Rational Expectations? A Time-Series Analysis of Building Booms in the London Office Market

Expectations of future market conditions are generally acknowledged to be crucial for the development decision and hence for shaping the built environment but there appears to be no consensus in the literature on what exactly constitutes rational behaviour of individual developers. This paper outlines the rationality conundrum that developers face when trying to anticipate their competitors’ knowledge and behaviour. Keeping in mind these limitations, we then test empirically for evidence of rational versus adaptive and naive expectations in the Central London office market from 1987 to 2009. Applying VAR models and a recursive OLS regression with one-step forecasts, we do not find evidence of adaptive and naïve expectations of developers. Although the magnitude of the errors and the length of time lags between market signal and construction starts vary over time and development cycles, our results confirm that developer decisions are explained to a large extent by contemporaneous and historic conditions in both the City and the West End but this is more likely to stem from the lengthy design, financing and planning permission processes rather than adaptive or naive expectations