In the space of just one year there has been a dramatic turnaround in the way investors view commercial property.

After enjoying mouth-watering returns of more than 15 per cent in the years 2004 to 2006 investors actually lost money in commercial property in 2007. Rental yields of about 4 to 5 per cent were outweighed by falls of nearly 8 per cent in the capital value of commercial property resulting in an overall loss of 3.4 per cent.

Chris Hills, of Rensburg Sheppards, the investment manager, thinks there is more pain to come. He says: “Our feeling is that we haven’t seen the bottom of the commercial property market. There are still some investors that will be obliged to sell some of their holdings. .

“Valuations are still falling as property agents struggle to come to terms with the sharp fall in market sentiment. When property prices are rising valuations tend to be a little over-optimistic, but when they fall valuations tend to err on the side of pessimism.”

He reckons it will be another three to six months before prices bottom out and that they could have a further 10 per cent to fall.

Rob Martin, of Legal & General, the fund manager, accepts that commercial property faces considerable headwinds in the short term, but argues that the asset’s long-term attractions remain in place. Commercial property remains a way of diversifying an investor’s portfolio away from just shares and bonds. The scarcity of land means property values tend to go up over time and the practice of having upwards-only rent reviews provides investors with the prospect of a steadily rising income.

On top of this, overseas investors remain keen to put money into UK bricks and mortar and the price falls that have already taken place mean that commercial property is once again starting to look attractive compared with gilts.

Mr Martin says: “We think 2008 will be a year of two halves. In the first half prices are expected to remain weak but in the second half the picture could be a lot brighter as yields stabilise and total returns move back into positive territory.”

The biggest cloud on the horizon is the state of the UK economy. If the downturn is more severe than expected this could undermine the prospects for rental growth and trigger a further fall in property prices.

So should investors put money into commercial property now? Mr Hills says the answer depends on what they have already got in their portfolio. If they have no exposure to the sector then it might be a good idea, even at this gloomy juncture, to add some commercial property as a useful way of diversifying their portfolio.

If they already hold a fair amount of commercial property he says they may not want to invest more until they can see more clearly how the market is developing. “They may want to wait until prices have started to rise a bit before they dive in.” A further option is to diversify away from purely UK property and add some overseas property to the mix.

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