Some investors are looking for a high risk opportunity that can yield a massive reward. Other investors are looking for opportunities that can provide a high yield in a more conservative way. For those who are looking for the latter type of opportunity instead of the former, a Master Limited Partnership could be the right choice. These MLPs offer distribution deals that are quite high most of the time and are well supported from ongoing cash flows because of their business type. Although growth typically comes from the issuing of new units instead of additional sales, the dilution of ownership still works out in many instances and everyone has value added to their portfolio.
The primary benefit of using the MLP as an investment opportunity is because of the Incentive Distribution Rights. For dividend investors, the entire structure of this type of investment is based on the distribution payout instead of allowing it to be an optional payout. When the partnership is able to grow in value per unit, then both the General Partner, who receives a specific percentage of the cash flow, and the rest of the holders in the limited partnership roles will all begin earning large amounts of passive income.
What’s One of the Cons of Master Limited Partnerships?
The one trap of the MLP is that incentive distribution payouts get to be too large for everyone involved, especially if the General Partner [GP] receives a substantial portion of it. This is because the GP is responsible for managing the operations and the individual investors or limited partners. There are many agreements out there that allow up to 50% of the total cash flow to go to the General Partner. On a good year, everyone wins. On a bad year, only the General Partner wins because they get a cut of the profits straight off the top.
In short, the limited partners [namely you] are stuck in a world where they must hope that a good year is achieved so that they can get the levels of passive income that they need. This is due to the costs that capital tends to bring.
Most growth comes in an MLP because of new units that are distributed. When more than 30% of the free cash goes to the General Partner at the later stages of an MLP, there’s very little money to distribute around to all of the unit holders. On the other hand, in the early stages of an MLP, there is very little incentive for a General Partner to focus on growth because they don’t receive enough compensation to make it worthwhile.
So why even bother to invest in such a strategy if it can be really easy to stall the revenues that are coming in? Because there are 7 investment strategies that can help you avoid the stalling problems and put you on the right side of the investments.
What Are the Tax Issues of an MLP?
The potential tax advantage of the average MLP is that most of the distributions that are received from them are classified as a return on an investment. This means that the distributions are not considered income. You won’t have to pay taxes on that portion until you sell your stake in the MLP. Even then, there’s a secondary tax advantage – the proceeds from a sale are taxed as general income instead of capital gains.
That’s the good news. Here’s the not so good news. If you’re involved with an MLP, you’ll need to file specific tax forms that account for your current financial status. It’s especially problematic if someone has an MLP in a tax-deferred account, such as an IRA. Collecting more than $1,000 in distributions from an MLP in tax-deferred account can subject investors to potential tax penalties. That’s why it is always recommended to speak with a tax advisor before proceeding with any investment in this particular arena.
How Do Investors Avoid the MLP Trap?
If you’re thinking about an investment into an MLP, then consider first what your long-term objectives happen to be so you can potentially protect your investment. Below is the best course of action you can take if you suspect that an MLP is in its later stages.
- Energy Transfer Equity – This is the easiest way to deal with distribution rights that are problematic. Instead of being on the paying side of the equation, put yourself onto the receiving side of the equation. This means that you’ll need to own a stake in the MLP as a General Partner. It has been unable to grow its quarterly distribution because of its IDR issues, but the yield of over 6% is above average when these investments are looked at as a whole.
6 Master Limited Partnership Investment Opportunities to Consider for 2017
Brookfield Asset Management – With a presence in multiple industries, including renewable energy and real estate, there are a few distribution rights that are owned with this partnership. The maximum payments are set at 25% instead of 50% or above, which means the costs of capital in the distribution rights rarely weigh down this MLP. Although they offer one of the lowest overall yields that can be found, it’s an attractive price and a conservative investment for those who wish to avoid risk.
Kinder Morgan – The benefit of this MLP is its structure. It is the general partner of Kinder Morgan Energy Partners, so it’s actually structured as a corporation. This gives investors fewer tax complications, which can be a definite benefit to certain portfolios. The yield of this MLP is just 3.5%, but the dividend growth rates are expected to exceed the organization’s overall growth rates. Although high levels of distribution rights payments bog down the process a little, it’s still a solid investment.
Oneok – There are many different types of investments held by this MLP, but the primary focus is the transportation, storage, and distribution of natural gas around the United States. Most of the businesses that are in the investment portfolio tend to be centered along the Gulf Coast, but their reach heads past the Greak Lakes and well into Canada. The one danger zone is that the MLP provides about 60% of the yield that the home organization provides, so there could be some greater growth potential not being realized internally.
Brookfield Infrastructure Partners – Investors don’t need to own a piece of the General Partner to avoid trouble. This MLP also has a 25% maximum cash flow on the IDR and this helps to spur on growth every year. With a presence on multiple continents and energy resources like coal and timber counted amongst their assets, the yields that could be expected from this investment opportunity could potentially exceed 5% in the near future.
Buckeye Partners – When there isn’t a General Partner around, then there’s no worrying about the distribution rights. This MLP bought out its GP and doesn’t have any more IDR payouts. Distributions come more quickly and the yields above 7% are one of the best that can be found in the industry today. It’s also been able to raise distributions every quarter, even during the Great Recession, but cash flow doesn’t cover the distributions as strongly as many investors may like.
Enterprise Products Partners – As a final consideration, here’s another MLP that bought out its General Partner. It’s also an energy focused investment that has raised their distribution levels for over 7 straight years. With tens of thousands of miles of pipelines, including the distribution of crude oil and petrochemicals, there are even two dozen processing plants, fractionation facilities, and off-shore platforms within the portfolio. The current distribution yield is right around 5%.
Are You Ready To Invest Using IDRs Today?
Master Limited Partnerships are a great investment strategy for niche investors who are looking to gain an edge on their portfolio, need some tax help, or there is a need for diversification. Those who are investing in a tax-deferred way may wish to limit how much of an investment is put into an MLP because of the risk of penalties. Others may not wish to invest in them at all, especially if there are certain IDR restrictions that allow for more money than necessary to go to the General Partner.
By using this information and these MLP tips, you can decide if one of these partnerships is right for your portfolio. Remember that the past performance of a partnership does not guarantee that a yield isn’t going to be cut in the future. When you pick the right partnership, you’ll want to hold onto it for several years because of the value that it contains. The time spent on researching each one will be an investment that is also worth making.