PHILADELPHIA — Real estate limited partnerships, the sizzling tax-shelter investment strategy of the early 1980s, are leaving millions of Americans feeling burned as the decade closes.
A victim of its own excesses, overbuilding in major real estate markets and flip-flops in federal tax policies, the real estate limited partnership industry is withering, according to numerous speakers at the Real Estate Securities and Syndication Institute conference here this month. Investment levels have plummeted, leaving the formerly high-flying sponsors of the programs struggling to survive.
Many investors, meanwhile, are just beginning to realize that they will not recoup their money, they could face serious tax consequences and they may be forced to take responsibility for failing real estate ventures--office buildings, apartment complexes, hotels and strip shopping centers--all around the country.
"I think we are viewing the end of an era," Samuel Zell, chairman of the board of Equity Financial & Management Co., a real estate syndication firm, told a glum crowd of limited partnership industry executives.
"It's all directly related to the fact that the real estate industry has played much too great a role in the economics of the country in the last 20 years," said Zell, who compared the situation to the aftermath of the Holland tulip craze in the 17th Century and the South Seas bubble in Great Britain in 1720, two schemes of long ago that attracted widespread investments but later went awry.
Real estate limited partnerships, also known as real estate syndication, first soared in popularity in the early 1980s, propelled by inflation-driven increases in property values during the 1970s.
The federal government made investment in real estate even sweeter in 1981 by enacting the Economic Recovery Tax Act, which dispensed additional incentives. High-income people who invested in real estate could quickly write off expenses and losses against income earned from other sources, while a lower capital gains tax rate meant that subsequent profits would be taxed at a lower rate. Many investors found they could deduct up to $4 for every $1 they invested, and some were able to avoid taxation entirely.
Consequently, real estate limited partnerships became an incredibly attractive investment to millions of American investors.
From 1980 to 1985, the amount of money put into real estate limited partnerships increased six-fold, climbing from about $2 billion in 1980 to $12.7 billion in 1985, according to the investment advisory firm of Robert A. Stanger & Co. Cumulatively, the industry raised about $67.9 billion from 1979 to 1988.
But real estate investing became more popular in other circles as well. Newly deregulated savings and loan institutions, allowed to venture into commercial real estate investments for the first time, launched many projects, as did insurance companies and pension funds.
What resulted was a virtual tidal wave of construction nationwide as cash-flush developers rushed to build, build, build.
By their own admission, few investment sponsors and developers showed much self-restraint during those years, with most of them focusing their efforts on raising as much money as possible and building as much as possible without regard for whether there was demand for the structures they were building and financing.
"If you allow (us) to have as much alcohol as we want, we will get drunk," said Roland D. Freeman, executive vice president for acquisitions of the Hall Financial Group Inc.
The underlying overbuilding problem was exacerbated in 1986 when the federal government abruptly reversed its tax policies, stripping many real estate investors of quick write-offs and the ability to deduct expenses against income earned from other sources.
The loss of the tax benefits combined with overbuilding to drive down real estate prices. Rents had already plummeted as competition for tenants increased, which translated to lower investment returns.
In some cases, property owners were unable to attract any tenants and buildings remained vacant, so-called see-through buildings.
At this point it is unclear how many real estate partnerships are faltering. Thomas Fendrich, managing director for real estate and partnership finance at Standard & Poor's Ratings Group, said 40% to 60% of the widely sold public real estate partnerships he has reviewed are in trouble, with investors unlikely to recoup their money.
Private partnerships, which are typically made up of smaller groups of more affluent investors, are in even worse shape, according to some industry experts, although less information on their performance is publicly available. In many cases, private partnerships were more dependent on tax breaks than public partnerships.
To make matters worse, the tax implications of their investments are beginning to haunt investors as well, because write-offs for depreciation enjoyed years ago must now be repaid to the federal and state governments.