In Search Of Income Alternatives

9/8/2014


Real estate investment trusts (REITs) account for about 3.5% of the U.S. stock market's total capitalization, while master limited partnerships (MLPs) and other publicly traded partnerships make up less than 3%. Both groups gobble up far more of investors' attention than their size warrants, mostly because of one attribute they possess in abundance.

Cash dividends.

The average REIT in our Quadrix universe of nearly 5,000 stocks yields 4.9%, while the average MLP yields 5.9%. Not surprisingly, today's yield-starved investors covet that income.

However, the stock market never gives you something for nothing. REITs and MLPs come with added risks, and you should understand them before you buy:

Concentration: REITs own either real estate or mortgage loans, while most MLPs operate energy businesses. When real estate or energy run into trouble, expect these stocks to suffer.

Tax complexity: REIT dividends may be treated as ordinary income, return of capital, or capital gains — or a combination of the three. Much of the typical MLP's distributions are returns of capital, which require investors not to pay tax, but to lower the cost basis of the securities. Investors will receive a K-1 form at tax time and should expect to spend a few more hours on their taxes.

Weak fundamentals: The REITs in our Alternative Income Watch List average Overall scores of 46 while MLPs average 54, with both scores weighed down by rich valuations.

Hopefully these caveats will make you tread carefully with MLPs and REITs. Check out our Alternative Income Watch List at www.DowTheory.com/Go/Alt. See Income Spotlight for more on MLPs and REITs.


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