Thirst for Yield Leads Fixed-Income Investors to U.S. Equity REITs, MLPs
- Apr 17, 2013
Fixed income investors have continued to scramble for yield in recent months. Two effective options within the universe of corporate bonds have been U.S. equity real estate investment trusts (REITs) and master limited partnerships (MLPs).
REITs and MLPs are both corporate bond issuers generally rated in the ‘BBB’ category that have similar liquidity needs and tax considerations. However, there are important contrasts between the two segments, including structure, leverage, and governance.
Whereas a REIT is organized as a corporation or business trust, an MLP is structured as a partnership. The common thread is that both structures allow for greater tax efficiency. By the same token, REITs and MLPs are both subject to higher event risk from future unfavorable changes in federal tax laws. That said, Fitch does not envision any nearterm changes in such policies.
One noteworthy difference between the two structures is leverage. Debt levels of ‘BBB’ rated REITs hover generally in the 5-6x range, while similarly rated MLPs have leverage more near the 3.5-4.5x range. One reason why REITs can operate with higher leverage than MLPs is because there are no alternative secured financing markets for MLPs as there are for most equity REITs. For instance, if the unsecured bond market is not an economical alternative, REITs may elect to access the CMBS market, insurance company or bank principal mortgage markets as sources of contingent liquidity.
Another contrast between REITs and MLPs are corporate governance practices. Publicly-traded REITs are typically internally-managed companies with corporate-style governance practices. This enables shareholders to elect boards of directors and exercise some degree of governance influence. In contrast, corporate governance practices for MLPs are weaker since the board of the GP solely controls the MLP board.
Fitch expects these structures to continue finding favor with fixed income investors for the foreseeable future given the ongoing combination of central bank easing and rock bottom interest rates.