The REIT (Real Estate Investment Trusts) and MLP (Master Limited Partnerships) have enjoyed a multi-year rally starting in 2009 when interest rates started their historic collapse. REITs and MLPs are corporate structures that behave like pass-through entities. These entities do not pay corporate income taxes so long as they pay out 90% of their profits to shareholders. Those shareholders then pay income tax on the dividends. If some portion of the dividend is a return of capital, owners do not owe taxes on a portion of the dividend. As a rule of thumb, if the company pays out a dividend per share that exceeds the earnings per share, the difference is a return of capital.
Investors who are starved for income like REITs and MLPs. Most investors consider them "bond equivalents" as the cash flow of the underlying business of these companies is relatively steady. As a result, we often believe that investors under-appreciate the risk they are taking. In the final analysis, REITs and MLPs are equities and investors need to recognize them as such. It is the lenders, such as the mortgage holders who have a bonified fixed income instrument. When times get tough, these entities cut their dividends and sometimes to zero or near zero. Just ask the MLP owners who lived through the oil price crash in 2014 and 2015. Many MLPs lost half to two-thirds of their value. These are not the characteristics of bonds which have a contracted coupon payment. With interest rates rising, we believe that REITs and MLPs are a vulnerable sector of the share market.
