8% Payouts with Acceptable Risk – RELPs

Publicly registered, thinly traded real estate limited partnerships (RELPs) can provide attractive income with safety to the small investor. These are perhaps less risky than buying interests in new limited partnerships.

Generally formed during the 1975-90 real estate boom, RELPs are not corporations, but limited partnerships managed by a general partner. They own income property, such as apartment buildings or storage units, collect rent on them, and pay out some of the profits to their unit-holders (analogous to shareholders). Limited partner unit interests can be purchased, just like shares of common stock, from specialized brokers. Many partnerships pay periodic distributions — analogous to dividends — and the yields can be very attractive, given that the partnerships often sell at substantial discounts to the market value of their assets.

Let’s restate that last point for emphasis: some of these partnerships deliver cash returns of 8% to 10% per year, yet they sell for as much as 20% less than the value of their own assets. It’s like buying a dollar bill for 80 cents, and then collecting interest of 6 cents a year on top of that. “A satisfactory return with adequate safety of principal,” as Benjamin Graham might say.

How can such an opportunity exist? Well, there are a few reasons. First, many of these partnerships are publicly registered, but not listed on any exchange. So you need to hunt around a bit even to find a broker who will help you buy them. Second, once you have them, they’re illiquid — it might take days or weeks to sell them at a fair price. And third, unitholders do not have the same rights as common shareholders. Among other things, the general partner may have special rights, including the ability to wind up the partnership, cancel payouts, et cetera. So this is an area where you really need to do your homework to get good results.

But the results can indeed be good. For example, Public Storage Properties V yielded over 8% to price in 2003, yet sold at a discount of 15% to 20% of its asset value.

Perhaps the biggest risk here would be of overpaying for units. This is the flip side of market inefficiency: because there is no quoted price, an unwary buyer could unwittingly pay much more than intrinsic value. One needs to be able and willing to do basic financial analysis to make such a purchase safely.

Just to be clear, this is completely different from investing in new limited partnerships. Instead, we are talking about buying interests “second-hand” in longstanding partnerships. We make this distinction because there are a lot of promoters out there selling new partnership interests, which are of highly variable quality.

Again, this is a tiny, little-known niche in the investment universe, with a total trading volume in 2003 of well under $100 million. Because the capitalizations are so low, large institutions don’t even look at them — leaving mispricing opportunities for the small income investor willing to do some homework.