UK investors are overcoming their reluctance to invest in continental European real estate – but not quickly enough, according to Ian Hally, head of real estate research at Scottish Widows Investment Partnership (SWIP).

The potential for higher total returns and more diversified risk has not been enough to tempt many UK institutional investors across the channel to real estate markets in France and Spain.

As a result, Hally believes many are still too domestically focussed with cross-border holdings only accounting for 5% of property portfolios. He argues that the international element in pension funds' equity holdings is closer to a third.

He predicts that, in the short term, pension funds will recognise that the quality of advice and ease of transaction have improved in maturing continental markets.

"Pension funds are recognising that they're probably underweight in non-domestic properties," he said. "In the long term, they'll feel pressure to diversify away from the domestic market.

Hally pointed to optimistic forecasts for Spanish retail, driven by strong economic performance and buoyant consumer confidence. Consumption is expected to slow but will average around 3% annually in the medium term.

SWIP expects total returns on Barcelona retail property to be around 10% per annum. Yet Hally also predicted continuing performance from distribution warehouses – a forecast that contrasts with that of Lasalle's Investment Strategy Annual, which recently predicted disappointing performance because of compressed yields.

Hally said: "Yields will fall as the sector matures, but logistics is still an immature sector and it has some way to develop. As central Europe becomes more economically active, there will be a greater need in northern Europe to shift products between manufacturers, retailers and consumers.

While Lasalle Investment Management predicts some growth in German retail real estate, that market is not part of SWIP's core investment.

Signs of a tenuous economic upturn in Europe's largest market have yet to convince Hally that domestic demand will rise.