Borrowing is easier, deal volumes are up and the diversity of funds launched is increasing. Even non-core is on the rise, as Christine Senior reports

Against a background of a slow recovery in the European economy, activity in its real estate market is gradually picking up. By and large the focus of investors' attention can be summed up as: prime properties in good locations with top-quality tenants on long leases. But little by little this is changing.

A lot depends on what kind of assets banks are willing to finance. Where a few months ago all the prime qualities would have been necessary, now there is evidence that some less highly favoured properties are making the grade to meet the banks' financing criteria.

"Banks are increasingly willing to finance on properties that don't necessarily have all but have at least a couple of the attributes," says Richard Bloxam, international director EMEA capital markets at Jones Lang LaSalle. "Either it needs to be a prime building in a prime location where there is confidence it can be relet; or a building let on a very long lease to a good tenant in a secondary quality location can work too. Where it doesn't work is for a poor quality location and a building with a shorter lease expiry profile."

Bloxam has seen what he describes as a "fundamental shift" in the past six months with the re-emergence of transaction activity in previously less favoured markets, which he expects will continue to increase over the coming months.

"To see transactions going through again in Moscow, Ireland and Helsinki is encouraging. The volume of activity in markets will, in our opinion, be higher in 2011 than 2010, in part because the range of geographies where people are prepared to invest has increased."

Investors are tending to focus on three markets whose economies are holding up relatively well: part of CEE, as well as the Nordics and Germany. Poland and to a lesser degree the Czech Republic are showing the greatest resilience, Poland being the stand-out location as the only country in Europe to escape recession. The Nordics are also attracting attention based on their relatively benign economic circumstances, as is Germany whose recovery has shown the most dynamism.

"The Nordics are attracting lot of attention, principally I think because they are not going through the same public sector austerity as most of the rest of Europe," says Michael Haddock, director of EMEA capital markets research at CB Richard Ellis. "Their government finance is in a much healthier position than anywhere else - Sweden, Finland and Denmark all have annual deficits that are sub 3% of GDP (according to 2009 figures) and also had total aggregate debt that was below the 60% Maastricht criterion as well. Germany, where the economic recovery is pretty sound, is also attracting investor interest."

While two Asian pension funds investing in European property may not qualify as a trend, it does highlight the attractiveness of the market to investors from outside the continent. Malaysia's Employee Provident Fund awarded RREEF and ING Real Estate a mandate to invest in the UK market, while Korea's National Pension Service bought Berlin's landmark Sony Centre this year and is reported to be negotiating the purchase of a stake in French shopping centre O'Parinor. This follows its acquisition of HSBC's Canary Wharf headquarters and a stake in Gatwick airport last year.

"Non-European investors are tending to look at Europe, and as London is the most liquid and transparent market that seems to be their main entry point," says Georg Allendorf, head of RREEF Germany. "We have just been awarded a mandate to invest in the UK by an Asian pension fund. It was the first international mandate they were placing and they looked at the UK as being the most transparent market to start with."

The prominence of London as a magnet for foreign investment was highlighted in recent research from CBRE, which showed that €6bn of cross regional investment totalling €22.4bn over the last 18 months was invested in London.

Anne Koeman, senior analyst, property research at PRUPIM Real Estate Investment Management, says Middle Eastern and Far Eastern investors have replaced US investors in European real estate.

"American investors generally have been after more value add and opportunistic type stock which goes hand in hand with quite high gearing ratios," she says. "Because of stringent conditions for finance currently I think a lot of these American investors have been staying out."

Nevertheless it is still Europeans, and not outsiders, who dominate cross-border investment on the continent. According to CBRE's research German and Dutch investors were the leading cross-border buyers in the first half of 2010. Cross-border activity seems to be creeping back up from depressed levels seen during the downturn: it rose from 33% of total activity in the second half of 2009 to 35% in H1 2010.

Diversified pan-European products, having proved their worth through the crisis, now seem to be finding favour over more specialised products. RREEF recently launched a pan European fund aimed at German institutional investors which is proving popular among investors new to real estate.

"Interestingly it is investors who have come to the real estate market for the first time - foundations, insurance companies, some corporates - that see this as an opportunity to get exposure to a pan-European portfolio," says Allendorf. "To a certain extent there is demand for more focused products but the crisis has shown that funds that are diversified have suffered less than some funds that are more focused."

David Jackson, head of international fund management for PRUPIM, also highlights increasing demand for pan-European products: "The more specialist country and sector funds in the past have typically been higher up the risk spectrum, often with more leverage and sometimes a higher return ambition. Coming out of recession there has been a flight to quality, lower risk, lower gearing, and more core balanced funds are seeing good interest."

As for new funds, INREV reports more diversity in the type of funds launched than in the recent past. "If we look at funds launched this year compared to last year, it's a relatively low number of funds compared to the peak of the market, of course, but while last year it was pure core funds, now we are seeing some variation, some value added some opportunistic," says Lonneke Löwik, director of research and market information at INREV.

But she says investors are now seeking funds with a clear strategy, which is easier to find at both ends of the risk spectrum, in core and opportunistic.

But overall the immediate outlook for opportunity funds looks rather bleak. Raising capital for opportunity funds remains challenging, says Chris Staveley, regional director, EMEA capital markets at JLL. "There is a pretty wide range and relatively deep resource of opportunistic capital that has been raised for some time, but it is difficult to match that with good opportunities. While the occupational markets remain weak or challenging it will be difficult for these groups to get significant sums deployed in the market."

What is clear is that opinion on how the European real estate market will develop from hereon is sharply divided. Any number of experts gathered together will fail to agree. Bloxam at JLL says this divergence of opinion has been clear from discussions at recent conferences: "There are varying views on almost every topic in real estate."