From the Federal Reserve Bank of New York's Liberty Street Economics blog:
The recent financial crisis—the worst in eighty years—had its origins in the enormous increase and subsequent collapse in housing prices during the 2000s. While the housing bubble has been the subject of intense public debate and research, no single answer has emerged to explain why prices rose so fast and fell so precipitously. In this post, we present new findings from our recent New York Fed study that uses unique data to suggest that real estate “investors”—borrowers who use financial leverage in the form of mortgage credit to purchase multiple residential properties—played a previously unrecognized, but very important, role. These investors likely helped push prices up during 2004-06; but when prices turned down in early 2006, they defaulted in large numbers and thereby contributed importantly to the intensity of the housing cycle’s downward leg.
Investors in the Housing and Mortgage MarketsVirtually everyone who buys a house is hoping for prices to rise, and most use leverage (debt)—in this case, a mortgage—to allow them to buy more housing than they can afford to pay for in cash. While the majority of borrowers have a consumption motive—as “owner-occupants,” they intend to live in the house—some borrowers own housing purely as an investment. As mortgage lenders have long known, investors are more likely than owner-occupants to walk away from an underwater property. So when a borrower acknowledges on the mortgage application that she won’t live in the house, the lender will typically require a higher down-payment and charge a higher interest rate to reflect the additional default risk. Within the category of real estate investors, some buy properties with the intention of renting them out, while others intend to simply “flip this house,” selling quickly and reaping a capital gain....MORE