A nationwide increase in occupier demand is expected to make the office market the best performing property investment in 2006, according to new research from Lambert Smith Hampton.

Terry Corns, director and head of the firm's Birmingham office, says occupier demand is steadily improving in all key office markets around the UK.

"A squeeze on office space is leading to higher rents and falling yields on prime office buildings, as offices seem set to take over from retail as the best performing property sector in 2006," said Mr Corns.

In central London, take-up in the West End in the third quarter was at its highest for almost five years reaching over one million sq ft.

In the City, where take-up was steady at 1.5 million sq ft in the third quarter, investment banks and financial institutions which were badly affected by the downturn are recruiting again and developers are regaining confidence and slowly increasing speculative developments.

Elsewhere, demand for office space is accelerating and supply levels are diminishing. The Slough office market, a key part of the wider Thames Valley office market which was hit severely in the TMT downturn, is showing renewed signs of recovery.

Take-up in the first nine months of the year has already exceeded the total for 2004 and, given enquiries in hand, it is expected that 2005 will total around 400,000 sq ft, the best performance since 2000.

"A strengthening Thames Valley market will have a positive knock-on effect up the M40 and M42 towards Birmingham, and as available office space is reduced, and rents increase there, occupiers will look to the West Midlands," Mr Corns said.

"In Birmingham, lack of available grade A space is likely to push top rents further towards the record #30 psf barrier in the next 12 months, with occupiers having increasingly to consider taking refurbished or secondary stock if they want to move in 2006."

As a result of increasing take-up, UK prime regional office yields have fallen to their lowest level since the mid 1980s and are about 6.25 per cent to 6.5 per cent. In Birmingham prime office yields have fallen to 5.2 per cent, with the recent sale of 55 Col-more Row for #58 million.

"Strong competition and prospects of rental growth will keep the downward pressure on yields for prime properties. Secondary stock should also continue to witness further downward shift in yields," said Mr Corns.

According to LSH's research, the retail market continues to face challenging conditions.

The recent slowdown in the economy and, in particular, the housing market and consumer spending, combined with the after effects of July 2005 London bombings, has taken its toll. However, although retailer turnover is under pressure, the retail investment market has shown continued strength.

Yields have come under further pressure, driven by the weight of money with prime high street shops currently at four per cent. The shopping centre market has continued to attract strong investor demand and as a result, yields have continued to harden.

In the retail warehouse market occupier activity has polarised between bulky goods and open consent schemes, with demand from traditional high street retailers remaining positive. Investor interest, meanwhile, remains strong across the board with yields for open consented retail parks at around 4.75 per cent.

Mr Corns said commercial property continues to remain a popular investment, providing a total return in the year to October 2005 of 17.5 per cent.

"Commercial property is regarded as an effective diversifier given the volatility of equities in the past two to three years.

"Overall, the outlook for the investment market remains positive. The weight of money, as well as an attractive debt rate and rental and capital growth, will continue to drive the market. Turnover is likely to remain strong, creating opportunities for profit taking and improving liquidity." ..SUPL: