Institutional investors and house price growth
Published as part of the Financial Stability Review, May 2023.
The presence of institutional investors, particularly investment funds, in euro area residential real estate (RRE) markets has increased markedly in recent years. This growth may be attributed to a range of factors, including persistent flows into riskier asset classes such as real estate over the prolonged period of low interest rates (Chart A, panel a).[1] Yet the implications for housing markets, as well as for financial stability more broadly, remain largely unstudied. This issue is becoming more pressing as the real estate cycle turns and as rising interest rates reverse the dynamics of flows into real estate funds. It also raises concerns that vulnerabilities in the investment fund sector may amplify any real estate market correction.[2] This box provides an initial empirical examination of the role of institutional investors in euro area RRE markets and the possible implications for financial stability.
Fluctuations in the demand from institutional investors for RRE assets are associated with changes in house prices. Purchases of euro area RRE by institutional investors are linked to changes in house prices between the first quarter of 2007 and the fourth quarter of 2021 in an empirical framework which also includes policy interest rates and variables to capture wider demand and supply dynamics in RRE markets. The results from the model suggest that a positive (negative) demand shock from institutional investors has a positive (negative) and persistent impact on RRE prices (Chart A, panel b).[3] Specifically, a one standard deviation increase in investor demand is associated with an increase in house prices of about 0.4%. It is also followed by an increase of 0.2% in mortgage lending, suggesting that there may be spillovers between the non-bank financial sector and bank activity in RRE markets. The model also shows that a tightening (loosening) monetary policy shock is associated with a drop (increase) in institutional investors’ demand for real estate.
Chart A
Increasing demand from institutional investors may be associated with rising euro area house prices and mortgage volumes
The link between local economic fundamentals and house price growth appears to weaken in regions with a greater presence of institutional investors, which may reinforce the build-up of financial vulnerabilities. The importance of institutional investors varies greatly across the euro area and is concentrated in certain countries and regions (Chart B, panel a). Regions in which institutional investors have limited presence are characterised by a clear positive link between local wage growth and house price growth (Chart B, panel b). This relationship weakens as the presence of institutional investors increases, while house price growth is typically also higher in such regions. During periods of high investor demand and low wage growth, this may support certain RRE markets but the disconnect between local economic fundamentals and house prices may also contribute to overvaluation. Regions with a strong presence of institutional investors may, therefore, be more vulnerable as investor demand falls and the cycle turns.
Chart B
Institutional investor presence varies across regions and can weaken the link between economic fundamentals and house price growth
Institutional investments made via real estate investment funds may amplify the RRE cycle, which raises the importance of developing policies to reduce structural vulnerabilities in such funds. Real estate investment funds play a prominent role among institutional investors. They are subject to a structural liquidity mismatch when they offer daily redemptions to their investors while holding illiquid real estate assets. This makes them particularly vulnerable to the effects of large-scale investor redemptions, which could lead to reduced demand or forced asset sales by funds. Where this results in further real estate price corrections and subsequent additional redemptions, adverse feedback loops can develop, amplifying the initial RRE market shock and its implications for the financial resilience of banks, households and exposed firms. Policies aimed at enhancing the resilience of real estate investment funds could include liability-side measures to reduce liquidity mismatch, such as lower redemption frequencies, longer notice and settlement periods, and longer minimum holding periods.[4]
See the box entitled “Explaining cross-border transactions in euro area commercial real estate markets”, Financial Stability Review, ECB, November 2019; Giuzio, M., Kaufmann, C., Ryan, E. and Cappiello, L., “Investment funds, risk-taking, and monetary policy in the euro area”, Working Paper Series, No 2605, ECB, October 2021; “The rise of non-bank financial intermediation in real estate finance: Post-COVID-19 trends, vulnerabilities and policy implications”, OECD, 2021; Schnabel, I., “Monetary policy and inequality”, speech at a virtual conference on “Diversity and Inclusion in Economics, Finance, and Central Banking”, 9 November 2021.
Amplification effects particularly depend on the prevalence of open-ended real estate funds, which varies across countries.
Structural shocks are identified with zero and sign restrictions. We identify household demand shocks and housing supply, as well as mortgage supply and monetary policy shocks. We distinguish between an institutional investors’ demand shock and a households’ preference-driven demand shock by the different reactions of mortgage lending volume and mortgage lending rates, relying on the assumption that institutional investors do not take out mortgages to finance their purchases. Moreover, we distinguish between the demand from investors and an income-driven demand shock by households by the different reaction in household incomes.
See also the article entitled “The growing role of investment funds in euro area real estate markets: risks and policy considerations”, Macroprudential Bulletin, ECB, April 2023.