Optimizing Value In The Pursuit Of Dividend Yield Income: REITs, MLPs And BDCs

by: Kevin Quon

With the pursuit of yield in times of higher volatility and a hazier macro-economic picture, investors have sought out the entities that provide pass through taxation effects on their income. Common publicly traded private equity companies that receive special taxation privileges such as Real Estate Investment Trusts (REITs), Business Development Companies (BDCs), and Master Limited Partnerships (MLPs) have pass-through income capabilities that often have specific requisites that must be followed in order to retain their status. As is the case with REITs, such companies are required to disburse 90% percentage of their taxable income in order to maintain their special designations.

Double taxation is the main problem for investors reliant on dividend-paying companies. For most companies, the income is taxed on the corporate level first, and then passed down to the individual where it’s also taxed again on an individual level. Thereby, companies that typically pass value to their investors in the form of dividend payouts tend to lose a compounding amount of value over every dividend paid. This can be disadvantageous for investors as an industry peer (all things considered equal) that doesn’t pay out dividends should in theory outperform the company that does.

REITs, BDCs, and MLPs are therefore the ideal entities under the right circumstances by which income streams can be obtained. Through bypassing the corporate tax level and enforcing a high payout requirement, income investors focused on yield can extract an optimal amount of value from their investment.

REITs and MLPs tend to operate more like rental companies in the sense that they typically generate income on real estate, pipelines, mining rights, and etc which is essentially extracting value out of fixed assets or real property. BDC’s on the other hand extract their value out of investments which could include financing or equity positions. A diversified investor would find value in the quality of each.

Like all equity positions, however, every company should be treated individually when screened. Their business models should be thoroughly screened and their balance sheets analyzed. Investors chasing high yield can easily be falling for the trap without a proper understanding of how that yield is being earned.

In either case a few basic statistics can help provide a reasonable assessment of the companies in question.

  • Net Profit Margin (NPM%) can be ideal in determining the overall profitability of the company’s revenues. Slim profit margins severely hurt a company when the economy hits a bumpy road.
  • Total Debt to Assets (TDA%) is a good measure of the company’s leverage. Debt is healthy when used in a sustainable fashion. If a company over-leveraged, they can run into some trouble paying it back if the plan goes astray. Expecting yield would be futile such circumstances occurred.
  • Dividend Yield (Yield%) is the basic expected return on the current price based on payout history.

Here’s a sample porfolio of possible REIT's, BDC's, and MLP's to consider under annual conditions:

REITs Price Yield% NPM% TDA%
CommonWealth REIT(NYSE:CWH) $17.12 12.02% 10% 49%
Vornado Realty Trust (NYSE:VNO) $77.1 3.61% 26% 53%
SL Green Realty Corp (NYSE:SLG) $66.44 1.52% 25% 47%
Brandywine Realty Trust (NYSE:BDN) $9.6 6.49% (5%) 52%
BDCs Price Yield% NPM% TDA%
Blackrock Kelso Capital (NASDAQ:BKCC) $8.45 12.58% 68% 19%
Apollo Investment (NASDAQ:AINV) $6.58 17.65% 52% 33%
MVC Capital (NYSE:MVC) $12.03 4.05% 69% 10%
MLPs Price Yield NPM% TDA%
Compass Diversified (NYSE:CODI) $12.74 11.67% (3%) 10%
Kinder Morgan Energy (NYSE:KMP) $83.77 5.74% 16% 53%
Atlas Pipeline Partners (NYSE:APL) $35.53 6.41% (4%) 32%
Magellan Midstream Partners (NYSE:MMP) $67.23 4.90% 20% 51%
Enbridge Energy Partners (NYSE:EEP) $32.02 6.82% (2%) 49%

Disclosure: I am long AINV, CWH.

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