Anthony E. Malkin

Early this summer, as it became clear that credit rating miscues and the ensuing sub-prime mortgage collapse was strangling debt availability in commercial real estate, this newsletter announced the conclusion of a series of refinancings in the W&M Properties office and retail portfolio that allowed $130 million of tax-deferred distributions to our investors.

With the closing of these transactions arranged before the turmoil, Wien & Malkin investors were able to recognize a significant liquidity windfall. In the following Q&A, Anthony E. Malkin addresses a question that has been asked by many investors since they received their checks:

What is next and how should we reinvest the cash we received?

Q: Are the problems in the credit markets having an impact on Wien & Malkin investments?

We have not been competing in the debt-fueled bidding wars for properties that have characterized the past few years. We have directed our and our investors' dollars into secure, if lower yielding, select direct investments in property, and branched into mezzanine debt and structured-equity positions yielding superior current returns. Our owned assets are moderately leveraged with institutional, relationship lenders at fixed interest rates. Therefore, we are not adversely impacted by the reduced credit availability or higher interest rates that now confront some property owners.

The constriction of available real estate capital may play to the benefit of our Strategic Capital program by stimulating greater demand for supplementary funding. As traditional lenders tighten their loan-to-value ratios, our Strategic Capital program is evaluating some interesting investment opportunities. Of course, if things get bad enough, we may see beneficial, long-term ownership opportunities stemming from some of our Strategic Capital positions. But nothing like that is occurring at present.

Q: You've previously said an attractive environment for investment in long-term direct acquisitions will not return until something causes the institutional and hedge fund investors to focus their attention away from real estate. Could credit rating changes and tighter debt markets be the catalyst for that event?

The disruption in the credit markets and its associated problems certainly are impacting some of the flows of capital into real estate. While there is plenty of equity still available for real estate, the commercial mortgage-backed securities market, which has been a major catalyst for mortgage origination, is unsettled and having difficulties pricing and being responsive to demand. What credit that is available is more expensive and subject to lower loan to value with higher amortization requirements. While new sales will be re-priced, the real question is whether changes in the debt markets will cause a lot of pain when it's time to refinance loans made at or near the top of the market -- loans characterized by very high loan-to-value ratios, very low interest rates, and no amortization. Of course, further weakness in the economy would serve to soften rents and cause more problems for high-leverage deals.

Q: What are you doing, and what should investors do until then?

While we've already seen a reduction of 10-20% in transaction pricing of real estate and a significant reduction in the number of deals getting done, we still do not believe now is the time to pile into direct ownership investments. There was a tremendous amount of equity raised to invest in real estate; it's still out there and it's going to be spent. The cheap dollar is attracting overseas investors, too.

We will be patient, remain disciplined and follow our model. The $130 million of funds distributed, which in the case of most properties represented a return of more than 100% of the capital originally invested, took years to create and there is no harm in taking a little time to reinvest. We buy quality properties at prices that enable us to create value over the long term, by upgrading, repositioning and reinvesting.

We are looking, and will always be looking for what we think are excellent risk-adjusted values. And, when we see them, we are sure to be sharing them with our investors.

Q: Do you have any additional advice to investors?

Remember that some of our best deals actually were done at times of the highest skepticism about real estate. We encountered significant disbelief in a lot of our fund raises. For example, 711 Westchester, MerrittView and Manhattan East/West retail have all been great successes, but each posed challenges for us in raising the equity. Real estate is cyclical. We always remember that, and so should our investors. Wien & Malkin investors should take advantage of the luxury of waiting for the right long-term opportunities. Our recommendation, and our practice, is always to put some money into every Wien & Malkin offering. There will be some really big winners, some solid performers, and always one or two that remain a challenge, but overall it has always worked extremely well for us and our investors.

In the meantime, there is no harm in putting some of these hard won proceeds to work in productive shorter-term money markets and certificates of deposit now.