Yield Differences Between Office Markets Along Time: Econometric Panel Analysis

Many European investment markets for properties have seen an enormous imbalance between demand and supply in the last years, causing a dramatic decrease in prime office yields until recently. Theoretically, the acceptance of generally lower yields can be explained by structural changes in investorsí behaviour, e.g. a shift in their preferences towards income-generating assets, and by the expectation of a cyclical upswing in the letting sector (lower vacancy risk, rental growth). Abstracting from the general trend, nevertheless the question remains unanswered in how far current yield levels are justified in each single property market. The application of econometric methodology is very effective in this context: It serves not only to test the theoretical hypothesis discussed in the literature, but as well is able to indicate on the base of forecasts (ex ante or ex post) if certain markets are overpriced or not. In the context of European markets, the use of panel methods proves especially suitable: Both the yield evolution in specific markets along time as well as the differences in national and regional yield levels can be investigated and explained within one single model at the same time. In the concrete case, such a panel model is derived on the base of time series data for over 30 European office markets. The estimation is based on a GLS specification using estimated cross-section residual variances to take into account cross-section heteroscedasticity. Prime office yields are explained by the achievable income returns of other assets, by the situation and perspective of the letting sector, by characteristics of the regional property market and by the institutional framework of the countries involved. Markets with a supposed mispricing of yields can be identified on the basis of econometric ex-post- or ex-ante-forecasts.