Limited Returns

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

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.