ON a harsh interpretation, last year was the worst for UK commercial property as a financial asset. Figures published by the Investment Property Databank show, for the first year on record, there was no net investment by fund managers. As a result, property fell to less than 6 per cent of institutional investment portfolios - an all-time low.

The performance of commercial property during the year partly explains this lack of enthusiasm on the part of institutional investors. The property databank figures show the average fund achieved a total return of 4.1 per cent from property during 1995, against 17.6 per cent from bonds and 23.8 per cent from equities.

The property figures are doubly disappointing after reasonable returns from commercial property in 1993 and 1994. The UK property cycle was generally seen to be moving into a benign phase.

Instead, rental values declined - albeit by only 0.1 per cent - and property yields drifted 0.3 per cent higher against a background of weak demand among tenants and creeping disillusionment among investors. However, there are some bright spots in the overall downbeat picture.

First, 1995 saw heavy trading activity. The databank recorded £3.5 billion sterling of sales matched by £3.5 billion of new investment. About 15 per cent of the £47.8 billion property measured by IPD changed hands during the year. These figures are surprising, as property agents spent much of 1995 complaining about the dearth of deals in the investment market. Yet, some clearly earned good fees as fund managers restructured their portfolios.

Second, funds improved their performance through trading and development. This is in sharp contrast to the late 1980s and early 1990s, when institutions diluted their returns through badly-timed acquisitions and developments. Indeed, without this activity, returns from property investment would have been almost a full percentage point lower at 3.2 per cent.

Third, certain sectors of the market - notably retail property - continue to deliver respectable returns. Overall, the retail sector outperformed offices and industrial properties for the fourth year in a row. Areas such as retail warehousing and central London shops achieved strong rental growth.

It is little wonder that funds have been shifting for some years in favour of retail property and away from the office sector, a trend which continued during 1995. The office sector had another disappointing year. The tentative recovery in rental values seen in the City of London during 1994 petered out. Rental values continued to fall in most provincial office markets. Industrial property was the worst performer of all. Rental values declined by 1.3 per cent, the fifth consecutive year of decline. Yields drifted higher by more than half a percentage point and, as a result, industrial property values suffered the steepest falls.

The most perplexing feature of the market, though, was the upward shift in yields for virtually all classes of property during 1995.

There are two possible interpretations. The yield shift could be a knee-jerk reaction by valuers to the unprecedented drop in yields which took place during 1993 and the first half of 1994.

If this is the case, it, should be a one-off movement. On a long-term view, though, property yields have been drifting higher for some years. The databank's figures show that yields have increased in 10 of the past 15 years. Only in 1993 and 1994 was there a significant decline.

The message from the marketplace could be that yields are still too low to justify a place for commercial property in many mixed-asset portfolios. This would explain why institutional investors were reluctant to commit capital to the market last year. It would also explain why property is dwindling as a percentage of overall portfolios.

But why should investors demand a higher yield from commercial property than they did a few years ago? Many fund managers argue that property investment is getting riskier. Leases are becoming shorter. Privity of contract, which protected landlords if their tenant failed to pay the rent, has been abolished.

There is also a greater understanding among. investors of the impact of depreciation and obsolescence on long-term investment returns. Many buildings are of doubtful residual value when the current lease expires.

Institutional investors are increasingly intolerant of the foibles of commercial property as a financial asset - high transaction costs, illiquidity, large lot sizes, management overheads. Sooner or later investors will conclude that property yields are high enough to compensate for these drawbacks and the gradual erosion of security of income. Legal & General, the life insurer, recently said it would increase its weighting in favour of commercial property on these grounds.

An equivalent yield of 8.2 per cent, the IPD year-end average, certainly looks seductive if one believes rental growth is around the corner. This is especially true at a time when bonds and equities look fully priced.

Looking on the bright side, then, last year's correction could lay the foundations for more institutional investment and higher total returns during 1996. Another year of disappointment would be serious indeed.