SHARES in companies that deal with commercial property have fallen by more than 40% during the past 12 months, but the worst may not be over if we examine what is happening in the underlying real-estate market.

Deals have dried up. Just £17 billion of commercial property has been sold so far this year — the same amount that was sold in the third quarter of 2007 alone.

In central London CB Richard Ellis (CBRE), the world’s biggest real-estate agent, says only £5.2 billion of office buildings have been sold in the year to date, compared with £17.5 billion for 2007 as a whole.

Meanwhile, values are plunging. CBRE predicts that property values will have dropped roughly 20% by the end of the year — but that figure could rise after the collapse of Lehman Brothers and the events that have followed in the global economy.

That fall is on top of a 10% drop in property values last year. In previous property crashes in the 1970s and early 1990s values fell more than 40% so there could be further pain next year. Falling values have pushed up property yields — the annual rent roll as a percentage of a property’s value. The Investment Property Databank says that equivalent rental yields hit a low point of 5.4% in early 2007 but rose to 7.2% in September.

Bank lending to the sector has dried up and even the line of cash-rich investors (of which there is a plentiful supply) are sitting on their hands because they know values still have further to fall.

Void rates caused by tenant collapses are still small but are rising gradually.

Until now property rents have held up reasonably well and have even recorded small rises. However, CBRE believes the worsening conditions in the global economy make it more likely that rents will start to fall sharply as well. The property group is expected to confirm in a presentation to clients in the next few weeks that it believes that prime rents in central London will suffer double-digit falls next year.

The worsening storm engulfing the sector will inevitably trigger fears of widespread covenant breaches. Any investment property bought in the past two years with borrowed money using a high loan-to-value ratio is in serious danger of breaching its banking covenants.

There have already been some high- profile casualties in the commercial property market. Plantation Place, a glitzy office building in the City of London, breached its loan-to-value banking covenants. More spectacularly, the private property empire of Dawnay Day collapsed earlier this year.

Following the sharp share-price falls, property stocks already trade at a 50% discount to the net value of their assets.

In this climate that means very little. Nobody trusts the asset valuations in today’s volatile markets. It is almost impossible to tell how much of the gloom is already reflected in the share prices. My bet, though, would be that the shares still have further to fall.

Eventually cash-rich predators will see a bargain and pounce. There are already signs they are watching and waiting.

The best example is that the international shopping-centre companies Westfield and Simon Group have taken small “investment” stakes in Liberty, the FTSE 100 shopping-centre giant. If the market continues to worsen both companies could have the firepower to execute a takeover deal.

However, there is little reason to move now. Exactly when we will reach the bottom of the property cycle is hard to predict — and it is difficult to forecast much brighter prospects before the spring of 2010 at the earliest.

jenny.davey@sunday-times.co.uk

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