As banks and hedge funds increasingly seek new ways to shore up balance sheets in the wake of the credit squeeze, property derivatives have emerged as a lucrative way of bolstering returns.

In the UK, which has the most developed market in the world, commercial property derivatives are expected to see volumes rise to £8.5bn - a 20 per cent jump since June - when new figures are published next week.

Michael Levi, head of property derivatives at CBRE-GFI, a joint venture between broker GFI and property group CB Richard Ellis, which is now a leading broker in property derivatives, said: "People are using property derivatives very effectively now. Despite the credit crisis, we have seen a lot more participants in the past few months.

"The banks are increasingly active. Hedge funds are starting to get involved too. Users see it as a good way to get exposure in a market that has a very cumbersome underlying product."

Property derivatives enable banks and funds to bet on the price movements of commercial property without having to buy the actual bricks and mortar.

The contracts tend to be swaps, with one party betting that property returns will outperform a set benchmark, such as the London Interbank Offered Rate (Libor), while the other bets that it will not.

The products may attract even more interest in light of the Bank of England's warning this week that the commercial property sector was "particularly prone to further shocks".

The reason the UK has been successful in developing the market is down to the quality of the data used for trading from the Investment Property Databank.

In the US, which has seen worthwhile volumes only since March, the market is growing fast, with an estimated $500m in trades compared with a meagre $50m at the start of the year. France and Germany have also seen the first trades in these derivatives this year.

In the UK and the US, the turn in the underlying market has encouraged growth. The UK saw the first fall in total returns for 15 years in September while in the US growth has slowed from the peaks of last year.

Doug Poutasse, executive director at the National Council of Real Estate Investment Fiduciaries, which provides data for the US market, said: "There has been a lot of activity in commercial property derivatives in the US recently as people think the market could go in another direction. When the market was at the highs, there was only one bet - everyone wanted to go long but now we have some participants wanting to go short and that helps to make a market."

Ben Hyam, a property derivatives broker at CBRE-GFI, said: "With derivatives volumes, it does not matter if the underlying market goes up or down. In fact, in the UK, it may help derivatives volumes now the underlying prices are falling."

Ian Cullen, founder of the IPD, said there had been indications of strong activity in the UK, too. "The market has grown dramatically in the UK since 2004. It is also significant that there is now trading in France and Germany as more banks and funds want exposure to continental Europe," he added.

The IPD will release third-quarter volumes for the UK, France and Germany next Thursday, with expectations that the cumulative total of trades will rise to £8.5bn in the UK and about £1.5bn in France and Germany. The UK market was worth only £260m at the start of 2004.

In the UK, 20 banks are now licensed to use the IPD data to trade, with seven - Abbey National, BNP Paribas, Calyon, Commerzbank, HSBC, Morgan Stanley and HSH Nordbank - gaining licences this year.

A number of hedge funds have also launched this year with the specific purpose of trading property derivatives, including the Iceberg Alternative Real Estate Fund, which will invest across Europe.

In the US, eight banks are active in this arena since the effective launch of the market in March, when four were given licences to use data from the NCREIF.

Jason Liddell, a property derivatives trader at Merrill Lynch in New York, said: "Activity in property derivatives has been building fast since the major banks became involved in the market in the spring."

Other markets are opening up in Australia and Hong Kong, which saw its first trade in February this year.

However, it is in the US where traders see huge potential.

The underlying commercial property market is estimated at $6,000bn compared with an underlying market in the UK of $800bn, although the quality of the US data is not of the calibre of the UK because the number of properties tracked by the NCREIF is much smaller in percentage terms than that by the IPD.

Residential derivatives can also be traded in the US, unlike the UK where there has been little appetite so far to develop this market. But the US residential derivatives market is also very small, with most investors focusing on the commercial sector. The latter should be boosted further by the launch of an exchange-traded platform on the Chicago Mercantile Exchange on Monday.

Mr Levi said: "The launch of the CME platform should encourage growth. It may take time before the platform is widely used but it certainly should help the market.

"When you consider the size of the underlying market in the US, then this is a product that could really take off in the States."