From time to time, Anthony E. Malkin comments in this newsletter about the real estate investment climate, and the economy in general, as they affect opportunities for Wien & Malkin investors. In this Q&A, Mr. Malkin explains why traditional direct investments offering high value and growth potential continue to be scarce, and consequently, how Wien & Malkin is exploring new investment structures.

Last winter, you described a marketplace in which quality commercial properties, especially buildings with little or no near-term lease rollovers, were selling briskly for historically high prices, despite weakening fundamentals in the rental markets. Has that scenario continued?

In addition to the volume of capital pursuing real estate, it's worth noting two key points: (i) high prices are being paid for properties with existing or near-term potential vacancies, and (ii) operators of opportunity funds, now unable to generate the high returns they promised in the past, are offering funds that provide reduced investment returns.

Why does interest in real estate continue to grow?

The biggest factor for new investor interest in real estate is yield. Many first time real estate investors are replacing maturing bonds with real estate investments. Others are still hesitant to return to the stock market.

Of course, with so much new money chasing real estate, current available yields have dropped 2-3 percentage points over the past two years and the prospect for upside has diminished. Moreover, most new investors are not focusing on the illiquid nature of real estate and the risk of reduced yields caused by increased vacancies and lower market rents.

Is it the surge of new capital for real estate that has slowed the pace of Wien & Malkin acquisitions?

Simply stated, yes. We are facing not only lower yields but also lower growth opportunities and a far higher risk for reduced performance. The combination of rising prices and deteriorating market fundamentals has been a deterrent to new investing. We invest our own money next to our investors' money. We will not throw away our discipline for the sake of putting more money to work near-term. Over the long-term, we and our investors have too great a chance to suffer.

What are the risks you perceive?

I am concerned with deteriorating rent rolls and revenues in office and apartment properties at a time when costs of operation are rising. Retail properties have performed well on the back of consumer spending, but I am troubled that the prices being paid for retail require significantly increased rents to meet our traditional longer term objectives.

I am also concerned that today's low interest rate debt will likely have to be replaced with higher interest rate debt in the future. On existing investments, I do not mind refinancing higher cost debt in order to recognize gains without taxes. But I am worried that investments made today barely make sense, even with low interest rates, and will be vulnerable when debt must be replaced at higher rates, risking loss of equity and reduced current returns in the future.

When will the market become attractive again?

The shortest answer is: when there is less capital in relation to properties for sale. In the past, Wien & Malkin investors profited from an imbalance, with more property and less money available, but that environment will not return until the herd slows its stampede into real estate. Meanwhile, our emphasis is on prudence and careful underwriting, because many decades of experience have taught us that the key to successful investing is, buy inexpensively and then operate it well.

So how do you spend your time these days?

We continue to evaluate and create investment structures that address inefficiencies in the marketplace over a range of investment objectives. We still seek to employ capital through Strategic Capital, which we created to achieve higher yields in today's environment while maintaining our intolerance for undo risk.

We also have sought ways to combine Wien & Malkin capital to help others with capital needs in their acquisitions, such as in Co-Investor Capital, with which we jointly purchased a pair of prime office buildings with other entrepreneurs.

We continue to review properties for which sale or refinance opportunities are compelling. Since we believe that the present flow of capital to real estate will ebb over time, there are some situations in which a sale at today's unprecedented prices or a refinancing at today's historically low rates may make sense.

Are there other new approaches contemplated?

Well, we're considering offering our investors the opportunity to invest side by side with the Malkin family in a hedge fund (see story on page 2.) This would provide further portfolio diversification, and perhaps the chance to profit from today's excessive enthusiasm for real estate. We have a few other ideas we are kicking around, but in general, sometimes when the room is too full, you should not try to get in. We are not going to do anything simply for the sake of doing it. That would not make our investors happy over the long run.

Do all of these new ideas constitute a sea change in Wien & Malkin's investment philosophy?

No. We are reaffirming our view of how best to fulfill our fiduciary responsibility to our investors. I am committed to our underwriting standards and the objectives of current return and capital preservation. This is how we have retained the trust and confidence of our investors for seven decades, and I see no reason to change.