United Development Fund III, LP, (UDF III) is a limited partnership that raised capital to originate and service land and development loans to home builders, both third party and affiliated, that are based in Texas. It raised its capital starting in late 2006 and finished in early 2009. At the end of the second quarter, approximately a third of UDF III's assets are affiliated transactions. On October 22, UDF III released its required per unit valuation in an 8-K that states that the value per unit is $20, the same value that the units were originally issued.
The 8-K lists a variety of valuation methodologies (income, market and asset) and resulting valuations. Valuations were determined by the general partner and by a third party. The valuations ranged from a low of $18.05 per unit to a high of $26.19. The general partner determined the low-end valuation, and the high value was determined by the third party valuation firm. The passage below discusses the general partner's value reconciliation process and how it arrived at the $20 per unit value:
In determining the Partnership’s estimated unit value, the General Partner considered the independent firm’s range of estimated values per unit of between $18.80 pursuant to an asset approach methodology and $26.19 pursuant to one of the valuation analyses used in the market approach methodology, as well as the lack of marketability discount discussed above. The General Partner also considered its own determination of the Partnership’s assets, less liabilities, of $18.05 per unit, as well as the General Partner’s estimates and projections regarding the execution of the Partnership’s business model set forth in the prospectus regarding the Partnership’s initial public offering of its limited partnership units and the General Partner’s expectation that a public trading market for the Partnership’s units is not likely to develop. The General Partner then determined the estimated value per unit of the Partnership’s limited partnership interests to be $20.00 per unit, which is within the range of values provided by the independent firm.We are to believe that an original $20 unit price, which paid approximately $2.80 per unit (14%) in offering costs and netted approximately $17.20 per share in net investable proceeds with which to make loans, is still worth $20 per unit? Well, I don't and here is why. In general, UDF III took that $17.20 and made loans, and the loans pay interest and principal. Fine, but the loans don't appreciate, they're generally repaid at par, and some loans don't even pay current interest as is common in the construction industry, principal and accrued interest are due at maturity.
Here is an example: let's say the fund made a $1 million loan with a twelve-month term and 12% interest. At the end of a year the fund would get its $1 million back, plus $120,000 in interest. From that interest the fund needs to pay investors a 9% distribution on the original $20 per unit price, which is approximately $104,650 of the $120,000 the loan earned in interest. The balance would be applied to the initial 14% load recovery, which only reduces the load by a small amount, so to fully recover the load, the money would have to be recycled 10 times! Below is the transaction example described above using a $20.00 unit price and fully investing the net proceeds. It shows that an excess $.26 that could be applied to the initial $2.80 load:
Initial Value: $20.00
Net Proceeds: $17.80
Loan $17.20 @ 12% for one year
Pay 9% on $20.00 per unit
Excess proceeds $.26 per unit
An astute reader may wonder what happens to loan origination fees and servicing fees. I believe the bulk of these fees are are paid to the general partner and affiliates and don't stay at the fund. UDF III's general partner does not have to use the small amount of excess interest to paydown the load, it can use to as part of a new loan or for other partnership purposes.
I don't see how the independent valuation firm could possibly derive a value of $26.16 per unit. (Actually, I suspect loan income was somehow capped at a low cap rate with little regard to the actual underlying asset.) Behringer Harvard and Inland need to find this valuation firm and call it immediately.
This post is not questioning UDF III's business model. That is a subject for another post or posts, because UDF III's affiliated dealings are worth analyzing. This post is asking how a mortgage fund with a 14% load is able to publish a value that overcomes its load (and in one valuation significantly exceed the offering valuation) when a portfolio of mortgages does not grow and the fund does not keep origination fees.