Examination of the rationality of real estate market pricing : focusing on the US office property market

Abstract

This study examines whether or not investors behave rationally when they price the U.S. office properties. After reviewing several previous studies on the market efficiency, this paper makes three new attempts: first, we employs the actual information on transactions and rents at the property level to resolve the substitution problems; second, we introduce another pricing method which use gross yields and typical cap rate method; lastly, Shiller Test with those actual data is conducted to determine whether future rental growth can be predicted by both or either of those two pricing methods. The major empirical results can be summarized into the two findings: 1) in the pricing models, the gross yield reflects a property's future rental growth, whereas the cap rate is mostly correlated to the relatively short-term rental growth in the past, 2) in Shiller Test, the future rental growth of a property can be forecasted by the gross yield, not by the cap rate. These findings suggest that although not perfect, investors of the US office properties, at least partially, forecast the future income of the investments, and reflect them into the pricings by means of gross yields rather than cap rates.