Scrutinize Real Estate Partnerships Closely

Severe financial problems at Integrated Resources, one of the nation’s largest sponsors of real estate limited partnerships, have added new woes to an already shellshocked partnership industry and highlight the need for you to take special care when buying those potentially lucrative but risky vehicles.

Limited partnerships provide income, capital gains and possible tax benefits by pooling your money with that of other investors to buy real estate or other assets managed by a general partner. The most popular have been real estate limited partnerships, which allow you to invest in shopping centers, apartment complexes, warehouses or other commercial real estate for as little as $5,000. In good markets they have the potential to earn higher returns than Treasury bills or certificates of deposit in exchange for a bit more risk.

But limited partnerships lost some of their tax benefits in the 1986 tax reform act. That in turn helped trigger the problems at Integrated Resources. The New York-based firm tried to recast itself as a seller of mutual funds and other investments, but in the process it took on huge debt. Last week it defaulted on nearly $1 billion of that debt, and its stock price has plummeted 70% in the past week.

The partnership industry’s problems are not limited to Integrated. Several other major sponsors--including Southmark, Equitec, Balcor and Consolidated Capital--have also suffered financial woes in recent years, in some cases stemming from poor investments in real estate.

Their woes may not necessarily affect their already existing partnerships since those are separate entities and thus not subject to the sponsor’s financial liabilities. Nonetheless, a sponsor’s problems could reduce its ability to monitor and support its partnerships.

If these woes aren’t enough, sales of public real estate partnerships so far this year are off 40% from last year’s pace, according to Robert A. Stanger & Co., a Shrewsbury, N.J., firm. That is due in part to the negative publicity surrounding industry troubles, and fears that a recession may make things worse. It also stems from the 8% current yields promised by new offerings, causing investors to flock to superior returns on Treasury securities, money market funds and certificates of deposit.

Also, returns on many already issued partnerships have turned out to be disappointing, with some likely to result in losses for investors. That has angered investors and is causing mounting headaches and lawsuits at brokerages such as Shearson Lehman Hutton that aggressively marketed the deals, sometimes to investors who didn’t know what they were getting into.

“We’re in a nationwide real estate recession,” says Larry Hales, president of Springhill Financial Services, a Glendale investment adviser. “Prices are dropping like crazy in office buildings, shopping centers, apartment complexes, nursing homes.”

The only exception, Hales says, seems to be in Southern California, but rental rates on commercial buildings are going down while prices are going up, he notes.

Analysts are split on whether the worst is over. Hales contends that it is not. He and others say that current problems in real estate are only the tip of the iceberg and that many partnerships are being kept afloat only by capital infusions from sponsors or by their willingness to forgo management and other fees.

Furhman Nettles, a vice president at Stanger, disagrees. He says real estate runs in 10-year cycles and we “should be at the bottom now. We are beginning to see declines in vacancy rates in Sun Belt areas such as Houston and Dallas and upturns in rents.”

He notes that the last time real estate bottomed was in about 1978, and the last top was in 1986. “It’s always darkest just before the dawn,” he says.

Of course, there are no guarantees to either forecast. But if you still want more real estate in your portfolio, you can find partnerships that are not so risky, says William F. Brennan, partner in the Washington office of Ernst & Whinney.

Although their current 8% returns from rental income seem low, they still have the potential of capital gains through appreciation in the value of properties. And you can still get some modest tax benefits such as depreciation writeoffs.

Up-front sales fees, which used to be 30% on average, are still high but now are closer to 20% range, Nettles says. (That means that only 80 cents of your initial dollar goes to work for you.) Some sponsors also are including insurance or other guarantees to protect your investment from loss, just like insurance offered on municipal bonds. Sponsors also are providing greater disclosure through more regular evaluations and appraisals once an offering is sold.

Some also are offering increased liquidity through programs that permit investors to sell their investment after specific time periods. Or the general partner may periodically repurchase shares.

Still, however, the key is to shop carefully.

When buying a new partnership, look for strong management from the general partner. How long has it been in business? If it’s less than five years, be cautious. What is its track record? What is its experience in real estate? What is its financial strength? Does it have much debt? A clean bill of health from its auditors?

Find this information in the prospectus or ask your broker to research it for you.

Also, at least three firms rate public limited partnerships.

They include Robert A. Stanger & Co., 1129 Broad St., Shrewsbury, N.J. 07701 (201-389-3600); Southport Advisors, 1300 Post Road, Fairfield, Conn. 06430 (203-254-0510), and Standard & Poor’s, 25 Broadway, New York, N.Y. 10004 (212-208-1514).

More shopping tips can also be found in the Investor’s Guide to Limited Partnerships, a $5 booklet available from the Investment Partnership Assn., Suite 500, 1100 Connecticut Ave., Washington 20036, or by calling 202-775-9750.

Another tip: If you are risk averse, stick to publicly offered partnerships with debt levels below 50% (meaning they buy their properties with at least a 50% down payment). Many of the partnerships with the worst problems in recent years were so-called private placement partnerships sold to wealthy individuals. They took on high debts to provide tax benefits that were since slashed under tax reform.

Low-debt partnerships promise somewhat less potential profits, but they can better ride out slumps since they won’t have the overhang of heavy interest payments, Brennan says.

However, some experts say you can find better deals in the growing secondary market for already existing partnerships. Although you may pay a high commission to a market maker or broker, they generally aren’t as high as up-front sales fees on new offerings, Hales says. These partnerships will sell for far less than their original price.

And you’ll have some idea of the track record of the partnership, and its dividend payments are more likely to have started, Hales says.

Entities that buy and sell already issued partnerships include Partnership Securities Exchange in San Francisco (415-763-5555), Equity Resources in Boston (617-876-4800), Raymond James in Florida (800-248-8863), Liquidity Funding in San Francisco (415-652-1462), and Springhill Financial (818-507-0975). Many other brokerages and small trading firms also deal in partnerships.

But be careful. Prices vary widely because trading is so thin. Call them all and get the best price you can.