Modelling the asymmetric behaviour of property yields: evidence from the UK office market

Abstract

This paper examines the determinants of UK office market yields and their relative importance depending on overall monetary and financial conditions, with special attention given to the role of macroeconomic liquidity. To do so, we rely on a standard linear model as well as on non-linear one that allows for a transition between two possible regimes of liquidity conditions – accommodative or tight – both models accounting for possible trend reverting behaviour. The results of the study provide new insights to the discussion on property yield modelling. Whatever the type of modelling, linear or not, we find that in addition to its traditional drivers – notably risk-free interest rate and expected rental growth – money supply is a key factor of property yields. Moreover, depending on the evolution of the ratio of M2 to GDP, property yields evolve according to two regimes; in the one depicted as a normal liquidity regime, the property yields dynamics mainly obeys an error correcting mechanism which tends to counter excessive discrepancy between property yields and their fundamental value deduced from a Present Value type model, while in the second one, this mechanism is dominated by the impact of money supply growth which can induce increasing movements in the property prices, possibly turning to bubbles.