June 2, 2001

Limited Returns

Limited partnerships have not performed as adverti

Secondary-market LPs have much in common with vinyl LPs. As viable products, both limited partnerships and long-playing records have become all but obsolete. The former lost its usefulness as a tax shelter to the Tax Reform Act of 1986. The latter, of course, was replaced by better technology.

But even though many financial LPs have long exceeded their expected life spans, secondary market limited partnerships--long-term instruments giving buyers ownership interests in illiquid assets such as real estate, equipment leasing, and oil and gas--seem reluctant to die. As a result, most LP owners have been left with high-maintenance relics of ever-decreasing value, and the choice of selling them for pennies on the dollar or keeping them, less in hopes of a miracle than from inertia. If investors feel as though they are stuck with their LPs, it is because many of them are; sometimes it can cost more to get rid of them than they're worth. Then again, sometimes they're actually worth keeping, though for less than obvious reasons. Regardless, rest assured that as your clients, these investors will pass along the tricky decision-making to you.

So how should advisors approach LPs these days? First, keep in mind that not all LPs are created equal. The future's bright for limited partnerships in housing and managed futures (more on these later), but as for those old-style tax-driven LPs, fuggeddaboudit.

"Never recommend them. Hate them when we get them. Try to dump them when we can," is what advisor Tom Batterman of Vigil Trust & Financial Advocacy, in Wausau, Wisconsin, has to say about secondary market LPs. Terry Balding, an advisor in Sun Prairie, Wisconsin, jokingly tells his clients that he "hopes to live long enough to see the LPs all go away." But like a lot of dedicated LP bashers, Balding admits that some have "actually done what they said they would, which is kind of rare." Take Cronos, a giant, San Francisco-based lessor of marine containers. Cronos was one of several all-cash lease deals offered after 1986 that Balding purchased units in, a few as late as 1998, for their income. "If we hold them until it's all done, the client will get the majority of his money back, if not a profit, in most of these LPs," Balding says.

He advises holding rather than selling, maintaining that those who are trying to buy them are "trying to steal them." He cites as example several equipment leasing programs from Datronic, which are due to soon run out. In this magazine's secondary market listing for the period January 1, 2001 to January 31, 2001, 16 units of Datronic Equipment were traded. The LP posted a 12-month high of $14 and a 12-month low of $9. To arrive at these figures, data was culled from seven secondary market brokers, who provided individual unit transactions to find a weighted average per unit and 12-month price range. The kicker, of course is this: Datronic Equipment 16's original price per unit was $500.

Exception to the Rule

As for buying secondary market LPs in the first place, don't, Balding says, though he notes one exception to his own rule: LPs in low-income housing that are eligible for tax credits. He believes this to be one of a very few areas in which LPs have a viable future, as there will always be people seeking tax credits and the government will always endeavor to build housing for people with lower incomes. Tax credits have also been available for limited partnerships involved in the restoration of historic properties.

For the right person, say, someone in the 31% tax bracket making around $100,000 a year (sometimes less), these low-income housing LPs can be very attractive, maintains Balding. Most are packaged in units costing $25,000 to $50,000 per, with seven-year payouts. The exception are offerings from Boston Capital, which sells blocks, instead of units, at $5,000 or $10,000 per. (Offerings from Boston Capital and other primary market vendors (see sidebar p. 62) are made on a continual basis.) Tax credits for qualified partnerships are awarded by the state and federal government, resulting in a dollar-for-dollar tax reduction. Balding says most of his clients have gotten back an average of 1.4 times their initial investment in tax credit savings alone; in other words, a single $25,000 unit will realize anywhere from $26,000 to $30,000 in tax credit savings. Since the client still owns a piece of the property, 15 years down the road he will also receive his share of the sale proceeds, depending upon the value of the property at that time. "You're going to get something back, even if you overpaid at the beginning," says Balding.

Laura Tarbox, president of Tarbox Equity in Newport Beach, California, is another secondary-market LP skeptic. She dislikes their illiquidity, lack of investor control, and endless hassles, including the fact that LPs report via K-1 federal tax forms that are usually drawn up late in the tax season. That can force clients into requesting income-tax-return filing extensions. Of clients who come to her with limited partnerships, the "bits and pieces" must be held at different custodians, which not only makes tracking difficult but adds to the expense. "We're anxious to get rid of them and so are our clients," says Tarbox. But, like Balding, she watches them wind down instead.

But what if Tarbox wants to sell some LPs? A small number of limited partnership trading firms match buyers and sellers via retail brokers. But business isn't exactly booming. Paul Frain of Frain Asset Management in Seminole, Florida, gives his profession another couple of years, as existing LP funds continue to liquidate, saying, "the future is bleak." Lori Sarain of North Coast Securities Corp. in Delray Beach, Florida, who also deals with non-standard assets such as private placements and unlisted REITs, agrees that LPs are "obviously" winding down. "For a while people believed they would come back and be attractive, but at this point they have a stigma attached to them," she says. "I've seen them come and go just like anything else. The market ebbs and flows."

True enough. Witness the modest comeback of real estate LPs in the mid-1990s. For example, in June 1993, partnership units in Balcor Realty Investors 85-2 (a portfolio of apartment buildings, which at inception in 1985 sold at $1,000 per unit) had plummeted to $44. June 1996 saw them shoot up to $329. The most recent report, in May 2000, shows 25 units were sold at a modest $16.50.

In terms of LP brokers, none is bigger than The American Partnership Board in Scottsdale, Arizona. With a staff of 20, APB bills itself as the nation's most active limited partnership trading firm. Operations Manager Jeff Lundgren notes that equipment leasing partnerships and real estate partnerships are still being traded, and people are still using LPs for tax credits. The company's strategy in the face of a shrinking market is to increase market share by creating an interactive auction-based resale system for buyers and sellers, called Online Central Auction Facility (at www.apboard.com) which also provides ti

Limited Partnership Resource List
Trading firms, secondary markets for LPs (trades reported in each issue of Investment Advisor) American Partnership Board 480-368-6457 www.apboard.com

DCC Securities

800-945-0440

www.dccsecurities.com

Frain Asset Management

800-654-6110

North Coast Securities

561-496-5387

New York Asset Exchange

941-955-8816

www.nyaex.com

Pacific Partnership Group

800-727-7244

Partnership Marketing Co.

888-824-8600

www.lpsales.com

A-1 Partnership Service Network

800-483-0776

Secondary Income Funds

708-325-4445

Primary markets, offering

low income housing LPs

American Capital Development

800-635-0315

Boston Capital

800-866-2282

Summit

800-676-2320

WNC Housing

800-451-7070

Related Resources

EDGAR: SEC data on public companies with less than $10 million in assets and 500 shareholders

www.sec./gov/edgar.shtml

The Valuations Group: Provides independent third-party valuations of LPs

800-824-5500

www.valuationsgroup.com

Securities Pricing and Research Inc.: Securities pricing and research

service for LPs

www.spardata.com

NAPEX: Lists LP units for sale and current

market values; provides an auction trading format

800-356-2739

www.napex.com

mely unit price data. The auction generates anywhere from $700,000 to $1 million in weekly trading volume with more than 250 registered buyers, which Lundgren says represents 55% to 65% of the market's total business. These deals are mainly in real estate, with some oil and gas. "There will always be a need for liquidity," says Lundgren, explaining that sellers sell because of "death, divorce, and disillusionment."

What does it cost to buy or sell LPs? Before the 1986 Act, there was no regulation regarding fees relating to the purchase of LPs. Front-end loads were typically 20% to 25%, notes Frain. "A lot of people lost a lot of money," he says. Today, secondary market broker transactions are limited by NASD to a 7.5% combined buy/sell fee.

Everyone bought public LPs in the 1980s expecting decent returns, or at the least, to get their investment back within five to seven years. "Here we are 15 years later and they're still out there," says Tarbox. Stranger things can happen, however, to the hapless LP owner, and sometimes they're not all bad--though they may very well be time consuming and frustrating as hell.

Stranger Than Fiction

Take the experience of Marjorie Fox, a planner at Rembert, D'Orazio & Fox in Falls Church, Virginia. Fox's tale involves one of her first clients, who ultimately named Fox to assume the role of successor trustee at his death, which occurred in 1998. Prior to becoming a client, in 1991, the client had invested in 30 units of Boston Financial Qualified Housing Tax Credits LP III, which owned and operated apartment complexes, qualifying for a low income housing credit. At the time of purchase, the client, then 75 and recently widowed, was looking for a tax shelter; this particular LP seemed to fit the bill.

Fox, who as trustee inherited the Boston Financial LP III, discovered that it was designed to offer tax credits for a 12-year period ending in 2001. In accordance with the law, the compliance period was to end in 15 years, or in 2004. This means the LP can't actually sell property until 2005, four years after the tax credits end. "I'm only beginning to learn what that means," says Fox, who is faced with distributing the estate--and, in part, cannot.

This unexpected development notwithstanding, Fox admits the LP has been a relatively good investment. Total tax credit benefits per $1,000-unit investment have exceeded $1,375. "This isn't bad compared to some of these dogs," she says. Given that the client's original investment was $30, Fox figures he has gotten back in tax credits at least 30 times $1,375, or $41,250. Of course over time the tax credit value has dropped. "Back in 1994 and '95 he was still getting $140 to $130 in tax credit per unit. 'Hold on,' was my advice. Unfortunately, he held on and died," says Fox.

She proceeded to scan the Boston LP data. In 1998 the tax credits projected for 1999 were $125 per unit; in reality, they were $92 per unit. Since she needed to value the LP for estate purposes, she took a quick look at the secondary market. On the estate tax return the Boston LP was listed as being worth $3,000, making it worth more in tax credits than whatever cash it would earn on the secondary market, "particularly after you subtract expenses," she adds. Meanwhile, tax credits continued to drop. In calendar year 2000 they were $32 per unit; in 2001 they're anticipated to be $4 per unit.

This past January, she called NAPEX and learned that the estimated value of the Boston Financial LP III was $17 per unit. NAPEX lists units for sale with their current market values, and provides an auction format to trade units of more than 1,200 limited partnerships. No fees are charged to list units. When buyers and sellers agree on a price, transaction fees are charged and vary according to the size of the trade. In Fox's case, it would cost $125 to auction the units. Add to this Boston Financial's $10 per-unit fee to transfer the interest, and she would be left with net proceeds of $85. "So again I looked, and said, 'I'm going to get, as meager as it is, $4 per unit in tax credit times 30 units--that's 120 bucks.'"

She called the general partner for the LP. They told her that if she was simply going to transfer the units on the books they would waive the $10 per unit fee, and charge a total of $50. "So I could transfer this thing for $50 to the beneficiary. But I'm still left with the question---what will this mean to the beneficiary? It isn't fair to saddle her with something that's going to create a negative tax surprise down the road. The capital account for this is now a minus $5,449. What does that mean? Essentially the end of the story hasn't been written." She plans to work with her CPA firm to determine the best course of action. "What a pain in the behind this has been," she says.

A Future for Futures

Advisor Marjorie Fox would be the first to say that managed futures can be a zero sum game. The investor must be on the right side of price movement and trend, a responsibility that falls to the trader. But Fox does feel managed futures may have a place in an already well-diversified portfolio. Admittedly, she has seen clients' multi-trader managed futures partnerships decline 15% for the year, but when they're good, they can be quite good indeed. (See "Playing With the Future" by Ben Warwick in March 2001 Investment Advisor). Managed futures are the only investment she recommends in a LP format, and she does so with great care.

A number of Fox's clients own interests in California Managed Accounts Fund III, L.P., whose general partner is T. Young & Co. of Santa Ynez, California. When observing how this fund fared over time, compared to the secondary limited partnerships we examined earlier, it's easy to see why managed futures are worth a serious look. CMA III returns (net of hefty expenses) ranged from 41.62% in 1988; to 34.77% in 1998; to a whopping 86.03 in 2000. CMA III is up an estimated 10% to date this year.

As advisor Tom Batterman puts it, purchasing a secondary market public LP is like buying a car. The car holds its greatest value on the showroom floor. Once you drive it off the lot, the value goes down, and it keeps going down from there. With judicious pruning, the savvy advisor can probably cull from today's limited partnership offerings those LPs that provide a reliable monthly income stream. But with the exception of low-income housing LPs and managed futures, time may be better spent exploring less hair-pulling investment options.

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