The commercial property markets of Europe, and in particular the UK, have suffered a slump, but there is growing evidence that a recovery may not be far off, meaning that this year could be an excellent entry point for investors looking to profit from the next property cycle, according to US-based fund manager Fidelity International.

Fidelity believes that a return to fair value is already taking place in the UK commercial property market, at least in terms of transactions taking place in the open market. Fidelity points out that, historically, a return to this point in the investment cycle has taken far longer, noting that the adjustment of capital values to present levels has happened three times as fast as it did in the 1990-91 property downturn.

The firm also sees the increased incidence of distressed selling as having created many "once in a generation" buying opportunities.

Over the long term, the most significant part of the return on commercial property comes from income, and investors are now enjoying a historically high income yield as a reward for the risk of tenant default.

Between 1981 and 2007, the IPD All Property Initial Yield averaged 6.4 per cent, but for most of the past five years yields have been well below this average. However, as Fidelity points out, the IPD monthly yield has recently risen to 7 per cent. Furthermore, given that the index lags behind the open market by around three months, the firm puts the real figure as nearer 7.5 per cent and still rising.

Fidelity’s view on property investment is supported by the fact that Western governments are taking extensive reflationary steps (which may even prove to be inflationary later). According to the firm, one of the reasons the 1974 correction in property was short and sharp is because institutional investors were rapidly attracted back into the market as inflation accelerated.

Fidelity also emphasises the importance of the asset allocation preferences of institutional investors. The more prolonged correction of property prices seen in the early 1990s was, the firm says, due to institutional investors cutting back allocations to property in favour of overseas equities and bonds.

Today however, Fidelity anticipates that institutions still place value in property due to its high yield and low correlation with equities over the longer term. Accordingly, the firm expects money sitting in low-yielding money market funds to increasingly come back to the property market.

Fidelity cautions that it would be foolhardy to unequivocally call the bottom of the commercial property market; the true bottom of the cycle only emerges retrospectively due to the way that property indices lag behind transactions in the open market. However, the firm says that the weight of evidence suggests that we are close to the bottom of the market, and as such is of the view that investors should begin to re-build their exposure to the commercial property market before it recovers and sellers regain the upper hand.