Sovereign debt issues are likely to continue to overshadow the fragile and uncertain outlook for the European economy, according to Knight Frank. This in turn is having a significant impact on the property sector, notably in respect of occupier and investor confidence.

Knight Frank's research, presented at a European property breakfast, shows a continuing polarisation in performance across Europe's property markets. Core Western European markets are seeing strong investor demand and activity, along with the Nordics and Central Europe. However, elsewhere, whilst there remains a degree of investor interest in the more peripheral markets, activity in these countries is down on last year.

So far in 2011, total investment volumes are ahead of 2010, although Q2 saw a moderation in activity in the UK and those Eurozone markets where confidence has been most affected by the recent bond market turbulence.

Knight Frank said that investors are focusing increasingly on markets which offer sound underlying economic fundamentals such as Germany and the Nordics. In addition, as a result of the yield compression in core markets over the last two years, an increasing number of investors have been prompted to consider higher-yielding markets in Central Europe.

Restrictions on the availability of debt finance will continue to shape the property market for the foreseeable future. Whilst there is strong competition amongst lenders to provide finance for prime assets, there is little or no appetite to lend on more secondary stock. A small number of mezzanine debt providers are emerging but so far these account for only a very small part of the overall debt market, the research found.