The Evolving Structure of Housing Markets: Institutional Investors and Their Influential Role During the Great Recession

When real estate markets undergo big changes, such as those brought on by unforeseen shocks, the underlying shift in property ownership can affect the behavior of home prices. Such was the case during the Great Recession, when institutional buyers stepped up their purchases of single-family houses and turned them into rental properties. Depressed home prices allowed institutions (also referred to as corporate buyers) to significantly grow their property holdings, thereby expanding their overall market share. But aside from simply becoming bigger, these buyers did something that would affect the trajectory of housing markets throughout the recession and beyond: They provided rental homes that generated enough demand to moderate the drop in underlying housing prices.

In his paper, “Institutional Housing Investors and the Great Recession,” National Economic Research Associates (NERA) Consultant Dick Oosthuizen shows that corporate buyers cultivated a specific advantage — in the form of lower operating costs — that helped them influence housing markets in a positive way, particularly when housing prices came under intense pressure.

To investigate how costs became an important factor in real estate outcomes, Oosthuizen designed a model that represents the rental house market as it traversed the Great Recession. His model accounts for the actions of investors and noninvestors alike (the latter being people who bought homes as a primary residence). Importantly, the model assumes that institutional investors achieve economies of scale — that is, that their real estate portfolios become big enough to absorb costs efficiently and maintain consistent profitability. What’s more, his model assumes that their purchases take place within the context of an open, competitive real estate market.

The model reflects real-world conditions across dozens of wide-ranging variables, accounting not just for different types of buyers but also for the mortgage terms they have access to, the property types they pursue, and the costs they incur. The model’s recreation of the housing bust features constraints — such as lower personal incomes, stricter mortgage standards, and higher mortgage origination costs — that directly inhibited mortgage markets during the recession. The concomitant drop in home prices is modeled as a drop in demand; to simulate the intensity of the market downturn, house values are lowered by 20 percent.

As noted above, the cost reductions achieved by institutions during the Great Recession are front and center in Oosthuizen’s study. The reductions, he writes, “increased…institutional investors’ market share of rental houses, which permanently lowered equilibrium rental rates.” Furthermore, “…the fall in rental rates increased (rental) housing demand,” helping to mitigate the broader fall in house prices.

In practical terms, Oosthuizen identifies cost reductions as the fall in operational costs associated with rental properties, such as money spent on physical upkeep, rent collection, and other core functions that property owners are responsible for. His model shows that relative to the costs incurred by other types of rental property owners, institutions enjoyed a significant drop in costs — a drop that continued for years after the housing bust. Consider, for instance, that the cost premium for institutional investors (measured as the difference between costs borne by institutions and costs borne by owner-occupiers) fell from 43.6 percent to 27.8 percent between 2001 and 2015.

As part of his analysis of institutional costs, Oosthuizen compares house price behavior within a cost-reduction scenario with a baseline scenario in which costs do not fall. “Notably,” he reports, “the house price falls less in the lower-costs case than in the baseline….” He concludes that the “corporate-cost reduction for houses stabilized the housing market during the Great Recession shocks.” The recession would have been worse, he calculates, if corporate buyers had not benefitted from such reductions: House prices would have fallen by an additional 1.64 percentage points.

Having shown how lower costs for institutions can temper the drop in house prices in the aggregate, the paper looks at outcomes at the household level. Which households are better off? Which fare worse?

The model reveals that the effects of lower corporate costs, when measured across all households (in total), generate net welfare gains as housing markets transition through the recession. The gains are especially visible among homeowners and mom-and-pop investors, who see their properties rise in value. (As the crisis wears on, renters also see benefits in the form of lower rental rates, although it takes time for these benefits to materialize.) The gains are not spread equally, however; indeed, for some households, lower corporate costs generate a net welfare loss. Younger mom-and-pop investors are in this category, because the decline in rental income (brought about by the lower rents implemented by cost-efficient corporate buyers, as noted earlier) more than offsets the rise in home prices. People who don’t own a home also suffer a net welfare loss because the higher cost of buying a home (likewise due to the effects of cost-efficient corporate buyers) overshadows the positive effects of a cheaper monthly rent.

Given the beneficial consequences of purchase activity carried out by corporate buyers, as reflected in the welfare gains that appear in his model, Oosthuizen notes a handful of implications for policymakers to bear in mind. For instance, regulations that limit the size of institutional investors might be misguided, especially when rental markets are fluid and competitive. Programs that promote homeownership might likewise be suboptimal “given the (welfare increasing) rise of the corporate…sector in [providing] rental houses during the Great Recession.”

The housing market model described in “Institutional Housing Investors and the Great Recession” shows that the drivers of real estate prices are not always visible. A close examination can reveal hidden pricing mechanisms. During the Great Recession (and for years thereafter), one such mechanism was employed by institutional buyers, who reduced their operating costs and grew their portfolios enough to provide a degree of support to home prices. These findings can inform policy decisions aimed at alleviating market downturns, and they can be used more generally as well, particularly when debating potential limits on the size of institutional investors.