The U.K.'s commercial real estate sector could be gearing up for fierce competition from buyers as funds, expecting more distressed property to come to market in the next two years, plan to snap up prime properties in hope of a recovery.

The market offers the potential of lucrative returns for overseas investors, in particular.

"The U.K. is attractive to overseas equity as values have fallen 45% peak-to-trough" and sterling has lost ground this year against major currencies such as the U.S., the euro and the yen, said James Thornton, founder of Mayfair Capital Investment Management, adding that "it makes for a very liquid market."

Thornton said he saw U.S. and Japanese investors returning to the U.K. market, as well as German open-ended funds, which traditionally have been prominent U.K. real-estate buyers.

According to CB Richard Ellis, 82% of the investors in the Central London office market in the third quarter were international, with U.S. buyers the most active, dominated by Blackstone Group LP’s (BX) acquisition in September of a 50% stake in British Land PLC's (BLND.LN) Broadgate Estates for GBP77 million plus the assumption of GBP987 million of debt.

German investors were the second-largest cross-border buyers in the quarter, having been relatively quiet since the last quarter of 2008.

Mayfair Capital recently has teamed up with Dallas-based property fund manager L&B Realty Advisors, which manages $4 billion of U.S. pension funds, to invest $250 million of equity from U.S. institutions into U.K. property over the next two years.

BNP Paribas Real Estate, the property adviser, said that planned new opportunity funds formed this year could have almost GBP18 billion to spend globally on commercial property, and GBP5 billion of that may be targeting property in the U.K.

German open-ended funds currently hold around EUR18 billion in cash or immediately liquid assets, of which up to EUR7.5 billion could be available to spend on real estate, according to property adviser CB Richard Ellis. If fund inflows continue as expected, they could have as much as EUR12 billion over the next two years.

Most of the opportunity funds were launched in the third quarter of this year, signaling hopes that the U.K. market has reached a bottom, but so far they have been chasing prime property only.

The U.K. commercial property market has been hit the hardest and fallen the fastest in Europe as a lack of debt financing caused declines in values and damped sales. While prices are beginning to rise again, vacancies still are high, subduing rental values.

BNP Paribas Real Estate is planning to launch a U.K. property fund for institutional investors, which is targeting GBP150 million of investment in commercial real estate by the end of the year while Aviva Investors, part of insurance group Aviva PLC (AV.LN), which manages GBP222 billion in assets, said its pooled property fund has returned to the market and is looking to snap up real-estate investments.

Aviva is planning to buy prime property, with secure leases and with strong covenants, across the U.K. and will focus on retail warehousing, high-street retail and supermarkets, with lot sizes in the range of GBP10 million to GBP30 million.

BNP Paribas' senior director Martin Francis said the property fund would aim at buying assets with good property fundamentals, which are more resilient as rents come under pressure.

But since prime and cheap property is limited, investors are waiting for distressed assets, under foreclosure after owners failed to meet lending or interest commitments, finally to come to the market on a larger scale.

"We also expect more assets to become available as banks reduce their property exposure on their balance sheets and from corporates looking to do sale-and-lease backs," said BNP's Francis.

Thornton said, "The risk appetite returned for all classes, but demand is only there for prime assets." He added that he saw good opportunities in property in prime locations but with shorter leases and, therefore, considered secondary, or less attractive.

-By Anita Likus, Dow Jones Newswires; +44 20 7842 9407; anita.likus@dowjones.com