The obscurity and unreliability of Italy's real estate market should not deter investors. Those who persevere should fare well as the market becomes more mature. Alice Breheny reports

Southern Europe has seen rapid growth and consolidation in its commercial property market over the past decade, resulting in very good performance for many parts of this market. Italy in particular has seen strong growth of inward investment. In the early 1990s Italy's real estate market was essentially limited to domestic players. There were only a handful of overseas investors and these were confined to northern Italy.
Recent performance of Italian property has been driven by weight of money and supply-demand imbalances. Increasing demand from occupiers, coupled with a shortage of quality space, has fuelled rental growth across all sectors. The limited pool of stock has also led to yield compression as investors have aggressively bid values up. Performance of the Italian property market has not been driven by strong economic growth, unlike in Spain for example.
Since mid-2007 low availability and the high cost of borrowing has adversely affected the Italian market, just like everywhere else. Prior to the credit crisis, yields in Italy,  as in much of Europe, had been bid to historical lows as cross-border activity remained high. Arguably, a disproportionate volume of money was targeting Italy and yields had been bid close to equilibrium, if not beyond in some areas. Before the credit crunch hit it was already inevitable that we would see some slowdown in the Italian property market as yield compression came to a halt. But as lending and investment conditions remain tough the short-term outlook is now weaker.
An imminent upswing in economic conditions in Italy seems unlikely. The consistently strong euro, rising export cost due to wage inflation and rapidly weakening global economy means the Italian economy has come under strain. Economic growth was negative in the final quarter of 2007 and, although it rebounded in the first quarter of 2008, the Italian economy is expected to continue to flirt with recession over the next 12 months. GDP growth for 2008 is forecast to be just 0.3%, which makes it the weakest economy in Europe in terms of growth.
We do expect there to be a modest recovery from 2009 but economic growth is only expected to average 1.2% over the coming five years. Again this makes it the poorest performer in Europe. Consumer confidence in Italy is weak and as a result retail sales growth is expected to be modest.
In addition to a weak short-term economic and property market outlook, there are further challenges to investing in Italy - some real, some perceived. Political instability, excessive bureaucracy, inconsistency of regulation and, not least, high taxes are all an issue.
It is certainly not the most transparent market. Legislation is notoriously opaque and there are persistent rumours of corruption. For an economy of its size there is more political instability than one would expect.  It is not only property investors that find accessing the Italian market a challenge. There has been a recent collapse in new foreign direct investment in Italy, just when such inflows elsewhere in Europe have been booming.  Italy also has the smallest percentage of foreign ownership of any stock market in Europe and there is a sense that investments are not made where they are not welcome.
Many investors cite the constant rewriting of rules as one of the main deterrents. Many perceive the market to be unreliable, with regulations selectively applied and changed at a moment's notice.
For property investors one of the biggest challenges is the planning system where most decisions are decentralised and generally made by regional or local offices. There are several different levels of government - state, regions, provinces, cities - sometimes without a clear definition of which one has jurisdiction. The strong influence of local businessmen at the city level means the outcome of planning applications is often unpredictable. Regulations can be overlooked, some are not applied to everyone and you run the risk that others will find a regulation to keep you out if they want to.
For an economy of its size, Italy's property market remains immature which means there has been less harmonisation across markets. This is difficult for non-domestic investors to fathom. In addition to the well known north-south divide, every town is different - one of Italy's charms - compared with some European markets where urban locations can tend towards sameness. Understanding local markets can only be fully mastered by locals. Finding property product of international grade is difficult and, in the European context, Italy remains very ‘Italian' with language barriers and local influences being difficult for international investors to work around. Having local players on the ground in Italy is crucial in sourcing stock, gaining planning consent and asset management.
Despite the short-term economic gloom, and general deterrents to investment, Henderson research remains positive about the Italian property market over the medium and longer term. Data suggest that the investment market has held up comparatively well during the credit crunch. For the first quarter of 2008, overall investment volumes remained at around the same level as they had been in the middle of 2007.  And the shift away from domestic investors towards international investors continues. 
The office markets in Milan and Rome are faring better than one would expect in the current economic environment, with both markets recording a high level of demand in 2008. Vacancies remain stable in both markets and there has even been some rental growth in Milan. In the retail sector, continued cross-border expansion of European retailers benefits good shopping locations in Italy. In both core sectors there is a lack of quality supply - so the market's immaturity will support both vacancy rates and rental levels. Post credit crunch, the ongoing demand-supply imbalance in Italy - supported further by less availability of funding for development - should ensure future rental growth. And lessons learnt from the credit crunch means investors are likely to be focused on markets that will deliver rental growth.
Perceived risk in Italy has already been much reduced in recent years. The market is likely to become more transparent and geographical disparities should be reduced. Once the present economic and investment conditions have eased, the Italian property market will continue its journey up the maturity curve. As it matures, liquidity and transparency will improve which, along with shortage of supply, will put downwards pressure on yields again. Low levels of supply should support rental growth over the medium term and so international investors should persevere with this challenging market through establishing local networks.
Alice Breheny is head of property research Europe at Henderson Global Investors