Property is back but the office market is not safe as houses: Nicholas Faith finds that amid the rebuilding of confidence, the bulls are talking prospects up too high

SUDDENLY it seems like the good old days are back in property. After three years in the doldrums, the sector is starting to move again. But the market is always prone to hype, and the underlying trends are not nearly as bullish as some of the recent gung-ho headlines imply.

Last year, investors saw a total return of 18.3 per cent and property shares rose by an average 80 per cent. Sentiment was boosted by the dramatic fall in yields on gilt-edged securities, so for the first time in a generation, yields on property were higher than on government stocks. At the beginning of 1993, at more than 9 per cent, they were higher than in the aftermath of the property slump of 1973/74 - when gilts went to more than 14 per cent.

Today it is increasingly difficult to find high-grade London office blocks at any price, even though advertised yields are now down to 7 per cent and Richard Ellis, the firm of surveyors, reckons the real yield is a mere 5 per cent, allowing for the degree to which present market rents are below those being paid by many occupiers.

In theory, there is better to come: quoted property companies raised pounds 2.39bn in rights issues last year and financial institutions are being lured in because their property holdings account for an historically low 7.5 per cent of their assets. And, as Robert Kynoch at NatWest Securities, points out: 'In 1993 property boomed without many of the normal bull factors. There was, for instance, no growth in rental levels. So 1994 could see more investment activity, some return of demand from new tenants and an erosion of tenant incentives such as rent-free periods.'

But the demand for office space is not as great as the bulls make out. Last year, it was the aftermath of the IRA bombs that provided the biggest single boost to the London property market. According to an estimate by Savills, the surveyors, the two City bombs accounted for the letting of 1.1 million square feet, a third of the total demand. And because the published figures do not allow for the offices vacated by tenants of new lettings, the net demand was much lower than the bulls make out.

Moreover, rents are unlikely to rise very much. The brokers Smith New Court warned that because the downturn in retail rentals was less than in previous slumps, the downward pressure would continue. For office rentals, the reduction had been the same as in other slumps, but because supply had run further ahead of demand than ever before, the downward pressure would again continue.

For all is not as it seems in the property world - especially in London, where the swings in the market were most violent. 'The central London office market is now polarising,' says Geoff Marsh of Applied Property Research, 'so that the structural changes which are essential for its long-term health are beginning to happen.'

Even today more than a quarter of the offices on the fringes of the City are empty, and many more have been boarded up and are no longer on the market. The bleak future for this fringe accommodation has been spelt out in figures compiled by Sandra Jones of Herring Baker Harris, the surveyors. They show that by the end of 1996 there will be virtually no Grade A office property vacant, but there will be growth to more than 4 million square feet of vacant space in Grade C accommodation, which is either old or in the wrong place, or both.

The outlook for well-placed modern property is excellent, but only for a couple of years. By 1996, the downward pressures could start to multiply again. Mr Marsh points to the significant number of leases that will be coming to an end in the last years of the century and says many of the tenants will simply move out of London rather than overpay.

Moreover, the pipeline of new offices could soon fill up. It takes at least two years to build a new office block and the financial institutions are still hesitating over whether to begin building. But observers reckon there will be a surge of new developments starting later this year, taking advantage of the large number of unused planning permissions overhanging the market. Well before 2000, the market could be in for another shock.