From the June 2004 issue of Investment Advisor • Subscribe!

June 1, 2004

A Rocky Ride

Limited partnerships, a once popular investment vehicle initially created to help investors avoid paying taxes, and a vehicle used to retain high broker transaction fees, has become a diversification dinosaur that many believe will disappear completely in the next decade.

With primary partnerships (publicly traded offerings) and secondary partnerships (private offerings sold in some cases as a result of death or divorce) no longer being thought of as primary investment options, the state of the industry is somewhat up for debate.

"In every industry, there are highs and lows. Tax law changes caused limited partnership investments to fall out of favor with investors and their advisors, and many partnerships began to fail," Neal Buckley, sales manager of Englewood, Colorado-based American Partnership Board, a secondary market broker, told us via e-mail. "While the stronger partnerships survived, limited partnerships . . . never truly recovered as an investment."

A Fading Raison d'?tre?

Larger players in the primary market such as CNL, Wells Limited Partnerships, WP Carey, and Boston Capital all provide public offering and tax credit funds for anyone to invest in. But for those dealing in the secondary market, these larger investments no longer seem to make much sense.

Limited partnerships were never an efficient investment vehicle, says Dan Foreit, owner of A-1 Partnership Service Network in Indian Rocks Beach, Florida, a private LP placement broker. "I don't think they ever were. Historically, the reason they put them together was to avoid paying taxes." Currently Foreit only deals in the secondary market and works with a very small staff.

"I don't think they should ever resurrect the partnership format," Foreit says. "It is too illiquid. It's great for you and your ten doctor friends to buy a building somewhere in town and all live there," he says. "But to parcel it out to the large wirehouses across the country makes no sense at all."

"I deal with secondary level people waiting to trade, waiting for sellers, death, and divorce," he continues. "That industry is shrinking. LPs created such a huge bubble in the 1980s, sat on it for a while, and then in the mid- to late-1990s started trading and people were sick of it."

Many brokers [in the secondary market] really don't care what they are buying and what they are selling, Foreit says. As long as they make their transaction fee and get their percentage they are happy. "I evaluate every single thing that I purchase. If I am buying it, it is because I want it. If I don't want it, I don't deal with it," he says. "Now we are seeing that a lot of it has been moved, or consolidated, or it is coming full term and getting sold out and paid back."

Paul Frain, owner of Frain Asset Management, in Seminole, Florida, agrees with Foreit that secondary markets hold more opportunity for investors than the primary markets. As a secondary market maker for all publicly traded partnership units--typically in oil, gas, real estate, cable television, equipment leasing, and tax credits--he says that because he trades LPs at discounts, there are some good opportunities for investors. "You are buying an investment that is already invested, so you know what the portfolio consists of," says Frain. "You know what the risk, net asset value, and earned cash flow are, and you are buying it at a discount. So it is actually a lower-risk type of investing."

Primary Concerns

As far as the primary issues, Frain says, it is hard to justify having a client buy a new fund that hasn't invested anything yet, is not producing any cash flows, but does provide an average 20% to 25% for broker and other various fees and commissions.

"It still is a tax credit and people need these credits," he continues. "If you can't find them on the secondary market, then the only thing you can do is go to the primary. To be honest, if you look at what is going on with [some of the larger players like WP Carey, Wells' Real Estate, and CNL], they have had huge years raising capital because the REIT market has done so well."

The old limited partnership name has been dragged through the mud, Foreit adds. "But larger traders are still raising money hand over fist with plain vanilla AAA and triple net lease real estate deals. All they did was put a new title on their limited partnerships and call them LLCs," he says, "but I don't think they are doing anything risky." Foreit recalls in the past hearing of some off-the-wall real estate LPs in "ostrich farms, bull sperm, and all kinds of other weird stuff."

"Everybody in my business has thought our time was limited because all the partnerships we traded were going to fall by the wayside and liquidate or become public," says Laurie Miller, owner, president, and licensed securities principal of Alliance Partnership Services in El Cerrito, Calif. Amazingly enough, however, she says it feels like there are more partnerships out there. "It depends on what you focus on. If you are focusing on the big flight of public deals, which are easy to work with, you don't think about the private deals. When there aren't as many public deals, you put a little more effort into the private deals and try to make business there."

What's Ahead

Although Miller doesn't deal with any partnerships directly--she only maintains a database of buyers, sellers, and pricing--she believes the secondary market will continue though the volume has gone down quite a bit (see sidebar, "Trading Down," below left). "There is less product, fewer units traded, and there aren't quite as many players," she says. "I don't think LPs are on their way out and some of the big [players] like Wells continue to put new deals together."

As the industry continues to consolidate--DCC Securities was acquired by Miller's Alliance Partnership Services last April--all secondary market traders feel the change. "The change that affected us the most was the closing of DCC Securities from the secondary market of limited partnership trading," American Partnership's Buckley said via e-mail. "There aren't many places left to trade LPs on the secondary market, and when one closes it affects everyone left. In the market, a lot of the consolidations and closures are just the marketplace making itself more efficient."

However, Buckley believes that "the industry is stabilizing now and we may see some slight growth. On the other hand, the private REIT market has experienced a tremendous amount of growth in the past year, and that trend is expected to continue in the near future."

Megan L. Fowler writes about business issues from Fairbanks, Alaska. She can be reached at mlfr@magwriter.com.

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