Merrill Lynch’s wealth management business is in no hurry to move into the property sector but it says that the UK real estate market is its favourite because of cheap valuations, low interest rates and a weak sterling exchange rate against the euro.

However, there is a risk that rents will decline further, implying a 25 per cent drop in property prices from peak levels, but rental declines have been tracking behaviour of the early 1990s, which suggests there is further decline likely, according to Bill O’Neill, portfolio strategist at Merrill Lynch Global Wealth Management.

“Regionally, we prefer the UK for a number of reasons. First, monetary conditions in the UK are looser than any other country, with the exception of the US, and bank lending conditions in the UK appear to have eased and are arguably looser than in Europe or the US,” he said.

He continued: “Second, sterling is still cheap against the euro and if anything this will provide an incentive for fresh capital to look first to the UK before elsewhere in affordability terms. Finally, on a price-to-book basis, UK property is trading at around 44 per cent below its long-term average.”

But Mr O’Neill warned that property rents have fallen 6 per cent so far and “will surely fall at least as much as during the 1988 to 1992 downturn”, when declines were in the 20-25 per cent range.

“Inflation may not be such an immediate concern on a wider macro view, diluting somewhat the argument to increase exposure to property as an inflation hedge. It is more likely that inflation concerns will be more valid in 2010.  In conclusion our view is to defer an immediate entry into the direct property sector, in the absence of a catalyst in the short term,” Mr O’Neill concluded.