Where commercial property goes, so goes housing. If that old relationship holds true in this cycle, house prices could be in for a very nasty fall indeed.

The same conditions of cheap money that led to the boom in house prices have also fuelled very strong growth in commercial property values in recent years.

Prices were further buoyed by an influx of new money from pension funds wanting to diversify from equities after the dot-com crash.

This mirrored the surge of new money into the housing market with the growth of buy-to-let investors.

Commercial property prices rose by 37 per cent in the three years to June 2007, according to the Investment Property Databank (IPD). This meant that price inflation for Britain’s £450 billion of shops, offices and industrial warehousing was running at 11 per cent a year.

The credit crunch hit commercial property at the same time as it hit housing. Yet, the impact has been swifter and steeper. Funding has dried up, just as it has for home mortgage borrowers, and there has been a wave of forced sellers as commercial property funds have had to sell buildings to meet a surge in investors’ demands for their money back.

Since June last year the average value of commercial property has fallen by 15 per cent, according to IPD. The actual prices being paid, however, are down by nearer 20 per cent.

The property derivatives market is currently pricing in a fall of 18 per cent for the whole of 2008. That would mean prices would have fallen 26 per cent between June last year and the end of December this year.

As in the housing market, sales volumes have slowed dramatically. According to the agent Cushman & Wakefield, only £2.83 billion of Central London property changed hands in the first quarter, down by more than a quarter on last year.

The optimists say the worst is over. They argue that price falls have been driven solely by the credit crunch and that strong tenant demand will now act as a cushion. Unlike in the last property crash, there is no large oversupply of commercial space. City office vacancy rates are under 5 per cent, compared with a 15 per cent of total space empty in the Square Mile in 1992.

This may not last, however. Banks are cutting jobs in the City and retailers are feeling the squeeze from a slowing economy.

In housing, there is no oversupply, at least not yet . . .

Aside from city-centre flats in Birmingham, Leeds and Manchester, there is still assumed to be a shortage of residential property. But if buy-to-let investors turn sellers, that could change.

The International Monetary Fund said yesterday that the UK was one of the countries most vulnerable to a further fall in house prices because so much of the previous rise could not be explained by “fundamental” factors. In English, that means it was particularly frothy.

Historically, commercial and residential property prices have tracked each other fairly closely. The drop in commercial property prices is the sharpest since records began more than 20 years ago — sharper even than the property crash of the early 1990s.

The house price optimists say that this time it will be different, because employment is still healthy and there is no oversupply.

But the commercial property market shows what a real credit crunch can do on its own.

david.wighton@thetimes.co.uk

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