Valuation accuracy and spatial variations in the efficiency of the property market

Purpose – The purpose of this paper is to address the variation of efficiency of local office markets. It has long been argued that as data in the property market are based on valuations, it has a tendency toward smoothing or stickiness. The accuracy of valuations is shown to be partially dependent on local variable factors such as the extent of information, the variability of local cycles and the heterogeneity of the stock. This paper assesses the efficiency of local office markets in nine cities of the UK by estimating unsmoothed annual time series of rents and returns and comparing with the original valuations.

Design/methodology/approach – The paper uses an econometric approach to identify true unobserved returns from observed smoothed data. It uses desmoothing techniques and compares the volatility of smoothed and desmoothed underlying returns. It then looks for autocorrelation over time in the errors where the presence of autocorrelation rejects the assumption of market efficiency.

Findings – Examining, regional city office markets, the results suggest that financial centres have the least efficient markets because of their high level of variability. Other provincial cities are characterised by weak-form efficiency. Market cyclicality is found to be a key factor affecting valuation accuracy.

Research limitations/implications – Research in regional markets is often constrained by shortness and low frequency of time series observations. This limits the analysis and the ways in which it could be developed. Issues also relate to the method of desmoothing adopted.

Practical implications – Key financial centre are found to be less efficient markets than other cities. Thus, price changes fully embody all previous information in regional centres but not in London or Edinburgh. Periods of significant cyclical volatility tend to cause valuation inaccuracy and pricing problems.

Social implications – There are spillovers from inefficiencies in property market pricing that can affect other sectors of society directly (through increased costs) or indirectly (by contributing to macroeconomic cyclicality).

Originality/value – This is the first paper to explicitly consider the efficiency of regional city office markets and to identify the true unobserved returns series in each city office market. Its findings, perhaps unexpectedly, suggest that most regional city office markets are more efficient at processing pricing information than London.