Property market returns will weaken in 2008 and 2009 across Europe, with rental growth decelerating as the economic slowdown gathers pace, according to Aberdeen Property Investors.

Aberdeen also predicts that capital values will decline, particularly in locations where yields had fallen to extremely low levels.

Nevertheless, the correction has already been rapid in markets such as the UK, and Aberdeen predicts that yields in such locations will rise to levels that could prove attractive to investors in 2009.

It says the eurozone economy will slow in 2009 to the weakest pace of growth since the early 1990s, hit by weakening global demand.

Where housing booms are in the process of unwinding, such as the UK, Ireland and Spain, it sees greatest risks of a recession in the next year.

Compared to the Anglo-Saxon economies, the eurozone and the Nordics are in better shape due to a lack of external imbalances or high indebtedness on the part of households, although notable exceptions to this include Ireland, Spain and Denmark.

Aberdeen says much lower interest rates and substantial support for the banking system should form the basis for a return of liquidity to the financial markets in 2009.

Financial institutions will grapple for sometime with impaired capital markets and new problem loans; though a modest improvement in European activity is expected by the latter half of next year and into 2010.

Aberdeen says the current conditions within global capital markets are having a profound impact on European property markets.

Capital values are falling, following the steep rise in the cost of borrowing and decreasing risk appetite among investors and property lenders.

Since mid-2007, yields for commercial property have risen by about 50 basis points in German markets and up to 200 basis points for some locations in the UK.

The level of investment activity across Europe stabilised in the third quarter compared to the second quarter. Investment transactions in quarter three amounted EUR26.4bn, which is almost 60 per cent down on the same period last year.

Aberdeen predicts a fall in occupier demand for at least another 12 months, being most pronounced in the office sector.

The only sector actually benefiting from the current environment is the rented housing sector, where demand is increasing, due to capital falls, mounting uncertainties in the owner-occupier market and the increased difficulty in obtaining mortgage financing.

Aberdeen believes property lending is likely to become more traditional again, with banks being more cautious, requiring higher compensation for risk that sits longer in their books.

It advises property investors to remain cautious for the next 12 months as further capital falls are anticipated.

However, as the process of price correction progresses, property investors should become more alert to opportunities.

UK property prices have already become more attractive, with yields now being higher than in many other markets on the continent.

Aberdeen also advises investors to focus more on market fundamentals. Countries that have sound financial fundamentals, for instance, those with high savings ratios, balanced current accounts and limited public and private debt, are likely to recover first.