Investor Rationality: Evidence from UK Property Capitalization Rates

Abstract

Recent analyses have suggested the irrationality of investors in Australian and U.S. office properties. More specifically, investors have failed to raise capitalization rates sufficiently at rental cyclical peaks to account for the obvious mean reversion in real rents and thus have significantly overvalued properties. In this paper we analyze the determination of UK office and retail capitalization rates and provide evidence that these rates reflect rational expectations of mean reversion in future real cash flows. Moreover, these rates are linked to capitalization rates (dividend/price ratio) and expected dividend earnings growth as expected.