Real Estate

A Close-Up Look at Real Estate

Interviewed by Ronna Kelly
Nancy Wallace

From building a better national housing index to advising on UC Berkeley’s Memorial Stadium, Professor Nancy Wallace has been playing a major role in real estate policy at the local and national levels in the past year. On campus, Wallace, co- chair of the school’s Fisher Center for Real Estate and Urban Economics, has been instrumental in creating a new UC Berkeley real estate certificate and the Fisher Center Real Estate and Financial Markets Laboratory. In the aftermath of the financial crisis, Wallace is also playing an important role in Washington, D.C., advising the U.S. Treasury and Federal Reserve on monitoring economic risk. Her work bridges public policy and industry, building on the Fisher Center’s deep relationships with real estate leaders. In a recent interview, Wallace discussed everything from the “shadow banking industry” to her groundbreaking work on national indices.

Let’s start with the new Fisher Center Real Estate and Financial Markets Laboratory. Why was it created?

Our goal in creating the lab is to better understand what is happening in real estate asset and capital markets at a deep level. We hope to inform the policy debate on the risk channels associated with real estate and mortgage markets in the U.S. and to develop real estate and mortgage market risk management tools. We intend to share our knowledge so that everyone from regulators to large real estate developers has better information about real estate markets. I’ve hired a fantastic new director, Paulo Issler, who has a PhD in finance and is very experienced in working with Big Data. We have vendors who have been incredibly generous with academic discounts on data sets because I’m training a lot of students here who will be going into industry.

And what will the lab do?

Right now our focus is on building housing price indices, which have been a great concern to me. I’ve been brought in to look at institutions forensically after they failed and realized the indices that they’re using for mortgage valuations and stress evaluations are not well designed.

It’s one thing to report in the newspaper that something’s going up and down, but it’s a whole other thing to feed a flawed index into a highly sensitive stress-testing model.

Explain the flaws a little more.

Here’s an example. The Case-Shiller Index is what’s called a “repeat-sales index.” You need at least two transactions to build that index. The index assumes that the components of the house in the first period and the components of the house in the second period are the same. The only thing the index is based on is the difference in price, not controlling for what’s going on with the characteristics of the house.

But in the coastal states, remodeling expenditures are extremely high per capita. These repeat sales indices ignore that. We have spent four years now building proper data sets so that we can monitor the characteristic dynamics of the housing stock.

We’re working on San Francisco right now. We see houses double in size. And guess what? Not terribly surprising, the house prices double, but you would not attribute that to price increases. These indexes are mixing price changes with quantity changes, which is the fatal flaw of a price index.

Did that flaw contribute to the financial crisis?

Yes, because it looked like price increases were astronomical. At least in the coastal markets, there was a huge amount of remodeling that was not being accounted for. The advantage of the repeat sales index is it’s really cheap, but as we’ve just seen, it leads to very big mistakes that we can’t afford.

The media is reporting that housing prices are going up again. Are we in another bubble? Defining bubbles is very hard. We don’t really have the tools we need to measure and pinpoint this highly narrowly defined outcome. Prices are rising fast, but they’re rising from a really low base.

On the other hand, we don’t really think they fell as far as the indices show they did. It all depends on how you think these things should be measured.

Can you give an example?

The East Bay, San Francisco, the South Bay. There was slowing down of transactions. Now about 30 percent of transactions are done with cash. That wasn’t happening before the crisis, and it slows down transactions. But prices did not really fall that far.

Any other projects planned for the lab?

The second thing we’re working on is the organization of the mortgage market and monitoring that. We have data on all the fixed-rate loans insured and securitized by Fannie Mae and Freddie Mac. That’s 32 million loans.

We’re mapping those mortgages to people who actually originated the loans, at all levels, from the brokers who do not make the loan decision, to the bank branches, to the many independent mortgage companies under regulatory controls different from those governing the large bank holding companies.

We’re working on graph-based, or lattice, technologies to monitor how things come through this industrial network and how mortgages get funded. The question we are considering is how capital is sourced for mortgages that are originated by non-depository institutions, since much of this funding is part of the shadow banking industry. We have found that pre-crisis much of this capital was provided to the independent mortgage companies from loan commitment relationships with the large bank holding companies. The accounting and capital requirements for this type of lending to independent mortgage originators was, and to a certain extent continues to be, extremely difficult to monitor.

It sounds as though you are applying your research to real-world situations every day. What about Memorial Stadium?

Professors Richard Stanton, William Fuchs, and I volunteered to help UC Berkeley Vice Chancellor John Wilton better understand the finances behind Cal’s Memorial Stadium. We’ve been working on a 100-page study analyzing what went wrong and outlining a strategy to manage this problem. We’ve spent a lot of time on it. Literally New Year’s Eve, Richard and I were emailing spreadsheets back and forth to make sure that we had signed off on every single detail. It’s informed by every detail of the debt contracts, the other contracts that could or should be in place, and the opportunities for raising money to pay the debt obligations.

What are the opportunities?

I’m now on an advisory committee to identify a viable tenant base for the stadium. We don’t have agreements yet, but there are very intriguing possibilities, which would enliven this part of campus with coffee shops, places to exercise, all kinds of music in the plaza space. Then when we look across the street from Haas, we will see people there every day of the week. The goal is to make this a really exciting public place that also generates fee income for the campus.

One of the things we’re considering is this becoming the visitation gateway to campus. Every new student who comes to campus with their parents, or every prospective student, would start there. There will be an amazing new center where student services can reach out to new students. People will have a place to park under Maxwell Field next to the stadium.

Shifting gears, what do you want Berkeley Haas students to learn about real estate?

Our real estate faculty is in the business of giving Berkeley MBA students an understanding of the drivers of supply and demand and how supply and demand in real estate markets evolve over time.

My goal is to get our graduates into the major real estate companies of the United States. They need to understand the most sophisticated, iconic deals in the United States. That’s cases, and understanding all the subtlety that goes into structured finance and deal structuring in the real estate industry.

I’m also very concerned that our students understand the interdisciplinary nature of real estate. For senior decision makers, real estate is about contracts and law. All the cash flows are generated through leases, which are contracts that are then collateralized and securitized through mortgages, which are another set of contracts. Students need to have an understanding of securities law and law that governs what you may and may not do with a property—state and local zoning laws.

They also have to understand the design components of buildings, which is, of course, what makes them such a wonderful asset class. They’re physical assets that people can admire. Our MBA students need to understand design, from site planning to construction.

The new UC Berkeley real estate certificate for graduate students recognizes that real estate is an interdisciplinary activity—whether you are a Berkeley MBA, law student, or CED (College of Environmental Design) student. All three units on campus are training each other’s students for successful real estate careers.

And undergraduates?

I have very similar expectations. The courses are simpler, not in the economics or the finance that we’re teaching, but in terms of how much experience students need to really tackle difficult cases. But we are doing cases with undergraduates.

We run a very successful Bay Area undergraduate internship program that places 15 students each year. We’re also placing our graduates as analysts in the top firms in the country—the major investment banks, commercial banks, pension funds, and insurance companies. They go to work for the big builders. These are very successful people. That’s what I expect.

How about placing MBA students?

The Fisher Center has very close working relationships with the principals of the major real estate operating companies, from home builders to brokerage and private equity firms. We’re very focused on giving our students—MBA students and undergrads—access to those people, and we do that in a couple of ways.

First, we need to make our students interesting and attractive. That’s why we run three MBA case competitions, two focused on assets and one focused on the capital market. I supervise our Haas teams, which have six students each. We also support the MBA students’ Berkeley Real Estate Club by providing connections to professionals in San Francisco.

That’s all intended to support MBA students’ job placement needs. Real estate is a very fragmented labor market. Many people don’t realize this but real estate is also very entrepreneurial. There’s enormous need for innovation in all kinds of areas, from managing energy to creating new financial instruments. It’s not staid. Real estate by its nature is extremely risky; that’s why the returns are so high.

But it’s not like consulting or technology, where recruiters come to Haas and hire eight students. Real estate companies come here to hire expensive partner-track people whom they intend to invest in heavily because the expectation is that they’re going to eventually run these operating companies.

We also help students meet and work with members of our Fisher Center Policy Advisory Board. It’s a who’s-who group of about 230 real estate leaders that’s existed for more than 30 years. Our advisory board meets twice a year for a two-day retreat, and we bring 10 students there to observe high-level strategic meetings and meet one-on-one with members. The Policy Advisory Board retreat has been hugely successful. Our members love it, and it’s been absolutely crucial for putting our MBA students on track for successful real estate careers.

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