UK - Property shares will rally by up to 20% between now and mid-year before halving in value over the subsequent 18 months as the economy slides into recession, according to a research note from Morgan Stanley, the investment bank.

Analysts led by Martin Allen urged investors to overweight UK versus continental European property as interest rate cuts designed to avert recession rally property shares by up to 20%. In contrast, they believe, there is "much less chance" of ECB interest rate cuts.

Issuing an immediate industry view of "cautious to attractive", the team claims the worst-performing firms in 2007 - including British Land and Segro - will become ‘outperform' as the focus switches from defensive stocks to beta.

The subsequent recession will drag many highly leveraged investors into insolvency, they claim. Previously, the bank had favoured retail over offices because of the risks associated with leverage.

Recent pricing distortions, the erosion of the yield gap between prime and secondary, and bank lending patterns for commercial property reflect the cycle of the late 1980s, according to the firm.

"While there are a number of major differences between now and previous periods, we think the differences are a lot less significant than many believe," says the report.  The similarities include the downturn in UK property share values. Were this to continue over the next two years, "we would see another further 40% fall in UK property shares in real terms".

They apparently base their forecast for a "short, sharp, counter-trend rally" on the current cycle's resemblance to the early 1970s and the late 1980s, which saw a five-month 20% rally preceding a bear market.

However, strong tenant demand will not be enough to avert a significant drop in demand for central London office space, weakening housing and occupational markets, forced sales of properties by highly leveraged unquoted companies and recession driven by consumer retrenchment.

Like other UK analysts, those at Morgan Stanley predict, in contrast to the early 1990s, the property downturn "will not be that protracted" because of a lack of central London office oversupply.

Meanwhile, a separate report published by CB Richard Ellis noted slowing rental growth across the UK, including in the capital.

"At the beginning of the year you saw aggressive upward rental in the City and West End, driven by low availability and the strength of the underlying economy. The turnaround came in the second half, and it caused companies to reappraise their demand requirements," said CBRE research associate director Michael Keogh.

"We anticipate a further adjustment in yields in the first half of 2008. The degree is still a matter of debate but capital will be an issue for the first few months," he told IPE Real Estate.

He added, in rental terms, the UK property market was "unlikely to pick up again in the short term. It's the end of this small cycle. We'll see rent plateau, and then it might fall back. It'll pick up again around 2010, with a general economic upturn."