The M25 office market has experience increased investor interest and seen headline rents stabilise in the third quarter of the year according to Knight Frank.

In its M25 third quarter research report, the firm said that a shortage of properties to buy had caused yields to fall 25 basis points to 7.25%.

Knight Frank said that competitive bidding on prime assets from institutions has seen some properties exchange at yields more than 100 basis points lower than the initial quoting price.

Investment volumes increased by 3% on the previous quarter.

However, the total transactions over the second and third quarters combined have reached £466m, which is more than double the level of transactional activity in the previous two quarters.

Tim Smither, investment partner at Knight Frank, said: ‘We have continued to see yield compression for prime assets driven by a wall of money looking for exposure into South East offices, coupled with an increasingly thin supply of stock coming to the market.

‘We believe that this trend will continue over the short term, as buyers seek further exposure and funds withdraw sales as they become net buyers.

‘This is decoupled from the secondary markets, where pricing remains difficult and hold costs and refurbishment costs remain punitive.’

In the occupational market, take-up in the third quarter was 361,468 sq ft – a small 2% increase on the previous quarter’s level – but 38% below the third quarter 2008 total.

It also remained in line with Knight Frank’s forecast for total take-up in 2009 of around 1.5m sq ft - less than half the annual average.

However, it reported ‘a significant improvement’ in the level of tenant requirements being seen in the market, and said that take-up should recover gradually over the next 18 months as the economic outlook improves.

Emma Goodford, head of south east office leasing at Knight Frank, said the level of take-up and latent demand indicated that the bottom of the market has been reached.

‘We can begin to look forward to a gradual rise in lettings activity, accelerating by the latter half of 2010 as the economy recovers.

‘We can forecast that with prime headline rents showing clear indications of stabilising and incentives close to peaking, occupiers will need to move quickly if they are to grab a bargain.

‘There are now reasonable prospects for a return to positive rental growth later next year, albeit restricted to those towns where Grade A supply is tight relative to average demand.’

Goodford added that in some tightly supplied towns there was now a case to be made for speculative development again in ‘the not so distant future’ if the banks are prepared to finance it.