INVESTMENT OUTLOOK : ASSESSING THE MAJOR MARKETS : Caution Advised for Limited Partnerships : Investors Shift Their Focus to Steady Income

Few investments carry a worse reputation these days than the limited partnership. Tax-law changes, troubles at many partnerships and the resulting bad publicity have sent partnership sales tumbling the past two years, notably in real estate partnerships--the industry’s biggest player.

Don’t look for partnerships to disappear in the 1990s, though. But they will likely shift toward providing steady income rather than promising a large payoff upon dissolution.

Limited partnerships pool money from investors--the limited partners--to buy real estate, oil rigs or other assets to earn income, capital gains and selected tax benefits. Run by a general partner, they typically last seven to 10 years before their assets are sold, and they are dissolved.

Ideally, limited partnerships should provide above-average returns for such a long use of investors’ money--and hopefully offer a big payoff at the end by selling appreciated assets.

Roughly $100 billion of partnerships already exist, and investors pumped an additional $5.6 billion into public partnerships alone in the first nine months of 1989, although that was down 25% from $7.5 billion a year earlier, said Robert A. Stanger & Co., a Shrewsbury, N.J., firm that tracks partnerships.

The industry’s woes--analysts say 5% to 10% are in trouble--are putting pressure on partnership organizers, or sponsors, to find high-quality assets or cut fees in an attempt to gain new investors. They can no longer rely on the appeal of tax benefits, which spurred the initial popularity of partnerships in the early 1980s but were mostly swept away by the 1986 tax reform law. Borrowing heavily to buy the assets also is losing favor.

“Now you’re seeing people putting together deals based on economics and not taxes,” said Frank R. Pope, general partner of Technology Funding, a San Mateo firm that has organized 10 partnerships to raise $210 million for fledgling technology firms.

Nevertheless, don’t count on these predictions coming true if you’re considering partnership investments today, experts said. Their advice: proceed cautiously.

“Do they need to clean up their act? You bet they do,” Paul T. Green, president of Southport Advisors Inc., a Southport, Conn., partnership research firm, said of partnership sponsors. To date, too many sponsors operated “by the seat of the pants, and I have to believe they did a lot of acquisitions in the seat-of-the-pants fashion.”

He recommends studying a sponsor’s track record to see how their earlier deals performed. Check to see how much debt the partnership plans to incur; high leverage might afford a bigger portfolio, but it also could swamp the partnership with interest costs.

And ask a lot of questions. Green said he has been “taken aback” by how some partnership officials were “not as good at putting their fingers on the kind of information that any prudent investor or investment adviser would look at.”

Recent sales figures indicate that investors are less willing to plunge into real estate or energy based on a sponsor’s promise that the assets will appreciate and provide a fat return years down the road. They want steady income now, such as from equipment leasing.

Investors “are less interested in a promise of long-term significant capital gains,” said Christopher L. Davis, president of the Investment Partnership Assn., the industry’s trade group.

In the first nine months of this year, equipment-leasing partnership sales rose 19%, to $987.3 million from $832.3 million, Stanger reports. But real estate partnerships, which account for 51% of total partnership sales, plunged 45% to $2.14 billion from $3.85 billion after skidding 24% in 1988.

Investors have shied away from partnerships because assets in many of these deals actually dropped in value or did not have the income streams their sponsors predicted. Many, particularly in the early 1980s, bought Sun Belt real estate or energy assets that took a drubbing, depriving the partnerships of income. That left some partnerships yielding annual returns of 6% to 7%, about what investors could get with municipal bonds or money market funds.

Yet, frustrated investors can easily sell the bonds or money fund shares. Partnerships, in contrast, attract few buyers in a limited secondary market, and even then the sellers usually must stomach a huge discount--perhaps 50% or more--from what they originally paid. Experts say it might be wiser to ride out a struggling partnership in the hope it improves.

Moreover, many of the early partnerships “were admittedly done for tax purposes,” Davis said. Money was poured into shaky deals to generate losses, and attendant tax credits, that could offset other investment gains.

The result: The partnership trade group estimates that up to $3 billion of public partnerships and $2 billion of private deals are in trouble, meaning they are withholding or cutting payments to their partners, renegotiating their debts or simply filing bankruptcy. That represents 6% of the partnerships sold since 1983, but some analysts think up to 10% of the deals are ailing.

(Private partnerships are designed mainly for well-heeled investors and do not file their plans with the Securities and Exchange Commission. Public partnerships, requiring investments of as little as $5,000 and peddled by major brokerage houses, do make SEC filings.)

With partnership sales under pressure, look for some sponsors to shave their up-front fees to draw in more investors. Sponsors to date have collected fees totaling 15% to 30% of each partner’s investment, enabling the organizers to prosper even if their partnerships ran into problems.

“We’ve had some pretty hefty fees in these deals,” said William G. Brennan, a partner at the accounting firm Ernst & Young in Washington. With smaller fees, he said, sponsors will be forced to find properties that are financially solid and thus “will make everyone’s performance contingent on the performance of the partnership.”

RISE AND FALL OF LIMITED PARTNERSHIPS Annual sales of public limited partnerships, which invest in such areas as real estate, energy and equipment leasing and typically last seven to 10 years before they are dissolved.

1987: 413.5 billion

Source: Robert A. Stanger & Co.