After the Tax Reform Act of 1986 gave most limited partnerships a bad name and caused the bottom to drop out of the tax shelter market, you practically couldn’t give LP shares away. Tables in Investment Advisor (now available on our Web site, www.investmentadvisor.com) tracked the secondary market prices for the dratted things for years as original unit prices of hundreds and thousands of dollars were replaced by highs and lows of not hundreds, sometimes not even tens of dollars, but single dollars and occasionally only cents. This made many people unhappy, many advisors unpopular, and many clients much less well off. Many of those old partnerships have been limping slowly along toward a natural demise, with investors unwilling or unable to extricate themselves as losses mounted; advisors have been trying to make the best of this bad situation for years.
Despite this bleak state of affairs, there are a few changes on the horizon. Nothing major, but there are times and places when and where clients should invest in LPs.
The Plus Side
Some share prices of older LPs are on the way up, and some have risen higher than their original issue price. “I think the supply is dwindling and the demand has increased, which actually makes it more competitive pricing-wise,” says Angelo Ragone, president of New York Asset Exchange in Sarasota, Florida, which values, appraises, and resells shares in various illiquid assets, including LPs. “We’ve actually seen the discounts [from original issue price] drop from a high of 48% in 1994 down to 28% [today]. I think two things have happened: Supply and demand, and partnerships are liquidating.”
Supply and demand? How can that be, for something like LPs that have been reviled for so many years? There are several factors to consider, Ragone argues. One is that partnerships in the process of liquidation are managing to do so at a higher value than shareholders originally anticipated. This increases the share price on other partnerships still out there, as people anticipate a higher return on those LPs. “If you look at a portfolio of assets,” says Ragone, “and they start liquidating some of those assets on the high side of expectations, it will encourage the buyers to pay up the next time they [partnership shares] come around [for sale].”
Add to that the fact that some brokers, Ragone says, “hustling to make money,” are looking for “buyers who are much more competitive. There’s actually been a big disparity,” he points out. “In the beginning, you’d see all these people who’d try to lowball and buy [partnership shares].” Now, however, with improved prospects for returns in the offing, there’s actually a market for shares of increasing value.
Another factor is general partners who are “proactive in liquidating assets.” This, says Ragone, “has really brought the market up.” One of the chief disadvantages of LPs has, of course, been the fact that funds are tied up for indefinite periods. Anticipation of liquidation improves the price–”Lack of liquidity probably accounts for at least 65% of the discount [on share prices],” notes Ragone. The general partners who are liquidating assets will cause prices to rise on their other partnerships, says Ragone. As partnerships begin to discuss exit strategies and plan for liquidation, he says, share prices go up. And “there are proposed roll-ups going on with some of the corporate property associate partnerships, which has helped to increase the value of the partnerships because they’re an exit strategy,” he points out.
This is where his second factor comes in. As partnerships liquidate and the number of shares on the market goes down, the ones left may rise in price.
The Market Is Downsizing
A good and bad thing about the LP market is that it is shrinking. While raising the price for some of the shares on the market (a minority of them, according to most industry experts we spoke with), the shrinkage is simply a sign that the old LPs are going away. As one source, an executive with one of the secondary market firms for LPs, says, “Prices have dropped simply because the assets in the partnerships are getting old and losing value.” The number of transactions may remain the same, but prices are trending lower. Prices are going down across the board, said the executive, who requested anonymity, but there are upsurges in trading activity at various times. “When the real estate market is hot, real estate shares go up. Tax credit programs are popular around tax season, when [investors] think they can use them or when they realize they don’t need them any more.”
The volume of tender offers has slowed down quite a bit from three years ago as well, according to Lori Sarian, a registered rep of North Coast Securities Corp. in Delray Beach, Florida, another firm that serves as a marketplace for LPs. “Entities that were doing a hundred [tender] offerings a month are now doing maybe thirty or forty. With the decrease in tender offers, sales [on the regular secondary market for LPs] have picked up. It’s not astronomical–probably two or three trades a month that I wouldn’t have seen before.”
One of the reasons the LP market is going away, Sarian believes, is the greater prevalence of Regulation D offerings, the SEC-regulated private placements open to qualified investors. “I read somewhere a couple of years ago,” she says, “that the IRS believes there are over three million Reg. D offerings. That’s where angel money comes into play. You have a few investors and not much expenses. You don’t have to file anything.” Not, she points out, that the Reg. D offerings are raising as much money as LPs did in the 1980s, but she theorizes that if you add them all together, “for investors whose portfolio is adequate for a little risk capital, private placements are filling the void.”
“I don’t know if those numbers [the three million Reg. D offerings] are accurate,” she says, “but every day I see two or three private placements that I never saw before. I know there are a lot of new Reg. D offerings out there.”