Systematic Valuation Errors and Property Cycles: A Clinical Study of the Sydney Office Market

Working Papers Series #96-11

21 Pages Posted: 6 Feb 1997

See all articles by Patric H. Hendershott

Patric H. Hendershott

University of Aberdeen - Centre for Property Research; National Bureau of Economic Research (NBER)

Date Written: January 1997

Abstract

The cyclical variation in office construction, vacancies, rents and values over the last decade has been enormous throughout the world. Numerous hypotheses have been advanced for this enormity, including prolifigate lenders, egomaniacal developers, and even rational behavior in the face of uncertainly and long gestation periods. Our analysis of the Sydney office market suggests a major role for the failure of investors to understand the workings of property markets. Given the incentives of developers to build when value rises substantially above replacement cost and not to build when value is low relative to replacement cost, the property market has to be mean reverting. That is, when times are really good (low vacancy rates and high real rents), they can't continue, and the same is true when markets are really bad. Because Sydney investors did not incorporate this implied mean reversion into their forecasts of future cash flows, they over valued properties when vacancy rates were low and rents were high, thereby triggering excessive construction and vacancies. Of course, valuations obtained by simply "capping" current cash flows with a normal cap rate will not incorporate full mean reversion.

JEL Classification: G12, R32

Suggested Citation

Hendershott, Patric H., Systematic Valuation Errors and Property Cycles: A Clinical Study of the Sydney Office Market (January 1997). Working Papers Series #96-11, Available at SSRN: https://ssrn.com/abstract=580 or http://dx.doi.org/10.2139/ssrn.580

Patric H. Hendershott (Contact Author)

University of Aberdeen - Centre for Property Research ( email )

Aberdeen AB24 2UF
Scotland

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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