Over the past decade, investors in real estate limited partnerships have suffered a kind of financial purgatory. Losses on their investments amount to many billions of dollars. Now, many of these hapless limited partners are being subjected to a further indignity: As they attempt to extricate themselves, they are falling prey to the blandishments of real estate firms that are systematically buying up these underwater partnerships at a fraction of their real value. In effect, the limited partners, many of whom are unaware of the real value of their investments, are losing out a second time. And it's all perfectly legal.
Here's how the process works: Real estate firms, most prominently Equity Resources Group, KH Financial (operating under the name Everest), and MacKenzie-Patterson, solicit limited partners and offer to buy them out. The firms employ a "mini-tender," which allows them to buy up to 4.9% of the outstanding units, most with a $1,000 face value, without registering with the Securities & Exchange Commission--and without disclosing such key details as the LP's market value.
"CLUELESS." Many investors are accepting the offers. "It's a quick way to sell a unit with no fees or charges," says Eggert Dagbjartsson, executive vice-president of Boston-based Equity Resources.
Few of these investors, though, are aware that there is an active secondary market in LP interests. Competition in this market drives prices usually much higher than deals offered by real estate firms to frustrated investors. The firms can often pick up interests at discounts of 60% or more (table). Limited partners may find out later that they sold on the cheap, but then it's too late, because sales are irrevocable. "Limited partners don't have enough information to determine what the assets are worth so they're clueless that the mini-tender is a lowball price," says James Frith Jr., president of the Chicago Partnership Board, a secondary-market maker.
Firms accumulating these interests expect to realize huge capital-gains profits. Values of real estate LP interests are rising, which is causing more general partners to liquidate partnerships and distribute proceeds to unit holders. In the past two months, more than 90 public LPs have disclosed pending asset sales.
Real estate firms that want more than 4.9% of an LP will employ a registered tender offer. That can be a better deal for limited partners. Offering documents, for instance, typically disclose secondary-market prices.
Investors solicited through tender offers, especially a mini-tender, should seek out the secondary market. One way is to call the general partner, who will supply names of firms buying partnership units, or act as agents to help sell them. Agents charge commissions as high as 7.5%. Some charge fees of up to $100 to process the transfer paperwork. Still, Ross T. Bowler, a secondary-market maker in Madison, Wis., says: "The transfer fees and commissions charged in the secondary market don't reduce net proceeds to anywhere near the price offered by the mini-tenders."
One recent deal graphically illustrates the price disparity between mini-tender and secondary-market prices. On June 12, Equity Resources offered to buy 4.9% of ARVIDA/JMB Partners, a troubled land development partnership.
BIDDING WAR. But just a few days later, ARVIDA/JMB got two registered tender offers from Walton Street Capital Acquisition and Raleigh Capital Associates, an affiliate of Leon D. Black's Apollo Real Estate Capital Advisors II. After a spirited bidding war, Raleigh beat out Walton with a $435 bid, a big jump from the prevailing secondary-market price of $295.41 before the price war began. A few weeks later, New York-based Boreas Partners, an affiliate of financier Carl C. Icahn, also made a tender offer at $460 a unit. Recently, Boreas terminated its offer and joined Raleigh Capital to bid for 46% of the outstanding units at $461 each. The bidding is now closed, and the tenders are being collected. The general partner opposed the bid, claiming the units are worth between $565 and $610.
Spencer Jefferies, the Dallas publisher of Partnership Profiles, a directory of partnerships, says there will probably be more unfortunate limited partners in the future. Mini-tenders are expected to increase for all types of partnerships, he says. Limited partners solicited by mini-tenders would do well to study the ARVIDA/JMB Partners deal. Pity the few limited partners who sold out to Equity Resources before the bidding war began. They cashed out at a miserable $100.