Average discounts from net asset value for shares of publicly registered real estate limited partnerships in the secondary market have continued to diminish in the last few years. Does this mean discounts for family limited partnerships are shrinking as well?

Not necessarily. But the trend highlights the importance of determining discounts on a case-by-case basis. Relying on average discounts in the secondary market can lead to overvaluation of minority interests in FLPs.

Several factors — ranging from lack of management control to investor expectations regarding cash distributions — influence the size of valuation discounts. It’s important, therefore, to examine the reasons underlying declining discounts to determine whether they apply to the entity being valued.

Secondary Market Aids Business Valuation
Determining appropriate discounts for FLPs is problematic because these entities lack direct market prices or comparables. As a result, valuators look at trading activity for registered limited partnerships that hold similar investment assets, such as apartment complexes, retail space, or insured mortgages.

The limited partnership secondary market consists of a dozen or so independent brokerage firms that serve as intermediaries, helping to match buyers and sellers. Transactions for limited partnership shares demonstrate how investors value partnerships investing in certain types of real estate. They also reflect investor reaction to a number of elements, such as risks associated with partnership investment assets, and the history and expectation of cash distributions.

Net Asset Value
An important part of the valuation process is the net asset value (NAV) of partnership shares, that is, the amount an investor would expect to receive if the company were liquidated and the assets distributed. The NAV is discounted to reflect what a willing buyer would pay. The amount of discount varies depending on the type of assets held by the partnership, the amount and frequency of cash distributions, and the amount of debt.

Every spring, Partnership Spectrum, a publication of Dallas-based Partnership Profiles, Inc., reports transactions from the previous year for the limited partnership secondary market. The survey groups the transactions into categories based on partnership type — equity-distributing, equity-nondistributing, and undeveloped land. Each category lists the number of partnerships involved in transactions, the average discount, and the average yield.

Survey Shows Diminishing Discounts
According to the survey, the discount for all partnership transactions averaged 28 percent in 2001, up from 25 percent in 2000, but well below the 48 percent posted in 1994. The report also provides an analysis of the data, including an explanation for declining average discounts. The report states that the primary reason for the trend is that investors in the secondary market have been anticipating ever-shorter holding periods.

Generally, the investment time horizon — from start to finish — for a limited partnership plays an important role in determining the average discount. Investors will pay more for an investment with a shorter-term payoff. In recent years, the average holding time for limited partnerships declined from 8-10 years to 3-5 years.

Public vs. Private
There are many similarities between public and private limited partnerships. Both have general partners who manage operations and minority partners without any management rights or powers. For this reason, minority interests sell at a discount for lack of control.

But there are important differences between public and private concerns. Public partnerships must register with the SEC and generally have larger staffs and are more geographically diversified. They also make announcements that allow investors to know when they can expect cash distributions.

Increasingly, general partners of public limited partnerships have been announcing liquidation plans, making interests in these partnerships more valuable in the eyes of investors and, therefore, causing valuation discounts to diminish.

By contrast, most FLPs don’t make liquidation or distribution announcements. This means that a minority investor has little information about when or if there will be a cash distribution. Under those circumstances, a discount greater than those reported in the Partnership Profiles survey may be appropriate.