EUROPE - Three potential outcomes of the European sovereign debt crisis will have widely differing implications for European real estate, according to new research from Aviva Investors.

The first, "muddling through", characterises European political leaders' current efforts to find a solution through measures to prevent a worsening of the crisis rather than tackling underlying issues.

The result of this continuing will be sub-trend returns from pan-European real estate over the next five years and a strong demand for defensive assets offering secure income streams.

In this scenario, Aviva also expects the gap to widen between performance of the resilient core markets, particularly Germany, and the periphery, particularly Spain.

The other potential, more extreme scenarios are categorised by Aviva as "disaster area" and "decisive and coordinated action".

"Disaster area" might be triggered by Greece failing to meet the terms of its support package, or the need for further peripheral bank recapitalisation.

The result could be major economic disruption, and a full-blown credit crunch.

European real estate markets would then face shrinking capital values.

Non-euro-zone European markets would most likely outperform, with significant underperformance from secondary assets, especially in the periphery.

The third scenario of "decisive and coordinated action" would require further long-term refinancing arrangements, ECB support for peripheral banks and market stabilisation measures, as well as a commitment from policymakers to banking and fiscal union.

In this case, according to Aviva, European REITs would benefit from a rebound in European equity markets, and European direct real estate would outperform current expectations.

Aviva would still favour core European markets in this scenario, but foresees more opportunities in value add strategies.

Prolonged muddling through is the most likely outcome, says Chris Urwin, global research manager for real estate at Aviva Investors.

"If the 'muddle through' scenario remains on track, after 2-3 years, we can hope to see a gradual improvement in real estate fundamentals," he said.

"It may be that we get to the end of the European sovereign debt crisis through many piecemeal actions."

Whatever the outcome, Aviva's investment policy is a matter of degree. In all scenarios, there is a preference for prime assets and core markets.

"That illustrates the fact that, even under the most positive scenario, times will be relatively difficult," Urwin said.

"But if we were fortunate enough to see coordinated action from policymakers, we would be starting to look at secondary markets much earlier than we currently expect to be doing."