Even as interest rates continue to rise and some experts predict that the next economic downturn is on its way, many eager investors are still putting their money to work in tight financial markets, searching for yield wherever they can. Asset classes that had been overlooked in recent times have been showing up again on investors’ radar screens, and some, like the limited partnership (LP), which had pretty much fallen by the wayside, are being reinvented and revamped, such that they are once again figuring in the menus of available investment options for some clients.
While the traditional LP structures of the late 1970s and 1980s still exist (albeit in greatly reduced numbers), trading in small volumes in a quiet secondary market, many investors today are setting their sights on a new kind of LP product: The untraded real estate investment trust, or REIT, is a structure that market players describe as essentially a new avatar of the LP of yore. It has overshadowed such traditional LP sectors as energy and equipment leasing, as well as other sectors, such as cable television, that had their day in the sun, too.
For all intents and purposes, the untraded REIT has completely replaced the old-fashioned real estate LP of the 1980s, and the products have raised about $20 billion in the past three years, experts say. Those who are familiar with the structure say it makes for a good investment option, not least because an untraded REIT pays high dividends and offers investors initial yields on their equity contributions ranging anywhere from 6% to 8%. These investments can be particularly attractive to the baby boomer generation, since their focus is more on income than total returns.
From 2003 onward, there has been a spate of untraded REIT deals, many of which were put together by such well-known players in the partnership business as W.P Carey, Inland Real Estate, and Wells Real Estate. The untraded REIT–which, unlike its public REIT counterpart, does not trade on an exchange–offers investors the chance to buy into an asset class that is more typically associated with larger, institutional real estate players. Investors can reap the benefits of investing in real estate without having to deal with the hassles of property management.
These untraded REITs provide attractive returns and opportunities for even the most ordinary of investors to put their money into the fixed asset that is real estate. Beyond that, these structures are also popular because they are very different from the LPs of the 1980s, which largely served as tax shelters for wealthy investors. Those LPS often were structured without economic foresight, were unfairly skewed toward the benefit of the general partner (GP), and commanded exorbitantly high front-end fees from investors.
Today’s REITs, by contrast, require GPs to be a lot more accountable than they were in the past, and while they do not trade publicly at inception, many untraded REITs have in their mandate a provision to either list on an exchange in a given period of time, or liquidate entirely. Those mandates mark a clear change from the structures of the 1980s, and represent attempts to address both the historic lack of secondary market trading in the LP asset class, and to make these investments more attractive to a broader range of investors, particularly the income-oriented.
The increased volume of investments in non-traded REITs has also enabled deal sponsors to reduce both sponsorship fees and brokerage commissions–another huge change from the 1980s, and a big incentive to investors. Despite all the positive changes that have taken place, many people still wonder whether untraded REITs will last as a viable and attractive investment option within the panoply of investment choices available today, or if they will unwind in the same manner as their LP predecessors of the 1980s, and simply disappear from view.
Thus far, it is too early to tell, say experts like Jack Hollander, chairman of the Investment Program Association (IPA), the national trade association representing the interests of investors in non-traded investment programs including partnerships, non-traded REITs, and limited liability companies. The cycle of new LP-style deals is really only just beginning, he says, but it is nevertheless clear that people are keener on untraded REITs than any other kind of LP deal, and want to see them go through a full cycle in order to fully assess their worth as durable investment options.
“The more people see these things perform, the greater the chance they have to appeal to a broader base of investors,” Hollander says.
The appeal, though, is already evident, experts say. According to data from Fiserv Investment Support Services, a company formed from the union of the four largest trust companies in the nation, approximately 91,000 investors held 61,000 LP positions at the end of 2003, representing $2.5 billion, or 17%, of Fiserv’s total holdings (the firm does not distinguish between SEC-registered LPs and exchange-traded structures). While at the end of 2004 the number of positions decreased to 53,000 and the number of LP owners declined drastically to 3,619, the value of LP assets in trust increased to $3 billion, which once again represented 17% of Fiserv’s total holdings.
“Because we are still holding the same percentage value, and because there has been an increase in dollar terms of the assets we hold in trust, we can see that there is still an interest in LPs, even though the number of holders has dropped off,” says Carol Gillet, VP of client relations for Fiserv. “While some clients are getting out of LPs, others are replacing the older ones that have little or no value with newer, more viable LPs.”
Not Your Father’s LPs
Undoubtedly the renewed interest level in LPs, in particular non-traded REITs, represents a sea change from the 1990s, when limited partnerships of every kind were well off the radar screen of most investors. Indeed, even before the soaring popularity of glitzy technology stocks completely overshadowed the potential appeal of other investment options, LPs were a tainted asset class that rapidly went out of style after the tax code was changed in 1986, and after many highly leveraged deals, set up purely for investors to write off as losses against their income, completely soured.
“You saw a crazy period of fundraising between 1982 and 1986, and then everything ground to a halt when the real estate market went into the tank,” recalls Spencer Jeffries, editor of Direct Investments Spectrum (a monthly newsletter that covers direct investment programs), who has been a keen observer of the limited partnership market for the past 20 years. “There were so many bad deals that went out and bought real estate at the top of the market that when it cratered, deals that had taken on a lot of debt just collapsed. As the recession wore on into the 1990s and real estate continued to suffer, people just lost interest in these deals.”
While a secondary market for LPs did evolve and, to a certain extent, flourish in the late 1980s and into the 1990s, thereby allowing those who wanted to rid themselves of their limited partnership holdings to do so, the volume of trades has steadily declined through the years (Investment Advisor has continued to track these trades through the secondary markets, however, even as trading volume dropped. Monthly trades and average prices for legacy limited partnerships sold on the secondary markets are available online at www.investmentadvisor.com.)