Efficiency in the United Kingdom Commercial Property Market: A Supply Perspective

Informational efficient prices are a necessary requirement for optimal resource allocation in the commercial real estate market. Prices are informational efficient if they reflect buildings' benefit to marginal buyers, thereby taking account of all available information on future market development. Prices that do not reflect available information may lead to over- or undersupply if developers react to these inefficient prices. In this study, we examine the efficiency of the UK commercial property market and the interaction between prices, construction cost, and new supply. We employ a dataset in our study that relates to the City of London office market over the period 1972-2011. First, we assess if real estate prices are in accordance with fundamental values, thereby testing for informational efficiency. By comparing prices and fundamental values, we can measure informational inefficiency and explore possible causes for it. Second, we assess if developers reacted correctly to the price signals. Development (or the lack thereof) should be triggered by deviations between fundamental values and cost; if prices do not reflect fundamental values, then they should have no impact on development decisions. We study empirically whether or not this was the case in what is commonly held to be one of the most mature and transparent real estate markets in the world.