Let's say your broker is E. F Hutton, and when E. F. Hutton talks, you listen.

One of Hutton's more provocative sales pitches, you decide, describes a series of real-estate limited partnerships called Corporate Property Associates. The first four in the series closed during the last few years, and are now yielding fully or mostly tax-sheltered returns ranging from 7.45% to 11%. And all hold out the prospect of capital gains a few years down the road, when the properties owned by the partnershps are sold to the next round of investors.

How there is a new partnership available, and hearing that the minimum investment is only $5,000, you're thinking about kicking in a little money. But doubts nag you. Real estate syndication, you know, has gotten a bad press lately. There are rumors that investors are being taken to the cleaners, and that the Internal Revenue Service is tightening up. Is this one of the risky ventures? And how do you tell the difference between the risky and the not so risky?

If investing in syndicated real estate had any drawbacks, you wouldn't know it from looking at the industry's growth over the past few years. Public real estate partnerships alone swelled from $1.3 billion in 1981 to $4.7 billion last year. Private syndications are estimated to total anywhere from 4 to 10 times that much. The largest two syndicators alone -- Balcor/American Express Inc. and JMB Realty Corp. -- each raised more than half a billion dollars in real estate money last year.

The economics of this burgeoning business are simple enough. Selling an income-producing property generates cash for the developer or owner -- even if, as often happens, the owner then turns around and leases the property back. Buying into a property gives investors the tax advantages of depreciation and mortgage-interest deductions, along with an income stream from rents and a chance for profits when the property is sold. Assembling and marketing the deal lets the syndicator take a healthy cut of the whole transaction.

What has made real estate particularly attractive in recent years is the Economic Recovery Tax Act of 198 1, which enables owners to depreciate a property for tax purposes over only 15 years, considerably faster than before. This tax change, coupled with the inflation-beating appreciation of a lot of real estate during the last decade, laid the groundwork for a rapidly expanding industry.

It is not surprising that such fast growth has attracted a host of operators with more enthusiasm than experience -- or, to put the matter differently, with more interest in a quick profit for themselves than in a longer-term profit for their investors. That, in turn, has engendered some critical articles in the business press and a generally circumspect attitude even among industry spokespeople. "Let's say l'm a bit cautious about an industry that has grown as quickly as this one," says Gregory S. Junkin, executive vice-president of Balcor/American Express. "This industry has grown tremendously, and I believe we are going to see some problems -- with deals offered by novices, with investors who are upset, with publicity, and with the tax laws. I caution investors to look closely at the partnership's capital stress and investment philosophy, in addition to the economics of the deal. This is especially important for investors who have not invested in real estate before."

Most of the criticisms of real estate syndication as an investment revolve around three issues. Fees are too high, the critics charge, and some of the costs are frequently hidden from prospective investors. Some partnerships are unduly risky, both as money-makers and as tax shelters. And none of the partnerships are easy to get out of should your circumstances or your investment needs change. Since there is some truth to all these charges, it is worth knowing in advance where the problems may lie.

Fees. When you buy a stock, 98 or 99 cents of every dollar you invest goes for the stock, with the broker getting only the remaining cent or two. Buy a real estate partnership, and very often only 65 cents to 75 cents of your dollar will go to real estate. The rest may be eaten up by partnership fees, management fees, broker's commissions, and half a dozen other expenses. And, when your partnership's property is sold, you as a limited partner typically will share in only 70% to 90% of the gains; the rest goes to the syndicator. Exact fees vary from partnership to partnership, but there is a trade-off between fees and experience. Syndicators with solid track records can get away with charging investors more than newer or less-well-established packagers.

At least the fees are spelled out in a partnership's prospectus. This may not be the case with the other costs an investor incurs. Often, explains Peter Trumbull of the Hartford law firm of Trumbull, Hetzel, Beck & Lauretti, the packager will buy the property and mark it up before reselling it to the partnership. The size of this markup can be critically important, both to an investor's chance for profit and to the IRS, which regards high-markup resales as potentially abusive shelters. But determining the size of a markup is seldom easy. "Even very sophisticated investors -- bank or insurance executives -- do not see enough of [these deals] to know the techniques that are used to mark up prices," Trumbull says. One giveaway, he adds, is a syndicator's refusal to disclose what he or she paid for a piece of property, using "appraised value" as a measure of its worth rather than purchase price.

Risk. Risk in the syndication business takes two forms. One is that the property that is purchased by a partnership won't pan out, or won't appreciate much. One much-cited study, by Charles Wetterer of Real Estate Tax Shelter Review, analyzed 158 sales in different parts of the country and found a compounded annual appreciation of less than 6% a year -- although once tax savings and cash flow were taken into account, the yield rose to 11% to 12%. Since most partnerships have been developed so recently, of course, most of the properties they purchased have not yet been sold. How well they eventually do will depend on regional real estate markets, inflation, and a host of other imponderables.

The second form of risk is that the IRS might disallow some of the deductions, making investors suddenly liable not only for back taxes but for interest and penalties as well. "One of the biggest current risks under the revised tax laws," observes Peter Trumbull, "is that [the sponsor] sells the properties to the partnership at such a markup that the IRS is able to fight it." Another potential problem arises when packagers take out a second mortgage on the property, accruing interest (and thus adding to the investors' tax losses) but not actually paying it. Such a technique, Trumbull says, is a sure sign of a tax-risky deal.

Private and public syndications differ by each measure of risk. Private deals (which are not registered with the Securities and Exchange Commission, and which are generally appropriate only for investors with high net worth) frequently package identifiable buildings with established economic histories, thus enabling investors to make relatively firm cost-and-revenue projections. But they are often highly leveraged in an effort to maximize tax write-offs, and are more likely to attract IRS scrutiny. Public syndications, by contrast, are usually relatively conservative in their approach to tax benefits. But most are "blind pools," in which property is not bought until the funds are in. Since investors buying into blind pools can't know where their money is going to go, they are essentially buying the track record and reputation of the syndicator.

Liquidity. Partnerships typically run from 7 to 12 years: At some point in thattime span it usually pays to sell a building and buy a new one. In the meantime, it is hard for investors to get out. Equity Resources Group Inc. in Boston specializes in providing a secondary market for private placements, and two California firms, Liquidity Fund Investment Corp. and MacKenzie Securities Ltd., provide a secondary market mainly for public offerings. But selling out early can trigger contingent tax liabilities, and usually requires the investor to accept a fraction of the investment's value. "These interests were intended to be illiquid, and they are," says Mark Thompson of Equity Resources. "As a result, they are worth 25% to 30% less to a sophisticated investor than if they had the liquidity of a widely traded security."

The firms providing secondary markets for partnership interests typically make purchase offers in the 70% to 75% range, Thompson explains. But other prospective purchasers are likely to offer less. He cites one Massachusetts bankruptcy trustee who almost sold an interest back to the general partner for $10,000 -- until Equity Resources offered $140,000, a bid the general partner promptly matched.

The conclusion? Real estate partnerships probably make sense only for a relatively small portion of your investment portfolio -- the portion that really doesn't need to be touched for several years, and that you're willing to risk in return for tax advantages and the chance of capital appreciation. Not all partnerships, however, are equal. The most important factors in evaluating them, advises Chris Geiling, national marketing manager for Rob ert Stanger & Co., a research and publishing firm specializing in limited partnerships, are the offering company's track record and whether or not the specific partnership meets your own personal investment objectives for tax benefits, cash-flow distribution, and capital gains. "Interested investors have to know something about these investments beforehand," he says. "Ask whether the economics make sense. If not, forget it."

To learn more, serious investors may want to subscribe to Stanger's newsletter, The Stanger Report: A Guide to Tax-Shelter Investing (P.O. Box 8, Fair Haven, NJ 07701) or Strategic Real Estate, a publication of Kenneth Leventhal & Co. (100 Spear Street, 12th floor, San Francisco, CA 94105). Both offer information on new offerings, and Stanger's offers methodologies and procedures for evaluating them.

And E. F. Hutton's offering? Certainly it has been popular Corporate Property Associates 5 recently closed at $56.6 million, with some 3,500 investors, and number 6 in the series is in the works. And for some investors, at least, the partnerships may not be a bad deal. W. P. Carey & Co., the packager, is well respected; the front-end load tends toward the low end; and the record of the first partnerships' yields to date is respectable if not spectacular. "It might make sense if you have a strong career path, if you're a single taxpayer who's paying a high marginal tax rate, and you really believe your income is going to march upward over the next four or five years," says Peter Trumbull. "But you should be certain you won't need to touch this money for several years, if ever."


William J. Grace Jr. is described on the jacket of his most recent book as a vice-president of a major Wall Street investment firm. Well, yes. The investment firm is Merrill Lynch, Pierce, Fenner & Smith, and "vice-president," as at most brokerage houses, means something like "senior stockbroker." Bill Grace's real claim to fame, in any event, lies not in his title but in his ideas, which, he hastens to add, are his own, and not those of his employer. A market strategist, he is not shy about telling any investors who will listen exactly why they are likely to be doing things wrong.

Grace's new book, published in February by Bantam Books, is called The Phoenix Approach, and it expounds his philosophy of investing in some detail. INC. staff writer Lisa R. Sheeran asked him to let us in on the secret.

INC.: The trouble with investing, someone once said, is that there's too much floundering around. What's the solution?

GRACE: I've been an investor for 15 years, and I floundered around for quite a while. About 5 years ago, I realized that there is only one group of investors who consistently make money in the market. They use what I call the phoenix approach -- and they didn't learn it from me, I learned it from them. These were investors who took sizable positions in out-of-favor companies during bad cycles and just held on to them for a long time.

That strategy runs contrary to what most people do. People usually get more and more interested in a stock when its price goes up; that's when they buy. Then they get worried and pessimistic when the stock starts going down; that's when they sell. The phoenix investor goes about things in a fundamentally different way. [Former Secretary of the Treasury] Bill Simon, who has been in the news in the past year for leveraged buyouts, doesn't just buy popular companies, he also looks for underpriced companies with real value. Warren Buffett, who bought a third of GEICO's stock at about $6, looks for trouble spots where there has been an overreaction. The smart money has always followed the phoenix approach.

INC.: It sounds as if what you call the phoenix approach is what the rest of the world knows as contrarianism or bottom-fishing.

GRACE: Wall Street would think of the phoenix approach as bottom-fishing, but the phoenix investor fishes deeper and fishes alone. Ordinary contrarianism can be as simple as buying low P/E stocks because those are stocks that are out of favor. The phoenix approach is a strategy for discovering real value in a company that may be in financial difficulty; it takes contrarian principles and goes one step further. The phoenix investor may invest in companies that are losing money or are even bankrupt. Phoenix companies can be found in most any industry. Aerospace had Lockheed; communications, MCI; transportation, Penn Central; insurance, GEICO; finance, Orion; retailing, Toys 'R' Us.

Of course, some distressed companies never make a comeback, but it is surprising the number of companies that do.

INC.: But certain sectors of the market must be better suited to the phoenix approach than others.

GRACE: Yes, many of the basic industries -- the ones that have been hardest hit by the recession. The steel companies, the airlines, farm equipment, paper companies: all the "worst" industries. The new high-tech, very popular companies that you read about in [John Naisbitt's] Megatrends are probably not the ones you should be interested in -- although recently there's been such a correction in the high-tech industries that some of these companies may be worthwhile investments once again. For example, MCI, in my opinion, was insanely priced at $28. At $9 it is interesting. Apple at $63 was nuts, but at $18 I think it was attractive again.

INC.: Some investment strategies work better in bull markets than in bears, or vice versa. Yours?

GRACE: The economic cycles that we've experienced during the past four years -- the combination of a severe recession and one of the biggest stock market rallies in history -- make the timing for this approach perfect. What we had was thousands of very distressed companies, along with a sudden revival of interest in the stock market. But there are always going to be troubled companies, and there are always going to be phoenix companies that are vastly underpriced.

INC.: The best ways of finding underpriced stocks?

GRACE: The simplest strategy is to be an ordinary contrarian and buy companies with low P/Es -- they stand out in the stock pages of the newspaper. Or you can start by looking at a company's book value, then try to determine whether it is overstated or understated.

Take Greyhound, which is one of my favorite stocks right now. It's not a troubled company, but one which I think represents very good value at this time. The company owns bus stations in downtown areas all over the country. Greyhound's real estate is estimated to be worth around $60 a share, and the company is selling for around $22 a share. That doesn't do any good, of course, unless the company is considering selling that real estate. But it is. It is getting offers from developers for some of its downtown stations, and is thinking of moving some of its stations outside the cities. Here in Washington, for example, Greyhound was offered $21 million for its downtown site. Reports from Greyhound show that the company carries that property on the books for $2 million.

INC.: What can the short-term trader do with the phoenix approach?

GRACE: Look at the phoenix approach as a lifetime strategy. Don't go into it looking for a kill. It does work in the short term, but I'd advise holding most of these positions for at least a year. That's long-term as far as the Internal Revenue Service is concerned. I bought Chrysler when it was down and held it for only two years. Or take GEICO. I've been buying this stock for five or six years and haven't sold any of it. I just buy and buy. Recently it sold for $65 a share, up from $2 a share in 1977. It's dropped back to $53 today, and on this drop I've been buying more of it. Of course, eventually you have to sell to take your profit. But you don't have to do a lot of trading. Many stockbrokers don't think that's the best way to invest, because there's not a lot of turnover, but it should be attractive to investors because there are fewer commissions.

INC: How much risk does your phoenix investor have to shoulder?

GRACE: You can take as much risk or as little risk as you want. If you don't want much, stick to low P/E stocks. If you want to take some risk, buy a mixture of low P/E stocks and companies that are in the red right now that you feel are on the way back up. If you want high risk, buy bankrupt companies and special situations like that.

INC.: The phoenix approach -- indeed, all sorts of contrarian theory -- seem so commonsensical. Why aren-t they more popular?

GRACE: If everyone was a contrarian, you'd have to be a noncontrarian to be a true contrarian. Paradoxes aside, this approach goes against human nature. When people see what they believe is a way to make money fast -- a rapidly rising stock, for example -- they are tempted to try it. Most people don't think with their strategy. In fact, I'd say 99% of all investors have no strategy at all, or else they keep changing their strategy -- which is no strategy. lt only works against them.

INC.: Some general advice for investors, please.

GRACE: Look at a stock the same way you would look into buying into a local corner grocery store -- look for value. There are many things you would look at before investing a dime. You would look at the store. You would talk to the manager to see what type of person he or she is. You would look at the neighborhood competition. What do you get for your investment? Will you own the building or rent it? What's the inventory like? These are the same considerations to make when you are looking at a stock, and no one does it.