Learn Before You Buy MLPs, REITs

2/9/2015


Many income-hungry investors turn to real estate investment trusts (REITs) and master limited partnerships (MLPs), which look and trade like common stocks, but are not the same.

Proponents of REITs and MLPs cite their impressive long-term outperformance. From year-end 1995 to Jan. 31, the MSCI U.S. REIT Index returned 714% including dividends, while the Alerian MLP Index (which contains 50 of the most prominent MLPs and captures about 75% of the group's total market value) delivered a total return of 1,487%.

In contrast, the S&P 500 Index returned 361% during the 19-year period. A $1,000 investment in the large-cap stock index at the end of 1995 would have grown to $4,613 on Jan. 31 — a solid return, but well below the REIT index's $8,140 and the MLP index's $15,873.

After looking at those numbers, you might ask why we don't recommend subscribers sink all their money into MLPs and REITs. Since the end of 2013, the MLP index has returned just 2%, versus 10% for the S&P 500 and 39% for the REIT index. Go back to the beginning of 2013, and you'll find the REIT index underperforming, its 6% return dwarfed by the S&P 500's 32% for the year.

Industry concentration adds to the risk of REITs and MLPs. By definition, all REITs operate in the real-estate industry. Real estate performed well over the past year, but you can't count on a repeat. The MLP group is more diverse, but 76% of the publicly traded partnerships in our Quadrix universe and 83% of the group's total stock-market capitalization operate in the beleaguered energy sector.

We at the Forecasts like to invest in common stocks because they have historically outperformed fixed-income securities, and because our Quadrix stock-rating system has allowed us to outperform the typical stock. But as much as we appreciate the good old-fashioned equity, we also understand the appeal of high-income alternatives like REITs (averaging dividend yields of 5.1%) and MLPs (6.7%). We currently follow 51 REITs and 32 MLPs in our Alternative Income Watch List (www.DowTheory.com/Go/Alt). None of the securities on that list qualify for our buy lists. Because of their unusual corporate structures, REITs and MLPs are more difficult to analyze than common stocks.

As the table below illustrates, REITs and MLPs earn lower Quadrix Overall scores than the large-cap stocks in the S&P 500. The selection of large-cap REITs and MLPs is slim, and when you add a requirement for solid Quadrix scores, the list gets anorexic. In our view, most income investors should limit MLPs and REITs to no more than 10% to 20% of a portfolio.

MLPs AND REITs VERSUS S&P 1500
On average, MLPs and REITs pay higher yields than stocks in the S&P 1500 Index and have generated higher sales and operating-cash-flow growth over the last one and three years. However, S&P 1500 stocks earn higher Quadrix Overall scores. All of the numbers below are group averages for companies in our Quadrix universe, except for the number of companies, the percentage with Overall scores above 80, and the percentage above three market-cap cut-offs.
MLPs
REITs
S&P 1500
Index
Number of companies
123
215
1,500
Dividend yield (%)
6.7
5.1
1.5
Stock-market value ($bil.)
4.5
4.5
14.6
% above $2 billion
48
51
65
% above $10 billion
13
10
26
% above $25 billion
2
3
13
Quadrix scores
Momentum
52
60
53
Value
56
35
56
Quality
52
44
63
Financial Strength
56
49
58
Earnings Estimates
33
61
47
Performance
38
73
56
Overall
49
46
59
% above 80 Overall
14
8
22
Valuation
Price/earnings
23
32
22
P/E over 5-year average
1.02
1.07
1.08
Price/oper. cash flow
16
31
33
P/CFO over 5-year average
0.91
1.18
1.18
Growth
Last 12 months
Sales (%)
21
29
9
Per-share profits (%)
6 *
27 *
10
Oper. cash flow (%)
17
17
7
Last 3 years (annualized)
Sales (%)
15
15
7
Per-share profits (%)
4 *
7 *
8
Oper. cash flow (%)
18
20
9
Total return
3 months (%)
(8)
7
3
12 months (%)
(2)
27
14
3 years, annualized (%)
8
18
16
5 years, annualized (%)
14
19
16
* While REITs and MLPs report profits, analysts often use different metrics, versions of cash flow, to measure their growth.

Before you dip into the alternative-asset pool, familiarize yourself with what makes REITs and MLPs different from stocks. Some key points:

• Neither REITs nor MLPs are technically stocks. The former are trust units, the latter partnership units. However, you can buy and sell them on exchanges like stocks.

• Most REITs own property, generating revenue from rents or sale proceeds. Mortgage REITs own collections of mortgage loans and are difficult to analyze. Mortgage REITs tend to score poorly in Quadrix, and we generally avoid them.

• The MLP group contains some entities that aren't technically master limited partnerships, but for the most part should be treated the same way.

• Both REITs and MLPs have unusual corporate structures that allow them to pay big dividends. REITs receive favorable tax treatment if they distribute more than 90% of their income to unitholders. MLPs receive tax breaks if they generate 90% of their cash flows from "qualifying sources," which for the most part limits them to natural resources, commodities, or real estate.

• MLP owners will receive a K-1 form that breaks down the distributions, which can include returns of capital taxed at the individual-income rate. Some, but not all, of REIT dividends are taxed at the capital-gains rate.

ALTERNATIVE INCOME OPTIONS

Our Alternative Income Watch List contains 51 real estate investment trusts (REITs) and 32 master limited partnership (MLPs). We rate those securities A (above average), B (average), and C (below average). As a group, these companies don't earn strong Quadrix scores, and none qualify for our buy lists. Below you'll find all the REITs and MLPs that earn A ratings, as well as the B-rated companies with the best Quadrix Overall scores.

Neither REITs nor MLPs use earnings per share as their core performance metric. REITs use funds from operations (FFO) and MLPs use distributable cash flow (DCF); both are variants of cash flow designed to reflect the peculiarities of each group's business model and accounting policies.

3-Year
Annual.
Div.
Yield
(%)
Stock-
Market
Value
($Bil.)
Distributable Cash Flow/
--- Funds From Operations ---
------------- Quadrix Scores -------------
Company (Price; Ticker)
Div.
($)
Yield
(%)
Last 12
Months
($Mil.)
12-Month
Growth
(%)
3-Year
Annual.
Growth
(%)
Value
Overall

12-
Factor
Sector

Reranked
Overall
Rank
REITs
American Campus
($45; ACC)
1.52
3.4
3
4.7
257
(7)
84
24
60
17
25
B
American Tower
($98; AMT)
1.52
1.6
NA
39.7
NA
NA
NA
31
51
49
30
B
Apartment Investment
($40; AIV)
1.12
2.8
30
5.9
412
NA
NA
26
59
27
28
B
Avalonbay ($173; AVB)
4.64
2.7
8
23.0
1,227
34
84
29
38
2
15
A
Boston Properties
($141; BXP)
2.60
1.8
34
21.8
904
(31)
27
23
56
44
25
B
Equity Lifestyle Pptys.
($55; ELS)
1.30
2.4
20
5.1
238
6
97
23
52
NA
NA
B
Equity Residential
($79; EQR)
2.00
2.5
14
29.5
1,177
(58)
(22)
16
49
23
17
B
Extra Space Storage
($67; EXR)
1.88
2.8
50
8.1
332
50
238
24
85
71
45
A
HCP ($45; HCP)
2.18
4.8
4
21.5
1,468
10
54
37
44
14
23
B
Home Properties
($72; HME)
2.92
4.0
6
4.2
332
(3)
99
29
49
14
21
B
Hospitality Properties
($33; HPT)
1.96
6.0
3
4.9
487
17
69
35
53
73
26
A
Host Hotels & Resorts
($23; HST)
0.80
3.5
98
17.6
1,190
24
108
35
68
77
36
A
Kilroy Realty ($75; KRC)
1.40
1.9
0
6.5
379
62
105
11
45
18
9
B
Kimco Realty ($28; KIM)
0.96
3.5
8
11.5
689
40
75
27
49
27
22
B
LaSalle Hotel Properties
($41; LHO)
1.50
3.7
40
4.3
265
18
95
41
79
59
48
A
Liberty Property
($40; LPT)
1.90
4.8
0
5.9
405
6
21
27
48
23
16
B
Mid-America Apartment
($79; MAA)
3.08
3.9
5
5.9
381
38
162
33
52
33
26
B
National Retail Pptys.
($42; NNN)
1.68
4.0
2
5.3
286
15
115
20
45
9
14
B
Omega Healthcare
($43; OHI)
2.12
5.0
9
5.6
337
18
146
30
77
45
39
A
Public Storage
($203; PSA)
5.60
2.8
17
35.2
1,523
9
33
20
52
8
20
A
RLJ Lodging ($34; RLJ)
1.20
3.5
123
4.6
268
19
123
33
65
NA
NA
A
Simon Property
($202; SPG)
5.30
2.6
14
62.2
2,537
3
22
19
64
16
28
A
SL Green Realty
($127; SLG)
2.40
1.9
71
12.9
892
78
(3)
19
53
31
19
B
Starwood Property
($24; STWD)
1.92
8.0
16
5.4
518
91
440
91
84
NA
NA
A
Taubman Centers
($82; TCO)
2.16
2.6
3
5.3
623
129
210
25
54
19
26
B
Weyerhaeuser ($35; WY)
1.16
3.3
19
18.8
NA
NA
NA
39
46
35
29
B
MLPs
Alliance Holdings
($57; AHGP)
3.66
6.4
15
3.5
433
63
24
92
92
94
97
A
Alliance Resource
($38; ARLP)
2.60
6.9
11
2.8
473
47
42

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