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Investors are increasingly targeting distressed real estate loans in Europe, according to Ernst & Young's latest global NPL investor survey.

Europe's market for non-performing loans is growing and could reach €1-1.5 tln, according to the survey, which polled European-based investors for the first time.

Whereas global investors in distressed loans were primarily focused on the US in the past few years, they are now increasingly seeking investments in Europe, it said.

The survey respondents focused on Europe said they were primarily interested in investment opportunities in Germany, the UK, Ireland and Spain.

In the eurozone, total NPLs (including real estate) as a percentage of banks’ total loans increased from 5.6% in 2011 to 6.8% in 2012. This year, NPLs will reach a euro-era high of €932 bn, amounting to 7.6% of total loans of €12.2 tln, the report predicts.

As economic conditions improve in 2014, NPLs are expected to drop to 5.6% of €12.5 tln of outstanding loans, or the same percentage as in 2011.

European banks have increasingly begun to reduce their exposure to NPLs via portfolio sales, the report notes. It points to Morgan Stanley figures estimating that Europe’s banks need to sell or refinance €700 bn of NPLs to meet regulatory capital requirements, deleverage their balance sheets and achieve other goals. As of January 2013, banks had sold or refinanced NPLs equal to 20% to 25% of that target.

‘By far, Europe represents the biggest opportunity worldwide,’ said Lee Millstein, head of European and Asian distressed and real estate investments at Cerberus Capital Management.

‘Europe will attract more investment from investors worldwide, and the pipeline will grow over the next few years,’ said David Abrams, senior portfolio manager of non-performing loans at Apollo Management International and managing partner and co-founder of Apollo European Principal Finance Fund.

Until now, the leading international buyers of Europe’s distressed loans have been US-based private equity firms. Such is the demand for NPLs, however, that other investors have entered the market, including smaller private equity firms, sovereign wealth funds, wealthy individuals, family offices and US real estate investment trusts (REITs), the report says. In some cases, these investors have offered higher prices than the big firms.

In December 2012, the German government agreed to sell TLG Immobilien to US private equity firm Lone Star Funds for €1.1 bn, including debt.

Christopher Seyfarth, a partner in Ernst & Young LLP’s Transaction Real Estate practice, said: 'This year’s survey indicates an increasing appetite among investors on both sides of the Atlantic for European NPL product as they look to both diversify their investments and access potentially higher returns in a nascent market.'