by James M. Vodola

While mini-tenders are most often used to encourage limited partners to sell their units for a low price (see "To Sell Or Not TO Sell"), the restructuring of a limited partnership into a different entity could have the same negative effect on the limited partner - a transfer of the limited partner's interest in the partnership's assets to a third party, or to the general partner, for too little value in return.

Currently, real estate partnerships are the subject of restructuring proposals, not necessarily in the best interest of the limited partners. The recovery of the real estate industry began around 1993 and continues through today, causing the present and recent past to be the ideal times for the sale of properties and the distribution of the sale proceeds to the long-suffering investors. Despite these compelling market conditions, limited partners In real estate partnerships who should now be witnessing the liquidation of their portfolios and a return of their capital are instead receiving proxies requesting that they approve the transformation of their partnership into an alternative, high-risk corporate or similar structure.

Restructurings differ from tender offers. In a tender offer, the buyer pays cash in exchange for the units. In a restructuring, limited partners exchange units for shares of a new entity such as a REIT. Many times more than one partnership is included in the transaction, commonly referred to as a roll-up. Restructurings are often mind-numbing in their complexity and usually guarantee the general partners future prosperity while placing the limited partners' equity at risk once again. As with tender offers, a healthy dose of skepticism and research are the allies of the investor.

As in so many transactions involving partnerships, restructurings are riddled with conflicts of interest because the general partner has structured the deal, determined the value of the components and determined how much each investor will receive. It is not uncommon for a partnership to contribute 30% of the assets to a new entity and the limited partners receive only 20% of the value of the new entity. The difference goes to management, the general partner. This is only one of several ways the conflict of interest can work to the detriment of the limited partners.

Similar situations, as well as grossly unfair tender offers made by management, can and do occur in publicly traded companies. As an example, REIT shareholders are increasingly being subjected to management buy-outs and internal restructurings. Management teams attempt to buy out shares of undervalued REITS, while acutely aware that the intrinsic value of the REIT exceeds the management offer.

In an effort to assure investors that despite the conflicts of interest, a good deal has been proposed to the investors, a Fairness Opinion is usually included in the Proxy Statement. This report of only a few pages is usually issued by a well-known Wall Street or appraisal firm. It is intended to assure investors that despite the fact that management sits on both sides of the transaction; "the transaction is fair from a financial point of view".

The first time I read such an opinion I was encouraged to know that management had finally recognized the need to seek independent review of this type of transaction. However, I never really nailed down what a fairness opinion is, only what it isn't. I cannot always understand what it intends to say, but I do know what it doesn't say. I'd like to share some of my observations with you.

It isn't entirely unbiased.

Although the report is paid for by your entity, it is commissioned by management. I have never seen a fairness opinion printed in a proxy stating that the transaction is unfair.

It isn't unlimited in its scope.

Management usually provides parameters limiting the type of analyses considered and may provide critical information about value, which is not independently verified. As an example, in a real estate partnership, the value of the real estate assets, often is prepared by management and is not subject to independent verification. The valuations are assumed to be reasonable and the opinion is built on this assumption. This is the foundation-in-sand approach to opinion writing.

It may not be based on the value of your investment today.

In most restructuring situations, the deal team has created an investment model incorporating management's new business plan contingent on numerous assumptions holding up over as long as ten years. Typically, these assumptions are not adequately disclosed.

It doesn't tell you how the conclusion of fairness was reached.

Usually, the fairness opinion lists a summary of the things considered (current value of the assets, the future business plan, etc.) and states: "In our opinion the transaction is fair from a financial point of view." Why is it fair? How was each factor considered? Which factor(s) was more significant or less significant? The investor never knows.

It doesn't expose the author to liability and therefore there is no accountability to you for the author's conclusion.

That is because the entity, your entity, typically indemnifies the authors from any litigation associated with the transaction and the opinion.

It doesn't offer you definitive information about the value of possible alternatives to the transaction versus the value of the transaction proposed.

Alternative transactions may include a sale of the properties and liquidation of the partnership, refinancing the debt and equity of the properties, or sale of the partnership as a whole to a third party not affiliated with the general partner.

The securitization of the real estate industry has complicated what was previously the rather simple business of dirt and buildings. As a result, the average investor and even the real estate professional have been left in the dust when it comes to the manipulation of once uncomplicated transactions. Should you receive a communication from your management that contains a fairness opinion, read it carefully and be wary. Otherwise, you may find that which was advertised as fair really wasn't.

James M. Vodola is the founder and President of Partners Advisory Services Corp., (Pascorp) a real estate consulting firm specializing in Limited Partnerships and REITS and a Certified Public Accountant with over twenty years of real estate industry experience. Pascorp has acted as the real estate expert in litigation that has resulted in the payment of hundreds of millions of dollars to investors in real estate Limited Partnerships. He is also a Professor of Real Estate Appraisal at the Newman Real Estate Institute at Baruch College in New York City.

Reprinted from the Partnership & Reit Litigation Newsletter, Winter/Spring, 1999

   Friday, July 04th, 2008