hard for it to be reinstated soon
Paris is one of the finest world cities, and France is one of the finest countries of the temperate zone with an outstanding cultural heritage. The country is still engaged in a self-destructive fiscal path.
The secular trend in fiscal policy means buying is currently more of a lifestyle choice than an investment decision.
Update 2019: for deep content on the slow and secular accretion of measures inimical to landlord, see this excellent article by Vincent Bernard's.
For further reference, the following articles by Vincent Benard give a good overview of the evolution of french policy from 1914 to 2011:
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