COMMERCIAL property prices have reached dizzying heights in the past 12 months, amid a worldwide scramble to buy trophy shopping centres and offices.

In the first half of 2006 $290 billion (£155 billion) was plunged into global direct estate, 30 per cent more than in 2005, which was a record year. Experienced property investors have watched rental yields crunched to record lows by the booming investor demand and, perhaps understandably, have opted to sell out before the party ends.

The champagne is still flowing, but a few signs of stretch are beginning to emerge. Shell-Mex House, a landmark building on the Strand in London has failed to find a buyer so far, and today property consultants say that there are maybe only four or five potential purchasers for some buildings where there would have been a dozen a year ago.

As interest rates rise, the flood of debt-backed buyers, who took advantage of readily available and cheap finance to pay top-dollar prices for buildings, is starting to tail off.

But while the latter part of the Nineties and the first few years of the Noughties were dominated by debt funded purchasers, the next few years are tipped to see the return of the equity investor as king in the property market.

The impending introduction of tax-efficient real estate investment trusts (Reits) to the UK is likely to make it easier for the giants of the quoted property sector to compete for buildings saddled with capital-gains tax liabilities.

Mike Prew, of Lehman Brothers, one of the property sector’s best-known analysts, forecast yesterday that once final details of the Reit legislation are ironed out next month there will be a swath of mergers and acquisitions in the property sector. He argues that Reit conversion candidates, such as Land Securities, British Land and Hammerson, could hoover up smaller listed rivals, private companies and big portfolios.

The thesis seems reasonable. After all, there are still more than 100 listed property companies, including many minnows with market capitalisations of less than £100 million. The sector has long been ripe for consolidation.

A slew of companies went private during the dot-com boom, when the public lost interest in property stocks. Since then deal flow has slowed, but it has been enlivened by the high-profile takeovers of companies such as Canary Wharf and Chelsfield.

Top of Lehman’s list of potential takeover targets is CLS, capitalised at slightly more than £450 million. Any deal would be dependent upon the agreement of the Morstedt family, which has a controlling 51 per cent stake. London Merchant Securities, capitalised at about £720 million, is also high on the list of possible candidates, and traders have long cited the listed rivals Derwent Valley and Great Portland as potential suitors. Big Yellow, Shaftesbury and Workspace are also in the catalogue of possible prey.

Bulking up their property portfolios through takeovers would lead to a higher Reit conversion charge for the big listed companies because the fee is based on a percentage of gross asset value. But provided they take account of that when determining the purchase price in a deal, they are unlikely to be deterred. After all, once a deal is done, they know they can wipe out many millions of pounds in tax liabilities on the assets once they convert themselves into Reits.

The projected buying spree should continue to prop up asset values for prime buildings and could create fresh investor interest in listed property company shares.

The underlying marketplace for property investment is likely to remain relatively benign, at least over the next six months. Although rising interest rates may curtail the number of debt-backed buyers for buildings, the growing economy should fuel higher demand from companies to rent office space, which will help to push up rents. In the City of London office rents have soared from the low forties a square foot only two years ago to high fifties today.

If problems do arise, they are likely to be restricted to poorer-quality properties in off-prime locations. Second-rate shopping centres and offices and out-of-town retail parks let to so-called bulky-goods companies, such as DIY chains and carpet companies, are already being shunned by some investors.

Luckily, the biggest listed property companies — British Land, Land Securities, Liberty and Hammerson — are mainly focused on high-quality regional shopping centres, retail parks and Central London office schemes. Together with specialists, such as Great Portland and Derwent Valley, they should continue to outperform.

Shares in many of the listed property stocks have climbed back to their Budget Day highs. Nevertheless, the prices still represent a 9 per cent discount to their “on-the-spot” underlying net asset value. This figure widens to a 19 per cent discount based on the projected net value of their assets 12 months from now.

Given that property stocks have produced total returns of 17 per cent this year — comfortably beating the all-share’s 7 per cent return — shares in the listed companies still look comparatively good value. The bull run may still have legs yet.

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