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By Aditya Jain ’19
Professor Stijn Van Nieuwerburgh is the Earle W. Kazis and Benjamin Schore Professor of Real Estate and Professor of Finance at Columbia University’s Graduate School of Business, which he joined in July 2018.
His research lies in the intersection of housing, asset pricing, and macroeconomics. One strand of his work studies how financial market liberalization in the mortgage market relaxed households' down payment constraints, and how that affected the macro-economy, and the prices of stocks and bonds. In this area he has also worked on regional housing prices, households’ mortgage choice, commercial real estate price formation, the impact of foreign buyers on the housing market, and mortgage market design. Professor Van Nieuwerburgh has published articles in the Journal of Political Economy, American Economic Review, Econometrica, Review of Economic Studies, Journal of Finance, Review of Financial Studies, Journal of Financial Economics, and the Journal of Monetary Economics, among other journals. He is Editor at the Review of Financial Studies. He is a Faculty Research Associate at the National Bureau of Economic Research and at the Center for European Policy Research.
He has served as an advisor to the Norwegian Minister of Finance and has been a visiting scholar at to the Central Bank of Belgium, the New York and Minneapolis Federal Reserve Banks, the Swedish House of Finance, the International Center for Housing Risk, and has contributed to the World Economic Forum project on real estate price dynamics.
Professor Van Nieuwerburgh was awarded the 15th Edition of the Bérnácer Prize for his research on the transmission of shocks in the housing market on the macro-economy and the prices of financial assets. The Bérnácer Prize is awarded annually to a European economist under the age of 40 who has made significant contributions in the fields of macroeconomics and finance.
Could you tell me more about your involvement in founding the Center for Real Estate Finance Research (CREFR) at NYU, and the work that the Center does? Can you share some of your experiences that led you to create the center, and the journey so far?
The CREFR at NYU Stern is the NYU counterpart to the Milstein Center at Columbia. It is responsible for research, teaching, and outreach in the real estate arena. At Stern, the real estate program was offered in the undergraduate and the MBA programs, and grew to include over 600 students and 6 courses over the past 6 years. CREFR also provided Excel and Argus valuation training, a real estate boot camp, an Executive in Residence series where a CEO visited campus about once a month and a mentorship program connecting MBA students and alumni.
The Center also held two large conferences each year. So, over my tenure, I have organized over 20 conferences bringing together thought leaders from academia, business, and policy circles. We always tried to come up with innovative ways to address new topics. Early on we had sessions on crowd-funding in real estate and co-working spaces. More recently, we covered disruptions in the retail industry and the implications from online retail on all players from suburban malls to urban shopping centers. Most recently, we spoke about infrastructure and its connection to real estate. The Trump administration has initially suggested that they would roll out plans for major infrastructure updates in the US, and so we thought about what lessons we could learn from major infrastructure projects like the Panama Canal, the Second Avenue Subway in New York City, etc. During that conference, I interviewed Stephen Ross, the founder of Related, about Hudson Yards. I am proud of the work I did at CREFR in building from the ground up a community of students, alumni, and industry captains around one of the major industries in this city an in the world. Now that I have left NYU, I am no longer a part of that Center, but my hope is to contribute to the Milstein Center in a similar capacity.
We’re also very glad to have you here at Columbia, where I understand that you will be teaching a PhD and MS Finance class on Empirical Asset Pricing. What conclusions do you hope students take away from this course?
Yes, this year I will be teaching the Empirical Asset Pricing course, and next year I plan to teach the introductory Real Estate Finance course in the MBA program. I think Real Estate Finance is a great course for a full-time faculty member to teach, because it is a foundational course, and will allow me to get to know the students early in the real estate program.
Empirical Asset Pricing is a modern asset pricing course which tries to bring students all the way to the frontier of investment research. We cover all major asset classes: equities, government bonds, corporate bonds, commodities, currencies, and of course real estate. The class covers modern research methods for analyzing return data. One point of focus is to take into account the special role of financial intermediaries, such as investment banks, broker-dealers, insurance companies, and other large institutions in the asset price formation process. The audience has PhD students who plan to engage in research themselves going forward, and one of the hardest things is to make the transition from being a student to an independent thinker. This course should help the students bridge that gap.
So, it sounds like you are blending a lot of theory with practice, while teaching students how to frame the right questions, collect data, run analyses…
Yes, we teach students what data is out there, what techniques and tools the best researchers use to analyze this data, and what the most important unanswered questions are. It’s an ambitious agenda! For example, my class next week is all about how machine learning techniques are used for predicting why some stocks are better than others. There are dozens of papers being written right now in academic finance on the topic. Ever since Fama & French documented the empirical failure of the CAPM in the early 1990s, the number of factors that have been shown to predict stock returns has grown rapidly, to the point where now people call this the “Factor Zoo.” There is a concern that not all these factors are important, some factors only work in a specific sample and are cherry picked, factors that worked in the past may not apply in the future. So, we need to work on cleaning out the “Factor Zoo” and identifying the factors that robustly correlate with future returns. The machine learning toolkit is great at this.
I am an Editor at one of the top three finance journals called the “Review of Financial Studies”, which is running a conference on Machine Learning Techniques in Empirical Finance at the University of Chicago’s Booth School. We plan to publish a special issue, and received over one hundred papers on this topic from dozens of researchers. This is one of the hottest topics in finance right now.
Speaking of factor models, I’d like to refer to one of your papers on REITs which was recently published. You mention that the implied growth rate of certain REIT sectors is very high, causing REITs to be overvalued. You also built a five-factor model for this. I’m curious, recently we’ve seen a decline in share prices of retail REITs. Has the market now priced these correctly, or is the decline for a completely different reason (such as the rise in e-commerce) meaning that there is more room for share prices to fall?
The paper asks how we justify the high REIT share prices we have seen after the financial crisis, from end 2009 to end 2016. One natural hypothesis is that over this period, the Fed has run an incredibly loose monetary policy. Interest rates were essentially zero for a long time. Mortgage rates for commercial loans were and continue to remain very low by historical standards. Low interest rates is a first candidate explanation for the historically high valuation rations in the REIT market.
However, the cost of capital does not just consist of short term interest rates. It also includes a risk premium, which I can measure using the five factor model. I found that risk premiums have been steadily rising over the past 7 years. So, REITs have actually become riskier. The CAPM beta of REITS has risen. Even more salient, the interest rate risk for REITs is now at an all-time high (as of end of 2016). The cost of capital has remained flat, due to the decline in interest rates and the increase in risk premiums which just about cancel each other out. Therefore, the cost of capital for REITs has been about average over the post-crisis period and cannot explain the above-average REIT prices.
My paper argues that the only logic alternative explanation is that market must be pricing in a very high cash-flow growth rate. I use a simple present-value relationship to back out the implied growth rate which justifies the prices of these REITs. I find growth rates as high as 15-20% per year. The conclusion is that the market was frothy as of end-2016.
This brings me to your next question, the decline in retail REIT share prices in 2018. Well, the rise of online retail is a very important part of that. A lot of malls in the US are economically obsolete, and as retail usually commands much higher rents than industrial space, converting these malls into warehouses would dramatically lower the rents. So, somebody has to take a large loss. We are just at the beginning of this process of converting retail to other uses, so I foresee large write-downs in these assets.
More broadly, I feel that we are at the peak of a stock market expansion, and the most likely direction from here is down. I believe prices have further to fall, not just in retail or in REITS, but across the board in all asset classes.
And when do you expect this to start happening?
Well, economists do not like to give specific time horizons, so I will not give such a proclamation! The way to think about it is in terms of vulnerability. The US economy and in fact the world economy is vulnerable right now. If there was a shock, we would see a correction. Vulnerability means there is a larger chance of a shock doing harm to the economy and the market. The housing market is safer than it was compared to the previous recession, but the shock could come from anywhere such as a political crisis, a trade war, a default wave in corporate credit or in the commercial real estate sector.
Very interesting. I’d also like to discuss your paper “Are Mutual Fund Managers Paid for Investment Skill?” Over the past decade, we have seen a continued decline in fees that active managers can charge, and there are more zero cost funds out there as well. Instead of focusing on individual stock picks, managers are going after broad ETFs and sector plays. Is this a trend you foresee continuing, and can active asset managers continue to draw capital?
This is a good question, and I think there has been quite a remarkable change. If you go back 20–30 years, a lot of portfolios comprised individual stocks held by investors. Today that has largely gone away, and people have embraced passive investment strategies. What is interesting though, is these passive investments are no longer just S&P 500 index funds, you have a plethora of smart beta ETFs. You can find any ETF to help implement your investment ideas. There are now more ETFs than individual stocks. It’s kind of funny, because it’s almost like taking a very active bet, in a passive way. I do see this trend continuing and it is putting great strain on the business model of traditional active asset management.
However, I also think that as investors continue to allocate more money to passive investment, the opportunity to beat the market will actually grow. If there is a wall of passive capital that follows mechanical trading rules, that increases the scope for active investors to take the opposite side. If a company comes up with a brand-new ETF product and you are a smart active investor that figures this out before anybody else, you can make a lot of money.
So there is an opportunity for active investors as the percentage of passive investors grows, so we should not be writing the active mutual fund industry off. In a sense, there is an increased importance of active investment going forward. That being said, it is an industry under a lot of stress, and fees have been falling. It is really not easy to beat the index, and that’s true across the board from stocks to real estate. Good managers are hard to find, and sometimes they’re closed for new investors, and focus on managing their own money.
These are interesting times we live in for sure. On another topic, I wanted to get more insight into your paper “Financing the War on Cancer,” which argues that life insurance companies stand to gain by covering the cost of cancer immunotherapy treatments. The medical industry seems like a market which needs disruption, and so how do you plan to disrupt this industry?
When you are a healthy 30-year old, you have, let’s say, around a 40-year life expectancy. You live till the age of 70. You buy life insurance with a death benefit of $1 million. This life insurance is very cheap, because you are going to live for a long time and pay a lot of premiums. The life insurance company (LIC) is going to pay your death benefit far into the future, so a present value calculation would suggest that the value of this future payment is very low today.
Now imagine the next day, you are diagnosed with cancer, which will reduce your life expectancy to 5 years. This does two things to your life insurance contract. First of all, it brings the death payment much closer to the present. The preent value of this is now much higher. Also, you will be paying a lot fewer premiums, only 5 years instead of 40 years. The combined effect makes the value of the policy on the LIC’s books suddenly increase from around $50K to $600K. The liability for the LIC just went up by $550K. This means that the LIC should be willing to pay $550K to restore your health to what it was before, if they magically could. This also implies that if they spend only $500K, they actually gain $50K, right?
Now, in come these new immunotherapies, which have been nothing short of a medical revolution over the past 5 years. Some cancers which were previously thought untreatable are now curable. We’re not talking about prolonging life by just a few years, but actually restoring life expectancy to what it was prior to diagnosis. Now these drugs do not work for everybody, but they work for around half the people, across a number of cancer sites. Previously, patients would undergo the standard chemotherapy and then try immunotherapy as a second line of defense, but now immunotherapy is used increasingly as a first line of treatment because it is much more effective and has fewer side effects than chemo- or radiotherapy.
The one big problem is that immunotherapy is extremely expensive. Even if you’re lucky and your health insurance covers treatment, the out-of-pocket costs are going to be fairly substantial and you’ll hit your maximum, say $20K. For a typical family in America making $50K, this is a significant expense.
And this is just for the people who have insurance…
Exactly, the people who don’t have insurance or whose insurance does not cover this therapy could face a much higher bill, sometimes over $1 million when doctor and hospital costs are factored in! As a result, some of these people who get cancer can see a solution but cannot afford it. That’s where our idea comes in.
There is a win-win solution. The LIC should pay for this therapy. Not only would the patient survive, but the LIC would also be better off. It’s a very simple idea, it’s just present value logic. From this idea, there are some interesting questions we can ask. How would this impact the cost for life insurance? All of a sudden, life insurance becomes a more attractive instrument, and more people would buy it. If more people buy life insurance, more people survive because of this feature, and the cost of insurance declines. We end up in a virtuous cycle, where more people get coverage, and the insurance continues to get cheaper.
Traditionally, I think most people consider their life insurance to be affordable, while health insurance is too expensive. By merging them, one subsidizes the other, plus there is the added benefit that if you pay money on the health insurance, you are delaying the payment on the life insurance.
Yes, there is an interesting relationship between life insurance and health insurance, which are separated in the US. What our idea suggests, is there are gains for merging them. The disruption in the industry would occur if you start a new company that offers health and life insurance as a combined policy, because the deductible for your health insurance for a cancer patient is lowered by the life insurance.
The LIC today does not even know when you get cancer. The last time they spoke to you was then you signed the policy. The next time they hear from you is when your family contacts them in the unfortunate event that you died. They do not have the information systems to deal with this. We believe this is archaic, and there is a better business model available.
So, we have been speaking with a number of insurance companies. I think it is unlikely that the big ones will make a shift, but there is a much more promise from smaller companies, who are likely to disrupt this space. In fact, there is a new Joint Venture with Berkshire Hathaway and some others…
Yes, I believe it’s Berkshire Hathaway, Amazon, and JP Morgan who have teamed up.
A consortium like that could experiment with this idea, on a smaller scale.
This idea actually works in multiple fields. We can talk about Alzheimer’s, and the cost of long term care. We all know that people live longer, and their last years of life are usually spent in a nursing home. Nursing homes are incredibly expensive, because they are not covered by Medicare. So, people need to save for private long-term care. Imagine that you could develop drugs that delay the onset of Alzheimer’s and postpone your entry into a nursing home. Long term care insurance companies should be willing to pay for the development and delivery of such drugs, it’s the same idea.
Do you think insurance companies internationally view things differently? I know in the UAE, usually insurance policies have a provision where if you get a terminal illness, you can choose to get the payout in cash to pay for treatment…
Yes, there are many companies in Asia that do that. In a sense, our model is even better, because imagine you take this option, and you survive this illness. Now you no longer have life insurance and want to buy a new policy. Who will insure you now that you survived cancer? That’s going to be an expensive policy. And that’s the best-case scenario where you survive. So, our solution is better, because it doesn’t have any of these flaws. It keeps your life insurance policy alive, even after this payment for treatment.
Immunotherapy has been a huge windfall for the LICs. We calculate this windfall to be around $7 billion. So, a reasonable question is why would they not want to share some of this windfall? They just got a $7 billion handout, thanks to the medical research community and the pharmaceutical industry. You have to tell a story where it’s in their best interest, it helps their reputation, grow their market share etc.
The bargaining power of the LIC is much higher than the consumers. Even so, they may be willing to structure the payment as a loan, with the life insurance policy as collateral. The loan would allow you to pay for treatment. Worst case scenario, if you cannot pay the loan back, they take it out of the death benefit.
Of course, they face a scenario of a certain payout if a cancer patient with life insurance dies. So, you are taking a certainty, and reducing it by the probability of success in case of an immunotherapy treatment. The low success rate of chemotherapy made it unviable.
Yes, the higher the likelihood of success, the more powerful the idea. As the drugs get better, the pre-testing diagnostics get better, are available for more cancer sites, and are applied to earlier stage cancers, the effectiveness of our idea grows.
This idea works in general. For example, think of Hepatitis C. You can take a pill that costs $80K and it will cure you. There are a bunch of people who cannot afford it, but again, it makes sense for the insurance company to pay for it.
So, what is the plan with this idea, are you proposing to form a company?
We are talking to several companies, many of the smaller players, and let’s see where it goes.
Closing out, what are the sectors or industries that interest you the most right now, especially from a disruption standpoint?
Besides the life insurance, the other sector I have been studying is affordable housing, which also has its own inefficiencies and is largely driven by government programs and incentives. Think about the current global urbanization wave, where many people are moving to cities, further pushing up the cost of living. We want to accommodate this influx because cities are engines of innovation. So what kind of policies can we adopt to rebalance demand and supply for housing? Rent control policies have a very bad reputation, but are making a comeback in parts of the country. Zoning policies are more promising. Usually, increasing the supply works to lower prices! There are very few cities where we have run out of space. New York city has a lot of space, and we could pack in more people.
But this raises the question, what else could we do to keep the city livable in terms of infrastructure? Done in a balanced way, there is a lot of benefit to improving the subway and building affordable housing in the suburbs, because you get a lot of bang for your buck in the other boroughs. I am doing a research project on the Second Avenue Subway in NYC. The idea is that if you create infrastructure, there is wealth created around the infrastructure hubs, and this wealth is largely captured by private home owners. If we could measure how much wealth was created by this infrastructure, which is the meat of my project, then we could tax the home owners accordingly and capture some of this value to help pay for the infrastructure.
Well, thank you so much for chatting with me Professor Stijn. This has been an enlightening discussion.
Aditya Jain ’19 is Co-President of the Real Estate Association and graduated with honors from Boston University, with a Bachelor of Science in Business Administration. Aditya worked as an Investment Associate with Gulf Related in Abu Dhabi, handling the financial analysis and investor relations function for a mixed-use development on Al Maryah Island in Abu Dhabi, and a multifamily project in Saudi Arabia. Before Gulf Related, he worked with Mubadala Pramerica Real Estate Investors as a Senior Transactions Analyst. Aditya also has over three years of corporate banking experience with BNP Paribas and is a CFA Charter holder.