In comparison with the large literature on house prices, housing investments have been studied far less. This paper investigates the behavior of private residential investments for the six largest European economies, namely: Germany, France, Italy, Spain, the Netherlands and the United Kingdom. It employs a common modelling structure based on an error correction approach and country specific models. First, co-integration among the parsimoniously specified set of fundamental variables is detected in all countries. Second, cross-country differences are found in the responsiveness of private residential investments to real prices and to other relevant factors. Germany has the strongest response of private residential investments to house price changes whereas Italy shows the lowest responses. In Spain investments seem to be primarily related to their lagged component and short-term changes in house prices, and show a poor relationship with deviations from long-term fundamentals. In some countries, the lagged component of residential investments seems to point to a high persistency effect.

Private residential investment represents on average between 3% and 8% of GDP in the largest EU countries over the last 40 years. Despite its relatively small share of total expenditure, it is thought to be an important factor for business cycles because construction activity remains labour intensive (André, 2010). Additionally, housing investment responsiveness to prices is thought to play a key role in determining house price dynamics for both new and existing houses, which in turn are the most important assets in households’ portfolio and hence a source of wealth effects. Moreover, possible differences of adjusting the housing investments to keep pace with demand forces may provide one explanation for the divergent amplified responses of house prices to market conditions. Following this last point, differences across EU countries in house price dynamics, and possibly also in private consumption patterns, are sometimes attributed to structural differences in housing investments. Thus, for example, the relatively subdued dynamics of house prices in Germany over the last couple of decades (which are also thought to have affected private consumption) were believed to be partly linked to a more elastic housing supply compared to other EU countries (see also Swank et al., 2002). Similar arguments have been put forward in the US. For example Glaeser et al. (2008) propose a model in which US cities with more elastic housing supply have fewer and shorter house price cycles, than cities with smaller price increases.