July 5 (Bloomberg) -- Rising interest rates and declining profits from real estate are pushing investors to ditch European property stocks after a four-year rally.

The Bloomberg Europe Real Estate Index just completed its worst quarter in a decade and the stocks are still expensive compared with European averages. Robert Parkes, who advises pension fund managers as a strategist at HSBC Holdings Plc, said the stocks have further to decline.

``There's a lot of negative momentum and it will continue for a while longer,'' said Parkes, who is based in London. ``Why try and catch a falling knife?''

Increases in borrowing costs -- the Bank of England raised its benchmark rate for the fifth time in a year today -- will eat further into revenue from buying and renting property. At the same time, prices of offices and malls in locations such as London are predicted to start falling.

According to Steve Bramley-Jackson, an analyst at Credit Suisse, there's no ``bounceback'' in the shares on the horizon. The two biggest U.K. property companies, Land Securities Group Plc and British Land Co., have both slumped more than 20 percent this year, trimming about $8.5 billion from their combined value.

Metrovacesa SA, Spain's largest real estate developer, has fallen by a third. British hotel manager Vector Hospitality Plc in June pulled what would have been the biggest stock sale by a real estate company in Europe.

No Recovery?

The dividend yield, or what a company pays to investors as a proportion of its share price, is the lowest ever for real estate companies, according to JPMorgan Chase & Co. That suggests the stocks have more room to fall before they become a bargain.

The European Central Bank has raised its benchmark rate eight times since December 2005, to 4 percent, and signaled it is ready to lift it further to contain inflation. The ECB today left the rate unchanged, while the Bank of England increased its key rate to 5.75 percent from 5.5 percent, as predicted by all but seven of 60 economists surveyed by Bloomberg.

``We won't see a sustained recovery until people are confident interest rates are coming down,'' said Andrew Jackson, property investment director at Standard Life Plc's fund unit in Edinburgh. It oversees 14 billion pounds of assets including shops, offices, warehouses and property shares.

Stocks in the U.K. and Spain, the markets that led the boom, have been hurt most in the recent slump. Eight of the 10 laggards in the Bloomberg Europe Real Estate Index in the first half of this year were from those two countries.

Four Years of Gains

In the last four years, the Bloomberg Europe Real Estate Index beat every industry in the 500-member Bloomberg European 500 Index except steel producers. The real estate index tripled in the period, led by Madrid-based Metrovacesa and British Land, whose tenants in London include Swiss bank UBS AG.

The rally in stocks reflected the increase in prices for office buildings, malls, apartments and warehouses. In the U.K., annual returns on property investments -- that's the gain in the value of the real estate plus income from tenants -- were at least 18 percent for three straight years between 2004 and 2006.

The price of so-called prime property, such as London offices in Canary Wharf, may fall as much as 8.5 percent over 2008 and 2009, HSBC said on June 29. Top shopping malls may slump as much as 13.5 percent in that period as rents stagnate, he said.

``These stocks are not going to find buyers until there has been some correction in property prices themselves,'' said Daniel Broby, chief investment officer at Renaissance Investment Management in London, which oversees about $4 billion.

Tempting Value?

The drop in stock prices means European property companies trade on average at a market value equal to only 4 percent more than what their holdings are worth, the lowest in at least two years, according to JPMorgan.

Shares of Land Securities, the third-worst performer in the benchmark FTSE 100 Index in 2007, traded at 24 percent less than the value of its properties at the end of June. The so-called discount was 2 percent at the end of 2006.

That makes Land Securities a tempting investment, said fund manager Ben Ritchie.

``Valuations of some of these U.K. stocks look exceptionally attractive,'' said Ritchie, who helps oversee $6 billion at Aberdeen Asset Management Plc in London. ``If you are not buying at that sort of discount, you should be packing up and going home.'' Richie said he bought more Land Securities shares in June.

Standard Life, Scotland's biggest money manager, bought shares of Great Portland Estates Plc, Jackson said. Shares in the company, which focuses on office buildings in central London, have fallen 19 percent from a record on April 11.

`All Bets Are Off'

The shares of only two of the 20 companies in the Bloomberg Europe Real Estate Index have risen this year. Meinl European Land Ltd., an Austrian company that invests in eastern Europe, has gained 8.7 percent and Unibail-Rodamco is up 1 percent.

Unibail-Rodamco, Europe's largest real estate company, is the result of Unibail Holdings SA's acquisition this year of Rodamco Europe NV, Europe's largest shopping-center owner.

With that backdrop, some companies were forced to abandon plans to sell shares to the public or cut prices.

Vector, a U.K. company planning to buy 71 hotels, was one of five planned initial public offerings by real estate companies that were pulled in June. The five were trying to raise as much as $6.5 billion combined, adding to the $8.5 billion of IPOs that have flooded the market so far this year.

Spanish developer Realia Business SA sold shares for 6.50 euros each on June 5, below the guide range of 7.90 euros to 9.70 euros. The shares since slumped as low as 6.11 euros.

``All bets are off for IPOs,'' said Patrick Sumner, head of real estate securities at Henderson Group Plc in London.

The collapse of Vector's IPO may stunt the U.K. real estate investment trust market just six months after it was created. U.K. real estate stocks rose 46 percent in 2006 in anticipation of the introduction of REITs on Jan. 1 this year. They allow companies to pay little or no tax in return for paying out almost all their income as dividends to investors.

``The glory years for property stocks are over,'' said Harm Meijer, an analyst at JPMorgan in London who cut his rating for real estate shares. ``It could last for years.''

To contact the reporter on this story: Peter Woodifield in Edinburgh at pwoodifield@bloomberg.net.

Last Updated: July 5, 2007 07:55 EDT