Comparing expected investment returns with recorded market prices: A Study of the UK Office Market 2000-2016

Investor expectations for commercial property returns are formed by a number of exogenous and endogenous factors. These expectations can change rapidly and will reflect pricing, current and predicted, of alternative asset classes and fundamental economic variables including interest rates and inflation. In order to create an estimated figure for expected returns, many investors have adopted a risk premium approach that compares existing and anticipated property prices with the yields available from investing in a pre-defined ‘risk-free’ asset class such as government bonds.The proposed paper develops a model that that provides a framework for deriving contemporaneous expected returns for a range of investor types and then compares those expected returns with transaction prices achieved in the UK office market between 2000 and 2016. The major aim of the paper is to pinpoint mispriced markets, principally by identifying periods where market pricing that is defined by actual transaction prices has not caught up with substantial movements in expected returns. The paper utilises transactions based data so the issues surrounding the use of transaction data as opposed to valuation based figures are considered. In addition, a number of concepts that relate to the design and construction of the model are explored.