SPAIN - Annual total returns have turned positive in the Spanish real estate market for the first time in two years, driven by income growth, according to Investment Property Databank (IPD).

The IPD Spain Annual Property index recorded a total return of 4.9% for 2010, despite capital values continuing to fall by 1.2% as yields continued to rise.

Total returns were, therefore, dependent on a strong income component of 6.2%.

Spanish returns were similar to those of its Iberian neighbour, Portugal, which posted a positive return of 4.2%, and so both saw an end to a two-year period of negative returns.

Spanish GDP fell by 0.1% in 2010, although this was an improvement on 2009's drop of 3.7%.

Elsa Galindo, country manager at IPD Spain, said: "This recovery is reflected in the Spanish commercial real estate market - while capital depreciation remains, it has slowed considerably, allowing returns back to positive territory."

Despite the improving picture in Spain, there has been little indication of cross-border investors returning to the market in large numbers.

That said, there has been ongoing interest in the Spanish retail sector, most recently demonstrated by Rockspring Property Investment Managers' acquisition of a portfolio of shops from Spanish food retailer Eroski.

Henderson Global Investors has produced a report on the Spanish real estate market, highlighting the challenging nature of finding attractive opportunities for institutional investors.

The fund manager has been arguing over recent weeks that investors should start to look outside the safe haven of prime assets in the core markets of Europe.

Henderson reiterated the contention in its latest research report, warning that prime assets in core markets were now fully priced, "if not overpriced", and that investments were "subject to potential price volatility at exit".

The report added: "Funds wishing to place capital must soon accept greater risk (location, product or tenant quality) in core markets, or target investments in markets they have previously overlooked."

Spain is an obvious target for investors looking to take on more risk, but the Henderson report warns that investment opportunities will be few and far between and must be sourced on an asset-by-asset basis.

It does acknowledge the retail sector as possibly offering the best opportunities for cross-border investment, but warns against investors expecting prices at distressed levels.

Andy Schofield, director of research for European property at Henderson Global Investors, said: "The pricing gulf between prime and secondary shopping centres will remain for years.

"At present, good secondary offers potential opportunities for core plus investors, but is difficult to access."

He added: "Further up the risk curve, the value-add space has been more or less vacated, suggesting equity players with more risk appetite could perhaps negotiate more favourable terms with struggling vendors.

"Stock selection is critical, so access to local knowledge is highly recommended."