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.
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.