Abstract

Informational efficient prices are a necessary requirement for optimal resource allocation in the 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 office market and the interaction between prices, construction cost, and new supply. We collate a dataset for the City of London office market that includes information on price multipliers (1 / yield) and their theoretical determinants, as well as on office supply, and employ this in our study. 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 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, in theory, they should have no impact on development decisions.