Journal of Real Estate Finance and Economics, 21:2, 185±201, 2000
# 2000 Kluwer Academic Publishers. Manufactured in The Netherlands.
Market Ef®ciency and Rationality in Property
Manchester School of Management, University of Manchester Institute of Science and Technology,
Manchester M60 1QD, United Kingdom
This article applies the present-value model to investigate property market ef®ciency in the United Kingdom. The
existence of ``rational bubbles'' in the U.K. property market is ruled out at conventional statistical signi®cance
levels, though the U.K. property market appears not ef®cient. In addition, there are variations among the of®ce,
retail, and industrial property markets. The rejection of the present-value model implies a price discovery
mechanism may exist for property investment.
Key Words: present-value model, bubble, market ef®ciency
The issue of property-market ef®ciency has recently attracted increasing attention in both
academic and professional research. Market ef®ciency, as empirical work primarily on the
stock market, has a number of dif®culties in its applications in the property market. First, it
is limited by the availability of data to carry out tests on the proposed hypothesis. Second,
the valuation methods of the property profession are not usually based on modern
economic and ®nance theory from which the ef®cient market hypothesis emerged. Both
the concept and research framework of market ef®ciency may not ®t into those for
property, and there may be some problems in communication. As a consequence, although
research on property-market ef®ciency has been developing in recent years, it is far from
comprehensive, compared with a vast literature on stock-market ef®ciency.
This article applies the present-value model to test whether expectations are formed
rationally in the property market and whether the property market is ef®cient in the United
Kingdom. It involves the fundamental relationships between value and income, which
amounts to testing the cointegration hypothesis and, furthermore, the restrictions on the
parameters re¯ecting these relationships. It differs from most of the recent studies in U.K.
property-market ef®ciency, such as Wang and Matysiak (1994), Barkham and Geltner
(1995), Lizieri and Satchell (1997), and Wang, Lizieri, and Matysiak (1997). These studies
all adopt a cointegration and Granger causality framework to investigate either the
relationship between direct property investment and indirect property investment
(investment in property companies shares) or regional rental movement patterns. In all,
these studies emphasise the signaling in the market. In this article, we pay attention to the