EUROPE - Income returns will continue to drive real estate investment performance despite an uncertain outlook for rental growth, according to Invista Real Estate Investment Management.

The fund manager said European markets had continued to deliver attractive income returns over the past two years, despite the worst economic conditions in modern times, and would continue to do so.

Income returns on real estate investments cushioned the impact of falling capital values in recent years, according to Investment Property Databank's (IPD) Eurozone index, which saw its income return reach 5.6% at the end of 2009 - the highest level since 2003.

Invista forecast a range of future income returns across the euro-zone, from 5% in markets like Austria, Belgium and Germany to more than 7% for Finland, Ireland, Portugal and Spain.

Tim Francis, director of continental European strategy and research at Invista, said:

"Over the longer term in continental Europe, income returns have typically made a greater contribution to overall property performance than capital growth, both in cyclical and non-cyclical markets."

Rental growth is expected to depend on the level and sustainability of economic and employment growth over the next few years, both of which have become more uncertain in the short term due to initiatives to reduce government budget deficits.

Invista said this suggested 2010 would be the worst year for rent declines in the current cycle.

Over the longer term, Invista identified modern office properties located in supply-constrained city centres, such as Paris, Munich and Vienna, as markets with rental growth potential.

It expected the retail sector to remain under pressure due to weak consumer spending, although it added that a number of rental growth "hotspots" could emerge as retailers consolidate within the best locations.

The report said this could generate some competition and a degree of rental growth in prime city-centre locations and dominant regional shopping centres.

The same could be said for the logistics and distribution market, where a 'flight to quality' trend was also expected to emerge among distribution occupiers.

Invista warned the risk of income returns being hurt by rising tenant defaults was considered to be "above 'normal' levels' and said it expected to see an increasing weight of investor capital seeking income-producing property investments.

Francis said: "Taking into account the subdued outlook for rental growth across continental Europe, we expect investors to remain focused on preserving and enhancing income returns at their currently attractive levels, and thus they are unlikely to be attracted to higher risk, capital-growth investments."