LP or LLC Share investing. Plausible?

Question

Hi everyone,

I rarely post but have read a ton from the forum. According to Bryan we're called "lurkers." I have a question about the plausibility of investing in limited partnership shares or LLC's.

Just to give you a little background, I am an accountant studying for my CPA and also have a finance degree. I am approaching this idea as an alternative investment where one can make abnormally large returns for the risk they are taking (the proverbial Alpha).

How possible is it to purchase the shares of limited partnership in the second market? Specifically cash flowing Real Estate. I imagine that when investors in the original partnership need to get out for a variety of reasons they would have to sell at a discount. And because the partnership is already operational with a good history and built-up equity, picking up these shares would give you a discount to the market value of of investing in a new partnership. Thus earning abnormally high returns.

This should be enough to start the topic. I also have a ton of follow up questions.

Thank you in advance for your responses.

Will Barnard · Answer

Great topic. I would like to interject my opinion/concern with this type of investment under the hypothetical that it was plausable (marketable to find them, etc).
Here are my concerns: A seller wanting to exit from a LLC or LP and sell there shares usually stems from their unhappiness with the operation and with the other partner(s) involved and as such could be your underlining risk that would be a deal kiler for me. if it was running smoothly and you ran into a great scenario where the one partner needed to sell due to financial trouble, medical expenses, death in family, etc, then you could have a situation wheer you could buy into a good partnership at a great discount. Just my $.02

Don Konipol · Answer

I believe that Bryan is correct, an offering not SEC registered or an intrastate offering not registered with the state securities board would not have a secondary market trading platform.  A SEC registered or state registered partnership may have a secondary market if there are enough units outstanding to cover the cost and leave a profit for the market makers.

The small partnership that are exempt from registeration have few partners, usually 35 or less, although some may have up to 99.  I would think that placing a ad or website link stating that you are looking to buy these units, and/or contacting the general partners (if you can identify them) and letting them know you would be interested in resale units would provide you with a large selection to choose from.

The difficulty would be in the evaluation.  Evaluating the property is one thing, evaluating the general partner is a lot more difficult.

Bryan Hancock · Answer

The question isnâ€™t whether or not it is POSSIBLE for the deals to get done.  The question really, in my mind, is whether or not it WORTH the energy to market for and analyze securities traded off the market.  This is coupled with the difficulty of GPs moving in the same direction on allowing someone to sell these securities without losing their exemption.  Most of the operating agreements I have seen address the provisions for liquidating securities if someone needs to get out.

In my mind the concept of â€œalphaâ€ is ivory tower mumbo jumbo with respect to distressed real estate investing.  From my experience people concerned with such concepts are living in the securities world that is fairly efficient.  One of the core reasons to invest in distressed real estate deals is to exploit the marketâ€™s inefficiency.  CAPM-based principles do not apply in the absence of an efficient market.  Read the theoryâ€™s assumptions.

Exploiting private partnerships would necessitate that the trader understand tens of different asset classes better than the MPs that allow for the security to be traded at a discount.  While this may happen for liquidity reasons and for the partnership to avoid a suit I still think the time spent analyzing everything and marketing for investments will more than outweigh the security mispricing in many cases.  People generally invest in these private syndicates because they trust the MP to provide big profits, not because they can buy securities at a discount.

Bryan Hancock · Answer

There generally is no secondary market for private offerings offered with exemptions because the shares can't be traded per the exemption.  I pulled these snippets out of one of our PPMs:

NOTICE TO TEXAS RESIDENTS ONLY: THE SECURITIES OFFERED HEREUNDER HAVE NOT BEEN REGISTERED UNDER APPLICABLE TEXAS SECURITIES LAWS AND, THEREFORE, ANY PURCHASER THEREOF MUST BEAR THE ECONOMIC RISK OF THE INVESTMENT FOR AN INDEFINITE PERIOD OF TIME BECAUSE THE SECURITIES CANNOT BE RESOLD UNLESS THEY ARE SUBSEQUENTLY REGISTERED UNDER SUCH SECURITIES LAWS OR AN EXEMPTION FROM SUCH REGISTRATION IS AVAILABLE. FURTHER, PURSUANT TO Â§109.13 UNDER THE TEXAS SECURITIES ACT, THE COMPANY IS REQUIRED TO APPRISE PROSPECTIVE INVESTORS OF THE FOLLOWING: A LEGEND SHALL BE PLACED, UPON ISSUANCE, ON CERTIFICATES REPRESENTING SECURITIES PURCHASED
HEREUNDER, AND ANY PURCHASER HEREUNDER SHALL BE REQUIRED TO SIGN A WRITTEN AGREEMENT THAT HE WILL NOT SELL THE SUBJECT SECURITIES WITHOUT REGISTRATION UNDER APPLICABLE SECURITIES LAWS, OR EXEMPTIONS THEREFROM.

O.	Limited Transferability and Liquidity
To satisfy the requirements of certain exemptions from registration under the Securities Act, and to conform with applicable state securities laws, each investor must acquire his Shares for investment purposes only and not with a view towards distribution.  Consequently, certain conditions of the Securities Act may need to be satisfied prior to any sale, transfer, or other disposition of the Shares.  Some of these conditions may include a minimum holding period, availability of certain reports, including financial statements from  Inc., limitations on the percentage of Shares sold and the manner in which they are sold.   Partners Inc. can prohibit any sale, transfer or disposition unless it receives an opinion of counsel provided at the holderâ€™s expense, in a form satisfactory to  Partners Inc., stating that the proposed sale, transfer or other disposition will not result in a violation of applicable federal or state securities laws and regulations.  No public market exists for the Shares and no market is expected to develop.  Consequently, owners of the Shares may have to hold their investment indefinitely and may not be able to liquidate their investments in  Partners Inc. or pledge them as collateral for a loan in the event of an emergency.

You don't need to be an accredited investor to participate in these products.  You just have to be sophisticated on your own or with the help of your advisors.  Some partnerships will exclude non-accredited investors because of the liability and additional reporting required.

There certainly is illiquidity that would potentially translate to nice alpha opportunities.  It will also present the opportunity for you to get chewed up and spit out by sophisticated investors trying to exit bad deals.  Performing assets with healthy dividends generally won't be sold at big discounts, although the illiquidity probably would present some opportunity for a discount purchase.

The fees you mention for the MPs are WELL worth the cost in my experience.  This is one area I would not want to skimp in if I was putting my funds at risk.

There is a real estate syndication group on BP you may want to join to continue the dialog with other experienced investors.

Don Konipol · Answer

There are two kinds of real eatate investment partnerships, public and private.  Public partnerships are usually very large and have been sold to the general public through an IPO by a underwriter and distributed through securities dealers.  The general partner publishes annual reports, complies with SEC regulations.  Many are listed on trading platforms that facilitate private sales/purchases.  Usually these sites will provide a bid/asked price, much like the old over the counter market did for stocks.
          
          The other kind of real estate investment partnerships are private.  These are all over the board.  Some are very small, release no data, and whatever information they provide is usually unadited and possibly unreliable.  The larger of these may provide audited statements and more detailed information.  These were sold utilizing an exemption from SEC registration and have far fewer partnership interests.  There are no platforms I know of for these private placements, finding out about the units for sale is a hit or miss proposition at best.
          
          The first category has many sales available that would provide an above average return to the careful, knowledgable investor.  The second category carries a much higher risk but also is where you will find the potential large payday.

Will Barnard · Answer

Thanks Don - appreciated.

Don Konipol · Answer

Will, I like your 2cents!  You have captured the two issues in a nutshell.  If you find good deals and are able to perform acurate due diligence, it can be very profitable.  There are good, legitimate reasons for selling at a discount.  There are also sales taking place because the investment is not good.  Just like any type of real estate investing.  The key is the ability to obtain reliable information.  and quite frankly, that is the part that scares me.

Jimmy H. · Answer

Just because there is no platform doesn't mean that such a deal can't be done. In fact I think that is what the OP is looking for - unregistered shares that are hard to buy and sell and that therefore present alpha generating opportunities because of their barriers to entry (lack of info, liquidity, etc.) 
          
          Of course, as has been mentioned previously, savvy investors looking to cash out of a bad deal could burn you. 
          
          Maybe it is just me, but I would be looking for partnerships with around 10 members that own high yield portoflio in my local market. That way I can do due diligence by visting the portfolio properties myself. Becuase these shares have no platform, have higher risk of getting ripped off, are not SEC regulated, etc. they could offer great returns and you could buy these shares potentially at a discount to what the founding members put in (especially in this market). It won't be easy to find or execute such a deal, and the risks are high so you must detemrine that the risks you undertake are truly being rewarded with alpha not just being rewarded with high returns because the risks are actually so high. 
          
          This is tricky stuff, and that's what keeps most investors away, theoritcally providing significant opportunity. I like the OP's train of thought.
          
          The question now is: are there any BPers who are familiar/experienced with such a strategy who could bestow upon us such useful info as to help us avoid pitfalls in the process.
          
          I think if your not going to go the SEC registered route, then you need a good lawyer with good experience, and you need to get to know and understand the business and portfolio intimately. Perhaps just as important - who is selling their interest and why (if it is such a good deal) and why are the other partners reluctant to buy the available share.
          
          Larger partnerships and the SEC registered partnership route are another avenue to pursue, but I like the idea of the smaller local entities with no platform to liquidate their holdings.

To the OP's comment on wanting to avoid front end fees: If a partnership is established with a cash flowing portfolio and wants to take advantage of opportunities in this depressed market but needs equity to do so - I think this provides a perfect opportunity to come in as an additional partner and contribute to how your new funds are invested, as well as buying into an already profitable partnership - I fail to see where the extra costs would come in as I am not talking about investing on the ground floor of a start up, and therefore the costs would no be any greater as you would avoid the fees I beleive you are referring to (legal, startup fees,etc.). And depending on what amount of capital your looking to invest, the start up costs could be marginal anyways.

-That is my train of thought, let me know if I missed the ball completely, lol

Yan P. · Answer

Jimmy you are correct, I am referring to the SEC exempt  private intrastate partnerships. Do you guys think it would be so difficult to properly value a real estate partnership if it has a history of dividends? In terms of audit, I'm sure there are small CPA firms that would jump to do a compilation audit for a decent price.

Jimmy, the last paragraph of your statement is exactly what I think one would want to avoid: the up front end fees such as acquisition that MP's generally charge.

Don, there are exchanges popping up all over the place that help transfer illiquid shares, I think the biggest one of them is secondmarket. My problem is that I am neither a qualified purchaser or accredited investor yet.

Don, can you please elaborate on the risks you foresee of investing in a cash flowing partnership with a history excluding fraud?

Jimmy H. · Answer

Correct me if I'm wrong but I believe Yan is focusing on private partnership / LLC investment, not public REIT's and such.

I know that there are "business brokers" in my region. But they are generally selling the local subway or sports bar. To find private interest in LLC or partnerships for sale would likely be difficult and would most likely be found through networking. Hopefully people know some other, more efficient, means of finding partnership interests for sale.

Also, without statements being audited - how do you perform thorough due diligence?

There are probably a lot of cash strapped partners trying to cash out of their investment interests right now. One problem with such investments is their illiquidity, but this can lead to large discounts if you could find someone desperate to sell - valuation would be key but also more difficult. Hard to know exactly what you are buying into.

Perhaps you could find partners with a cash flowing real estate portfolio and LLC set up already, and no one is selling their interest, rather they may be looking to raise equity capital and you could partner up that way.

LP or LLC Share investing. Plausible?

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