WASHINGTON — The stakes are high for the little guy in the latest real estate investment maneuver, known as the "roll-up."
Roll-up is the term that describes what happens when a number of individual limited partnerships are combined into a new entity, which is traded on a national securities exchange. There is an estimated $50 billion in limited-partnership equity nationwide.
In the wake of the savings and loan crisis and its rising price tag, $50 billion may seem like a piggy bank that hardly jiggles. But to the 8 million small investors depending on the few thousand they have put away in a limited partnership for retirement or a child's education, it means a lot.
California alone is home to 1.5 million limited partners with an average individual investment of about $10,000 and a total statewide investment of $15 billion.
"Many of my constituents have seen their savings substantially eroded by roll-ups," said Rep. Barbara Boxer (D-Greenbrae). "Some have seen IRAs or other retirement savings wiped out."
In the typical limited partnership, an investor buys an interest for $10,000 for a finite period, usually five to seven years. The money is combined with similar investments from as many as thousands of people. The total is used by the general partner to purchase assets, usually real estate or oil and gas properties.
The general partner earns fees for managing the assets for the life of the partnership. At the end of the period the assets are sold and if all goes according to plan, the investors recoup their $10,000 plus a profit.
More and more limited partnerships are being rolled up today as the real estate market turns sour and partnerships flounder. Promising economies of scale, administrative efficiencies, investment diversification and better access to capital markets, the general partner approaches the investors with a proxy proposing the marriage of several limited partnerships.
Many of the problems seem to arise from the lengthy prospectus, which is devised to meet disclosure requirements imposed by the Securities and Exchange Commission. Few average investors have the sophistication to decipher one of these proxies, so they often depend on the cover letter written by an independent investment banker who attests to the fairness of the deal.
What few limited partners know, however, is the independent analyst is paid by the general partner for this advice. Further, if a limited partner calls his broker for advice on how to vote, he may not know that the broker may be paid a commission by the general partner only for each "yes" vote that is delivered.
When limited partners approve a roll-up, they are switching their money to a completely different type of vehicle--one that is traded publicly and has an infinite life, one designed to reinvest proceeds from asset sales rather than distribute them to partners as originally planned. Investors can no longer recoup their money at the end of a specific period without selling shares, which has proven difficult.
The general partner, however, can come out quite well. He charges a fee for arranging the roll-up, trading a finite investment for one in which he continues to charge fees. General partners also tend to cut themselves in for a greater percentage of the total assets in a roll-up.
The problem is that although the roll-up supposedly offers the investors a greater potential for selling the new investment, it offers little in terms of cash flow or growth potential. Therefore, there has been little market for selling them. There is yet to be a real estate roll-up that has traded at the value of its original offering price.
"They have fallen an average of 39% on the first day and continued falling an average of 73% to date," said Richard G. Wollack, chairman of Liquidity Fund in San Francisco.
"The question is, why would investors, like lemmings, continue to vote for these things, these roll-ups?" Wollack asked. ". . . because the promises sound so wonderful. And because the general partners need only 51% yes votes to win."
As a first step in evaluating the practice, the House telecommunications and finance subcommittee held hearings recently.
"I am deeply troubled that the current means available to investors to understand and fight unfair roll-ups may be inappropriate and, at worst, totally ineffective," said Rep. Edward J. Markey (D-Mass.)
The Senate Banking Committee also is studying the roll-ups, evaluating such issues as whether there are direct conflicts of interests in the proxy process. Although it is too early to be certain, staff members at both panels expect some new regulations to be proposed when Congress reconvenes next year.
Although some are advocating a total prohibition of roll-ups, others think the solution lies in reducing the conflicts of interest in the proxy process by paying brokers for yes and no votes, enhancing the disclosure process and providing a package to reimburse those who oppose the roll-up.