Limited Partnerships : Being a Landlord Without Hassles
If you like the idea of investing in real estate but don’t like all the management responsibilities it entails, a good alternative might be investing in a publicly held real estate limited partnership.
Partnerships pool investors’ money and use the cash to build or buy apartments, office buildings, warehouses or other types of income-producing property. The company that puts the deal together is known as the sponsor or syndicator and serves as its general partner.
If you buy shares in the partnership, you become a limited partner. A minimum investment of $5,000 is usually required, although a growing number of these ventures will let you in for $1,000 or less.
Offers Diversification
Investing in a limited partnership provides you with several benefits you wouldn’t enjoy if you purchased an apartment or office building directly.
First, there’s diversification: Instead of owning just one piece of property yourself, a partnership gives you a stake in a portfolio of several different properties. It also takes far less cash to get into a partnership than it does to make a down-payment on a single piece of real estate.
In addition, the general partner--not you--will handle all the details of finding and managing properties. And, if the partnership is sued or goes bankrupt, the most you can lose is the money you’ve already invested.
On the downside, much of the cash you invest--sometimes more than 20%--is eaten up by various fees and commissions. And, importantly, your shares will be difficult to sell if you want to get out before the partnership sells its properties and dissolves. Even if you can find a buyer for your “used” shares, you’ll have to sell them at a minimum 25% discount.
If you’re thinking of buying shares in a partnership, you’ll first want to meet with a stock broker or financial planner experienced in selling partnership shares.
The Securities and Exchange Commission requires these professionals to meet “due diligence” standards, which means that they must determine whether buying shares makes sense for your overall financial position and investment goals. If it does, they must then help you to determine which partnership is best for you.
Information in Prospectus
In order to evaluate a partnership, you’ll need to obtain the offering’s prospectus. It contains information about fees, the background of the general partners and how their previous investments have fared. In most cases, the prospectus will also state the types of properties the fund expects to build or purchase.
The fees a sponsor takes out to cover its acquisition costs and other charges usually range from 10% to 20%. “If the fees are more than 20%, the company will have to give me a real good reason for it,” says Robert H. Gardner, a financial planner in the Woodland Hills office of Christopher Weil & Co.
A growing number of syndicators are keeping their front-end fees down, but are allowed to take a larger amount of the profit when the properties are sold if the investment fares better than anticipated.
This type of arrangement often works out well for the limited partners, because it reduces their costs during the holding period and gives the general partner an incentive to get the most out of buildings in the portfolio.
One of the most popular forms of partnerships being offered today buy or build on an all-cash basis. Since they borrow no money, the portfolios of these unleveraged partnerships tend to have a positive cash flow almost immediately. They also reduce the risk of foreclosures and eliminate loan fees and other expenses associated with financing.
Partnerships that borrow large amounts of money, on the other hand, can take months or years before their portfolios began turning a profit because they must first get rents up to a level that covers their monthly mortgage expenses.
The primary disadvantage to investing in an all-cash partnership is that its lack of leverage reduces your potential return on resale profits.
For example, a $200,000 building that was purchased for cash and was later sold for $240,000 would provide investors with a return of 20% from appreciation. Had the partnership made a 20% down-payment of $40,000 on the property and financed the rest, the return would have been 100%.
Check on Record
Regardless of whether the partnership is leveraged or unleveraged, it’s imperative that you check out the sponsor’s “track record.”
The SEC requires sponsors of public partnerships to include information about how their past deals have performed in the prospectus. If the sponsor’s previous partnerships are doing poorly, there’s a good chance the current offering will flop, too.
The prospectus should also contain information about the general partner’s officers and directors. Some financial experts suggest investing in partnerships that are run by people who have had at least 10 years of experience in the partnership business, in part because they have lived through a full boom-bust-boom real estate cycle.
You might want to supplement your own research with information published by two East Coast firms. Both the Partnership Record, published by Southport, Conn.-based Southport Advisors, and the Stanger Register in Shrewsbury, N.J., rate current offerings based on their risk and fee structure.
There’s no real consensus about what type of properties make the best investment. William Brennan, editor of Valley Forge, Pa.-based financial newsletter Brennan Reports, favors partnerships that buy existing buildings that are already leased because new projects may have problems finding renters.
Hal Katersky, president of Woodland Hills-based syndicator Katersky Financial, prefers shopping centers because their good cash flow is being boosted by high levels of consumer spending.
Others favor partnerships that act like banks, raising cash from the limited partners and lending on various types of property. Investors get interest income as the loan is repaid, and many of them also offer a chunk of the properties’ appreciation when they are sold.
In a relatively new twist to the partnership business, a handful of firms are buying “used” partnership shares from investors, pooling them, and then selling shares in those pools to new investors. Lawrence A. Krause, president of a San Francisco-based financial planning firm that bears his name, thinks these “repackaged” partnerships can be good investments.
“When you buy these repackaged shares, you know exactly what you’re getting,” Krause says. “You know which properties are in the portfolio, and how they’re performing. And all those enormous start-up fees have been paid for by the original investors.”
Krause says the returns from these partnerships often outperform results of newer offerings, and that their risks are relatively low.
Some experts are bullish on “vulture funds” that plan to snap up financially ailing properties at bargain-basement prices and sell them several years later for large profits. But those partnerships can be unusually risky, and their investors will have to be patient.
“There are some really good bargains out there, but it could take years before the really bad markets turn around,” says Lon Carlston, senior editor at Stephen Roulac & Co., a San Francisco-based firm that tracks the syndication business.
Regardless of which type of property a partnership buys, be wary of any sponsor who is promising big tax write-offs from your investment.
“For all intents and purposes, partnerships that allowed you to write off $3 or $4 for each dollar you invested are dead,” says Nicholas S. Patin, national marketing director for Emeryville, Calif-based syndicator Johnstown/Consolidated Capital. “Tax reform really cracked down on the pure tax shelter deals.”
Even if a partnership generated large losses, Patin adds, it’s doubtful investors would get to deduct them on their tax return. Under the new tax law, losses generated by most partnership investments can’t be written off unless you receive income from another partnership that is making money.
But while most current offerings don’t promise excessive tax breaks, you can still reap some tax benefits through the depreciation of the property. At the end of each year, the sponsor will send you a “K-1” form that tells you how much your investment earned and the amount of write-offs you can claim on your tax return.
Generally, even conservative limited partnerships will allow you to shelter at least 30% of your partnership-related income over the life of the investment.
Many people buy partnership shares for their tax-advantaged Individual Retirement Accounts or Keogh plans. Reid G. Samuelson, president of Los Angeles-based T. Rowe Price Realty Advisers, says more than half of the 33,000 investors in the two partnerships his firm has sponsored placed their shares in retirement accounts.
“Partnerships and IRAs are well-suited for each other because they’re both long-term investments,” Samuelson says. He notes that the income from a partnership can grow tax deferred inside a retirement account, and so can gains from the sale of properties.
The key to successfully investing in a real estate partnership lies in your ability to match the partnership’s goals with your own investment objectives.
If you want immediate income and don’t want to take much risk, buying shares in an all-cash deal that will buy leased-up buildings may be your best bet. If you’re willing to take a bigger risk for a potentially larger return, consider buying shares in a program that will erect new buildings or will buy structures in areas currently depressed by economic difficulties or overbuilding.
“When it comes right down to it, there’s just not a good surrogate for investing in real estate,” says Samuelson. Nor is there a substitute for doing your own homework if you’re pondering any type of real estate investment.
