Working Paper Series no. 626: Real estate prices and corporate investment: Theory and evidence of heterogeneous effects across firms

In this paper, we estimate the effect of real estate prices on productive investment (i.e., machines, equipment and intangible assets), focusing on potential heterogeneous impacts depending on the composition of the firms' assets. We first formalize the link between real estate prices and productive investment in a context where credit markets are frictional thanks to a partial equilibrium model, we then bring our theoretical predictions to the data to show that an increase in local real estate prices hinders the investment of firms that do not benefit from a collateral channel.

From the late nineties to the financial crisis, real estate prices in many advanced countries have experienced a boom, unprecedented in size and duration. This has led to question the impact of this boom on productive investment. In countries where a bust has followed the boom like Spain, the adjustment revealed a significant capital misallocation and led to a rebalancing towards the exporting sector (Cette, Fernald and Mojon, 2016). On the contrary, in France, real estate prices did not correct significantly and remained higher than in the nineties relative to consumer or equipment prices. Yet, France is also subject to questioning about the impact of the real estate prices boom on sectoral allocation and on productive investment (Askenazy, 2016): did the real estate boom alter the allocation of investment towards less productive sectors or firms?

The literature has focused so far on the collateral channel that connects real estate prices to productive investment. In an imperfect credit market, collateral pledging enhances the firms' borrowing capacities. The ability of the lenders to seize pledged collateral increases the debt capacity of the borrowers as it mitigates the agency problem in this external financing relationship. The extent to which the borrowing constraint is relaxed by collateral pledging depends on the collateral liquidation value.

In these empirical studies, real estate prices are regarded as mere shifters of the pledgeable assets' value which determines the borrowing capacities of firms. Yet, an increase in real estate prices surely raises the value of the pledgeable assets and mitigates the agency problem but it simultaneously lowers the profit due to the increase in the cost of inputs.

In order to formalize the causal impact of real estate prices on productive investment, we propose a simple partial equilibrium model of investment subject to a credit rationing that results from moral hazard and where real estate assets are both pledged and used as an input in the production process. In this model, a representative firm optimally chooses its level of investment subject to an endogenous borrowing constraint that is derived from the incentive compatibility (between the lender and the borrower) and the lender rationality constraints. When the endogenous borrowing capacity is binding, we show that the sign and the magnitude of the effect of real estate prices on investment are determined by the volume of real estate holdings of the firm. When prices increase, firms owning few real estate assets suffer from a negative profit channel without significantly benefiting from a positive collateral channel; conversely, firms owning more real estate assets face a less stringent profit channel and amply benefit from the collateral channel.

We use a large French firm database to confront these predictions with the data. France is a particularly relevant case to test these theoretical predictions as it experienced both a very steep, and yet uncorrected increase in real estate prices.

We contribute to the existing literature by showing that the sign and the magnitude of the effect of real estate prices on productive investment are driven by real estate holdings. We notably show that real estate prices have heterogeneous effects on productive investment depending on the position of the firms in the 2-digit sectoral distributions of a normalized measure of real estate holdings (see the graph presented above). We find a negative impact of an increase in real estate prices on productive investment at the bottom of the distribution, while the effect is highly positive at the upper end of the distribution. Our preferred estimates indicate that a 10% increase in real estate prices causes a 1% decrease in the investment rate of firms in the first decile of the distribution but a 6% increase in the investment rate of firms belonging to the last decile. Our empirical results also suggest that the impact of an increase in real estate prices on aggregate productive capital is positive. The documented heterogeneous effects across firms could link real estate prices dynamics to suboptimal allocation of inputs.