The Role of Liquidity In Forecasting Office Yields In Europe

The impact of the global financial turmoil and the sovereign debt crisis on the volume of investment transactions has been well publicized. A prominent trend has been the volatility and shifting pattern in investment flows in European investment markets post 2008. This volatility in investment activity levels, which is hardly surprising given the Eurozone woes, has been reflected in pricing which also exhibited significant variation. Capital flows or investment turnover reflect investor sentiment and impact on risk premia. A key research question is to assess the incremental impact of fluctuating turnover volumes on office yields.Existing global research to study yields builds on theoretical frameworks that incorporate economic factors, financial series and fundamentals in the real estate market. Further, this body of research explains yield movements utilising a host of other factors. These include market transparency, currency risks if not hedged, financial risks, lease structures and property rights à with the list of such factors being more extensive. However, the high volatility in real estate prices and yields in the last five years directs our research attention to investor confidence and sentiment as causes of rapid yield/price adjustments. This guides the setup of our empirical investigation which takes part into two stages.In the first stage a model is built aiming to capture yield movements. This model needs however to be strongly responsive to allow for quick adjustments in yields, which was the case in the period 2007 to 2010. In the second stage the model is augmented to accommodate cross border capital flows. These models are estimated with data from major European office centres.The contribution of the study is threefold. First, the study sheds further light into the determination of European office yields. Second, it identifies the factors which have more immediate effects on yields and are more appropriate to explain their short-term fluctuations. The third implication of the study is deemed the most important one. It quantifies risks for the current office yields in Europe that can arise from the economy and reversals in investment turnover.