A new report shows that property investment returns are rising to healthy levels, a significant difference from just two years ago.

U.S. real estate investment performance for 2010 delivered its third strongest annual returns over the last decade, at 14.2%, as measured by the IPD US Annual Property Index. IPD, based in London, is an information and research firm that measures commercial real estate performance.

The all-property annual double-digit performance represents a substantial turnaround for investment performance after 2009’s revised annual total return of -18.9%, the worst performance in its 12-year history, according to the research firm.

IPD’s Annual Databank measures the performance of 46 mainly core funds worth $119 billion in annual return. The annual property index gauges returns on direct investment in U.S. commercial real estate by calculating the total return on capital employed in market investments, excluding transactions and developments.

“This strong return was surprising given the magnitude of the
distortion in the capital markets in 2008 and 2009,” said Jim Valente, director of performance and risk analytics at IPD. In 2010, large core open-ended funds were net sellers of real estate, he added. The trend turned positive in the second half of the year as managers were clearly making buy-sell decisions to reposition funds for the next cycle.

Primary markets in coastal cities, as well as multi-family and retail sector appear to be the favorites for fund managers, while secondary and tertiary assets and secondary locations in primary markets drew less attention.

The capricious movements in underlying U.S. market values over the last three years, in which real estate values were written down by a third over 2008 and 2009, seem to have ebbed, according to Simon Fairchild, managing director of IPD North America. Market values are likely to be moderate, with cap rates stabilizing, and bank lending and capital market problems improving, he said. Capital is flowing back into markets, he added.

Cap rates compressed across all sectors by an average of 70 basis points to 6.3% in the industrial sector, followed by office at 80 basis points to 6.5%, residential 70 basis points to 5.1%, and retail 60 basis points to 6.5%.

The retail sector outperformed the national average by 70 basis
points at 14.9%, driven by strong performance among large regional malls, the only segment outside of residential to deliver double-digit capital appreciation, at 11.4%, according to IPD.

The office sector delivered a total return of 12.6%, although performance varied across regions, with New York City and Washington D.C. outperforming the national average with returns of 21.4% and 19.6%, respectively.

Meanwhile, at the other end of the spectrum, Atlanta and Chicago office markets reported total return at just 2.3% and 3.1%, respectively.