The CB Richard Ellis measure of prime commercial property yields rose further to 6.2% in the second quarter, up from 4.8% a year before and close to the 6.4% average over 1972-2007.

Using the raw yield to assess valuation is problematic because rents fluctuate significantly with the economic cycle. A high yield may not indicate that property is cheap if rents have been boosted above a sustainable level by a buoyant economy. Conversely, it may be right to invest when yields are low if rents are below trend and likely to benefit from future strong economic growth.

Based on their long-term relationship with GDP, I estimate rents are about 5% above trend currently – see first chart. There were much greater deviations in the early 1970s and late 1980s, when rents overshot by 30-40%. This implies a normalised or cyclically-adjusted yield of 5.9%.

Any judgement about valuation should also take account of returns on competing assets. The rental yield is often compared with yields on conventional gilts but this is invalid because bond interest is fixed while rents rise with inflation over the long run. In other words, the rental yield should be compared with real not nominal interest rates.

The second chart below updates my comparison of the normalised rental yield with real yields on long-term index-linked gilts. The gap between the two has surged from 3.1% in last year’s second quarter to 5.1% currently – the highest since 1994 and well above a long-term average of 3.6%.

Tight credit conditions and a weakening economy should lead to a further fall in demand for property space and rents are likely to undershoot their trend level over coming quarters. Current valuations already discount much gloom, however.