The big, new investment of recent months -- peddled to the rich and middle-class alike -- has been the income partnership. Real estate is drawing the most money, but income partnerships in oil-and-gas and equipment leasing are also contending for your attention.
The pitch is an attractive one, especially to investors who consider themselves conservative about money. The partnership buys into existing, commercially viable deals, like fully rented office buildings or producing oil wells. Tax deductions and credits shelter the rental or royalty income thrown off by these investments, so buyers can earn money on a tax-deferred basis.
Yields from income partnerships are generally presented as both high and safe. In some of the investments -- real estate, for example -- there is hope of capital gains when the property is sold. Who could resist?
A look at these deals suggests to me that a good many people ought to resist, unless they are speculating with money they can afford to lose. Income partnerships can certainly be successful, but they aren't the sure thing that some salesmen suggest. Petro Lewis, granddaddy of the oil-income funds, almost failed last year when it misjudged the oil market; buyers lost a good portion of their principal and income.
It is also doubtful that the yields from income partnerships are as high as the salesmen imply. There is no standard way of computing returns from an income-partnership investment, so promoters tend to use the method that makes their deals look the best.
Take real estate partnerships, whose advertising brochures may dangle the lure of investment gains averaging 20 to 40 percent a year.
First, to cite "average" returns is itself a way of magnifying your apparent gain. An average return of 21 percent a year over 10 years pays exactly the same, in dollars and cents, as 12 percent compounded over the same period. Put another way, over 10 years, "21 percent average" and "12 percent compounded" are just two ways of stating exactly the same yield. But investors are likely to be misled into thinking that the "21 percent" investment is by far the higher of the two. On that assumption, they are apt to spurn a stodgy 12 percent bond, in the mistaken belief that the real estate partnership has been doing much better.
Second, the figures citing real estate investment performance refer only to how much the underlying properties rose in value. They do not adjust for the 15 to 25 percent that investors usually pay up front in fees, or the closing fees that they'll have to pay when the properties sell. So your real investment return will probably be much less than advertised.
The Real Estate Tax Shelter Review estimated that an income real estate partnership, with no underlying mortgage and average fees, might yield 5.4 to 10.2 percent to an investor in the 50 percent tax bracket. (The higher figure assumes that the properties appreciate by 15 percent a year.)
Some oil-and-gas partnerships have been claiming returns of 15 percent a year, but partnership expert Bill Brennan says that two-thirds of that money could merely be a return of the capital that you yourself put up. Jerry King of InveSearch thinks that new income partnerships will yield 10 to 12 percent tops, before taxes, with the average investment paying less.
That means many buyers may do better in secure Treasury bonds or tax-exempt bonds, without running the risks of making money in real estate or oil. A partnership investment could, indeed, do better -- but it's a speculation, not a sure thing.
You have a better chance of doing well if you can reduce the enormous fees that most partnership investors have to pay. Around 8 to 10 percent of your investment typically goes to the firm that sold it to you. Another 7 to 15 percent goes to the promoter off the top. Annual fees in real estate partnerships could amount to 5 percent or more of the cash distributed every year. Promoters may also take an average of 18 percent of the price when the properties are sold.
To give buyers a better break, the Baltimore-based mutual-fund company T. Rowe Price is now selling the first no-load (no sales charge) income partnership, called Realty Income Fund I. It's being sold by mail, with total up-front charges not to exceed 12.5 percent (for information, call 800-638-5660). The company says that its new partnership is designed to compete with traditional income investments such as utility stocks and bonds.
T. Rowe Price's lower fees mean that investors will get more of the income than is usual in other partnerships. But you're still relying on the future of real estate for your profits. That's an interesting speculation, but only with money that you can afford to lose.