Back From The Dead: Limited Partnerships
Surprise! The once moribund market for publicly registered limited partnerships has perked up. The recovering real estate sector, where more than half of these disastrous deals were done, has brought new life to this group of widely promoted investments of the 1980s.
"You couldn't give away some of these partnerships three years ago," says Spencer Jefferies, the Dallas publisher of Partnership Profiles, a directory and newsletter of partnerships. Not anymore. Such investments, which are long-term instruments giving buyers ownership interests in assets such as real estate and oil and gas, are still being sold for much less than what the original investors paid for them. They generally sell at a 20%-to-60% discount to net asset value. But recently, prices for many of the real estate deals have more than doubled.
Take Balcor Realty Investors 85-2, a portfolio of apartment buildings originally sold in 1985 at $1,000 a unit. In June, 1993, partnership units were selling for $44, according to James Frith Jr., president of Chicago Partnership Board, the largest of the firms that trade limited partnerships in the secondary market. Early last month, units sold for $329 apiece.
GOT STUCK. This is welcome news for the estimated 10 million buyers who gobbled up $130 billion worth of the limited partnerships when real estate was booming and oil and gas prices were strong. Lured by tax breaks that allowed deductions of limited-partnership losses from ordinary income, investors watched that advantage disappear along with the Tax Reform Act of 1986. Gross mismanagement, high fees and debt, and a severe real estate recession further harmed many of the partnerships.
Unfortunately, investors were stuck. Limited partnerships weren't designed to be traded. Of the 2,000 partnerships, only about 300 trade with regularity--and then only at independent dealers that have established their own clearinghouses for such transactions, yet offer no guarantees that sellers are getting the best prices. But trading volume jumped from $100 million in 1993 to $200 million last year, and that upward trend is expected to continue, according to Jefferies of Partnership Profiles.
What's driving the increased trading activity? Liquidations, in part. More investors are jumping into the secondary market because there is a definitive time frame for investment returns on dissolving partnerships. Some sponsors see the improving real estate market as the long-awaited opportunity to cash out. Merrill Lynch, for instance, has already liquidated three of the six MLH Income Realty partnerships its brokers hawked to clients. "Brokerage houses are anxious just to get out of the market," says Ross T. Bowler, a secondary market maker in Madison, Wis. These deals left them awash with expensive shareholder lawsuits and hefty fines levied by the Securities & Exchange Commission for improper sales practices. But careful investors have lately been noting that, while the selling techniques often may have been shoddy, many of the properties are still valuable.
Indeed, when these properties are sold and the proceeds are paid out to unit holders, it can mean huge capital gains. Consider MLH II, an apartment-building deal sold by Merrill Lynch in 1985 at $1,000 a unit. In July, 1995, a unit sold for $105.63 in the secondary market. Two months later, Merrill Lynch liquidated the assets and paid investors $179 per unit. That's a 66% return in just two months. Add that to the cash distributions, and these quirky little deals can make attractive buying opportunities--but only for the sophisticated investor who avoids highly leveraged partnerships and is willing to plow through financial statements to study the market.
Locating information and evaluating it to determine how much the units are worth is tough. "This is the used-car market, not the New York Stock Exchange," warns Glen Bigelow, a portfolio manager in New York.
IN THE BALLPARK. It's getting easier, though. The Chicago Partnership Board launched a free Web site (http://www.cpboard.com) that reports units available for purchase, most recent prices, and other data. The site also has partnerships' financials. Or you can call Disclosure Inc. (800 638-8241) to get annual reports, 10-Ks, and 8-Ks. Pricing is also available from Robert A. Stanger & Co., which tracks limited partnerships for $5 a minute (900 786-9600). And federal approval is pending for the National Association of Securities Dealers' plan to list limited-partnership quotes on its electronic OTC Bulletin Board.
Armed with the financials, you can do some basic research. For a ballpark estimate on an unleveraged real estate unit's value, divide the annual cash distribution by 0.085%, advises Bowler. Take IDS/Shurgard Growth II, a 1989 miniwarehouse deal sold for $250 per unit. It currently pays out $16.25 a year in cash distributions. Divided by 0.085, each unit would be worth about $190. Indeed, one unit recently traded in the secondary market at $195. Discounts to net asset value are steeper for partnerships with higher debt and lower payouts.
There are other considerations when buying partnerships besides valuation, however. Most important is the general partner, or sponsor. Many of them have gotten a bad rep--for good reason. Several general partners, such as now-bankrupt Integrated Resources and Southmark, put their fee-raking motives before the interests of their limited partnerships. "The general partners have complete control," says Matt Rigg, a Miami financial planner who invests in limited partnerships. So stick with partnerships that have high-quality, well-known management and good track records. The prospectus should report prior results. Also, look for deals where sponsors sold partnerships to their own clients, as in the case with brokerage firms and insurance companies such as Merrill Lynch and CIGNA.
HOW LONG? Those with less stomach for risk may want to invest in partnerships that are liquidating or have announced the intention to do so. PaineWebber, Dean Witter, JMB Realty, Merrill Lynch, and Balcor, which is owned by American Express, are all in the process of selling assets. Details should be reported in the most recent 8-K. Unit prices will probably be bid up, but the risk is minimized because the investment time is capped. Avoid deals where the liquidation time tops three years, and try to discern how long your money will be tied up before you buy.
You'll also want to take a look at the cash-distribution histories. Several partnerships are highly leveraged and stopped cash payouts during the real estate recession. It's best to buy into deals that have had consistent cash distributions. Also, check financial statements to make sure cash flow from rents and other sources is enough to cover payouts. Balcor Colonial Storage, an unleveraged miniwarehouse deal sold in 1986 at $250 per unit, paid quarterly distributions until it was liquidated for $256 per unit late last month. In general, expect 8% to 11% yields on units of unleveraged real estate deals.
AND LOCATION. Of course, the type of real estate makes a difference. Miniwarehouses and apartments are hot. Attractive deals to consider, suggests Bowler, are IDS/Shurgard series, Balcor Realty 85-2, and Dean Witter Coldwell Banker Tax Exempt Mortgage Portfolio. But many older office buildings have become obsolete, and their values probably won't rebound. So before buying into any office deal, look closely at vacancy rates, the location of the properties, the number of leases coming up for renewal, and lease provisions. You'll also want to consider the fee you'll pay your accountant at tax time: Limited partnerships are notorious for creating tax-preparation headaches.
Still interested? Although limited partnerships are often very complex, their returns can be quite rewarding. So happy hunting--but remember: Understand exactly what you're buying, or don't bother.