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."
LPs: The Next Generation
If the LP market is so dire, where's the opportunity? Ask Jim Carroll, a planner at Investment Resource Center in Albany, New York. About 20% of his clients are in limited partnerships, Carroll says, and very few of them had such investments before they came to him. "My clients range from blue collar to doctors and lawyers and accountants and business owners," he says. "They're across the board in partnerships. The dollar amounts that they invest will vary, depending on their economic status," but he finds LPs suit their portfolios, for a number of reasons.
"They're very reliable investments," he says. "The due diligence on the broker/dealer's part [his B/D is Hornor, Townsend & Kent] is really tight, and the regulations are tight." He points out that there are criteria that must be considered before a client is approved for an LP investment. "You have to go by suitability," says Carroll. "They're not necessarily accredited investors, but they have to meet certain suitability requirements. Each partnership has its own set of rules, depending on what state you're in, but most B/Ds have more stringent rules beyond that."
So, say a client meets the requirements. What does he use and how does he use it? "I own eight, maybe nine different partnerships myself," says Carroll. "I rarely recommend anything I don't already own." But the three that he uses most are ATEL, an equipment leasing LP; Petroleum Devel- opment Corp. (PDC), which looks for domestic sources of oil and natural gas; and Boston Capital, which provides tax credits for affordable housing for the elderly. This is no new strategy for him, either; he's been using PDC since 1992, Boston Capital since 1993, and ATEL since 1997.
As to how Carroll uses them, he points out that "ATEL, for example, has a steady flow of cash right away. Petroleum Development, too; always a check. Boston Capital? The Treasury Department administers the credit program. Once credits are assigned to the property, as long as the landlord adheres to the program, those credits are there. You can count on those for a tax reduction every year." It depends, of course, on the individual client's needs, but "I find them to be a vehicle to diversify [client portfolios]," he says, "and as we've seen over the last couple of years, diversification is very important. Some of these [LPs] are such that they don't move with the stock market, and that's something many people are interested in these days--and rightfully so."
How It Works
It's obvious that Carroll enjoys using LPs to solve his clients' problems. "They all have a unique product and fill a different need," he points out happily. "I have a few clients who have used them all and some who just use some and some who use none," he adds, lest one think that LPs are the answer to all his clients' planning needs. He knows the LPs he uses inside and out, and can recite pertinent information as quickly as a sports fan can give you a player's vital statistics.
"For example," he begins, "with ATEL, they're leasing equipment to Fortune 1000 companies--GE, Campbell's Soup, Kraft, all large companies. There are tax advantages to anyone who gets into these. People consider partnerships to be risky, but the interesting thing about equipment leasing, for example is that if you are an investor in ATEL, as a lessor you stand in front of the bondholders [if there is a claim]. So GE bondholders get behind you. There's definitely an advantage there. It also acts as an inflation hedge, because when they ultimately sell the equipment, they sell at fair market value."
This could be a double-edged sword, if you listen to the cautionary words of other industry experts, who point out that the equipment is aging and therefore losing value. However, that's not the sole reason that Carroll uses these LPs. "Recovery of your money is really quick with that program," he asserts. "They're paying out at nine percent [per year], and for the first six years there's no tax."
Another strategy that Carroll uses is balancing passive losses with passive income. "For example, someone has Boston Capital, which most people get into for tax credits, but it also generates passive losses. Most people never get to use passive losses; they're happy enough with the tax credit. But if you combine Boston Capital with ATEL, for example, the passive losses and gains cancel each other out. There are many things that can be done with these that can enhance a portfolio. Payouts on ATEL can be used for 529 plans, or long-term care insurance, or generation skipping, or gifting."
The first place Carroll looks, he says, when he meets a new client is the tax return. "You can tell pretty quickly where they need help, and where you can give them some relief," he says. "An acute tax problem, tax from a sale, can put them in a higher bracket; it can be devastating. They lose deducting exemptions, pay more tax on Social Security, get disqualified for IRAs, on and on. If you find someone in a situation like that, Petroleum Development will fit the bill; you get an 89.5% writeoff for the first year." (See sidebar on page 107 for an example of how Carroll uses these LPs.)
LPs make Carroll's practice more interesting. "I really enjoy using partnerships," he says. "It's a value-added option and distinguishes me as a true planner. It requires more hands-on work, but I enjoy working with my clients." He points out, too, that the partnerships themselves appeal to his clients: "Many of my clients are older, and so affordable housing for the elderly is something of interest to them. It's socially conscious. Many people are turned on by that. Looking for sources of petroleum and natural gas reduces our dependence on foreign oil and expands the cleanest energy source we have, so that's appealing. They're all looking to reduce taxes and make money, but if they can do something good for the country as a whole, it's an added bonus."
If partnerships are carefully reviewed and their benefits matched properly with a client's needs, they still have a place in today's portfolio.