EQUITY investors have a good recent record of predicting the future path of commercial property values in the UK. In 1993, property shares raced ahead when sterling was ejected from the European exchange rate mechanism. Property values followed. Last year's correction was presaged by a shares sell-off.

So what should be made of the recent spurt in shares which has seen the sector index advance by to per cent?

The market started to move up three weeks ago, partly dragged higher by the general rise in equity prices. The gentle pick-up turned into a surge following a positive recommendation from the equity research team at Merrill Lynch, the investment bank.

There were technical factors behind the sharp reaction of the market to this change of emphasis by Merrill Lynch. The property sector is relatively illiquid at the best of times, with only a handful of stocks which can be easily traded. This can make for a volatile ride. Moreover, Merrill Lynch's note was published at a time when many investors had already taken short positions in property shares following the good performance over the previous few days. The market was squeezed sharply higher as market-makers bought stock to cover these short positions.

Whatever the underlying cause, though, property shares now stand at very narrow discounts or premiums to net asset value. Since the start of April, shares in British Land have risen from 383p to 444p, Hammerson from 353p to 385p and Land Securities, the biggest company in the sector, from 621p to 675p.

It is rare indeed for the shares of big property companies to trade at a premium to net assets per share. In recent years, a similar phenomenon has occurred only twice, in 1987 and 1993. In both cases, property values subsequently increased sharply to justify the premium valuation. Property values advanced by 18 per cent in 1987 and 22 per cent in 1988 as the UK economy roared ahead. In 1993, property values increased by 10 per cent as interest rates declined and institutional investors poured capital into real estate.

Yet, it is difficult to see where the next upswing in values, which the equity market seems to be anticipating, is going to come from. Economic growth is steady but unspectacular. Tenant demand for business space remains patchy. Although there are occasional bright spots - such as Burford's letting last week of a new 400,000-square-foot warehouse to Argos, the retail group on a 30-year lease - there is no sign of real rental growth.

The best that can be said is that rents have stopped falling in most locations and in a few select areas - such as the City of London and Thames Valley office markets - may now be on an upward trend.

The interest rate outlook is also unpromising. Government bond yields declined sharply in 1993 and helped drag property yields lower. This year, UK government bond yields have drifted higher.

Inflation is subdued but by no means dead and buried. Attempts to control the public sector borrowing requirement continue to disappoint. Turbulence surrounding the possible introduction of a single European currency, and the looming general election, make it unlikely that property will get swept along on a wave of bond market euphoria.

Neither would it do to anticipate a flood of institutional money flowing into commercial property and driving values higher. Most fund managers regard property as fairly priced compared with other financial assets. Some are looking to add to their portfolios - but many were burned by the experience of 1994, when they committed cash to the property market only to see values drift lower.

Against this background, property shares look over-priced at a premium to net asset value, except in cases where the management has a proven ability to drive the company forward through dealing or development.

The suspicion remains that companies will be quick to appreciate that their shares are more than fully valued. If the rally is sustained, investors should brace themselves for a flurry of equity issues.

Capital & Regional was the first to raise equity in 1993 and led the pack last week by making a £26m sterling issue of convertible loan stock. Others are likely to follow.