An Alternative to REITs: Master Limited Partnership Units of Real Estate Firms

Investors are beginning to take new look at real estate and real estate stocks. Some REITs such as FRT (Federal Realty Trust), BXP (Boston Properties) and BDN (Brandywine Realty) have displayed truly impressive performance during this most recent stock market rally. HPT (Hospitality Trust) has also run up nicely and is now closer to $20.00 than it is to $10. There is reason for cautious optimism.

More and more real estate investors are discovering opportunity in a somewhat obscure class of securities called Master Limited Partnerships (MLPs). Although MPL units trade just like REIT shares, they distribute income and capital gains differently and have different tax ramifications. MLPs are not for everyone, but learning the basics could be rewarding for an investor who takes the time to understand them.

Quite simply an MLP is a partnership (or a LLC being taxed as a partnership) whose shares (called units) trade on public exchanges just like shares of corporations. Buyers of the units simply become limited partners rather than equity shareholders.

Restrictions in the tax code limit the industries that can trade partnership units on exchanges. Most MLPs are energy companies involved in the production and transportation of oil, natural gas and propane. There are also MLPs in the financial sector, natural resources, commodities and, of course, real estate. The primary objective of MLPs is to provide a high, tax advantaged income to its unit holders.

For tax purposes, partnerships are not considered separate tax-paying entities. Partnerships are what’s known as “pass-through” entities. Because of this distinction, taxes are not payable by the partnership itself; only the individual partners get taxed and only on their proportionate share of the income and gains. By avoiding the double taxation that corporations are subject to, MLPs are able to distribute larger income and capital gain payouts.

Partnership earnings are passed through to investors in the form of a quarterly cash distribution. Tax-wise these distributions are treated much more favorably than dividends from stocks or mutual funds. Instead of considering them investment income the IRS looks at them as “return of principle” and they reduce the cost basis of the investment. In-other-words, you don’t pay taxes on these distributions until the units are sold or the basis is reduced to zero. Income distributions are taxable, but the tax due is usually very low because MLPs can pass through deductions and depreciation along with their income.

Analyzing MLPs is a tricky business. The dividend yields can seem high, but an investor can’t tell just by looking at a quote if the firm is producing income or returning capital. Further, when units are sold it takes some sophisticated calculations to determine cost basis, capital gains and income. Also, unit holders receive K1 forms rather than the 1099s they may be used to. When properly understood and used correctly MLPs can provide excellent income and great potential for appreciation over time but if you don’t know what you’re doing, it’s best not to dabble.

New England Realty Associates, LP (NEN), NTS Realty, Ltd (NLP), W.P. Carey & Co. LLC (WPC), America First Tax Exempt Investors (ATAX) and Centerline Holding Company (CLNH.OB) are a few real estate MLPs for you to check out. I’m not recommending them to you, just listing them for you. As always do your own homework and seek the advice of a trusted professional before investing.

Disclosure: Author is Long HPT. No other positions, long or short in units/stocks mentioned. The author, in the course of his business in commercial real estate finance and investing, has occasion to do business with W.P. Carey & Co. LLC

Comments

[Rhino Realty:]

Are these units as "liquid" as stock ?

Aug 08 08:34 PM

[Commercial ...:]

Yes they trade just like stocks. It is the tax implications that are different.


On Aug 08 08:34 PM Rhino Realty wrote:

> Are these units as "liquid" as stock ?

Aug 09 11:09 AM

[Rhino Realty:]

I would like to chat with you further...can you email me your contact info ? [e-mail]


On Aug 09 11:09 AM Commercial Mortgage Loans wrote:

> Yes they trade just like stocks. It is the tax implications that
> are different.

Aug 09 10:45 PM

[MAPLLC:]

Great article. I would like to speak with you further on this also. You may contact me at henderson_zachary@yaho...

Aug 23 08:03 PM

[leviticus1935:]

You might take a look at the shares of unlisted REITs managed by W.P. Carey. These trade in the secondary market at a discount to NAV. The discount allows an investor to receive a higher yield, around 8 percent. The obvious negative is a lack of liquidity, so these are buy and hold investments.

Aug 24 08:31 AM