Property Capitalization Rates and Investor Rationality in Stockholm

Abstract: We have established that real rents for office contracts in the Stockholm Central Business District are mean reverting. Do investors realize that mean reversion actually exists and have they managed to incorporate this development into capitalization rates? In order to examine this question we have applied a model constructed by Hendershott and MacGregor to Swedish property data linking property capitalization rates to both future real rental growth and the stock market. We have also included a qualitative section linking the results of our model to actual events on the property market. The most prominent results of the model is the significance and importance of proxies for expected growth in real rents and dividends reflecting mean reversion in the time series. Our results are mainly in line with those of Hendershott and MacGregor and even though our empirical model is based on fairly simplistic assumptions, it gives some support to that capitalization rates in the Stockholm CBD reflect rational expectations of mean reversion in future rents.