Looking for income? A compelling alternative to REITs and Utilities
I participated in a discussion panel at the Wilson Family Office Real Estate conference on Friday, October 2 in New York. Almost all of the discussion surrounded the topics of the real estate cycle, capitalization rates (rate of return on a real estate investment property), difficulty in finding good cash flow from REITs, areas of opportunities, etc. The topic of the panel discussion was finding yield in a low yield environment.
I was asked to compare Master Limited Partnerships with REITs. Among the similarities that I detailed were that both own real assets, both produce income, both require land, both are pass through entities that return capital and pay out income, both use leverage, both rent their properties and have a history of raising rents, and both are cyclical.
A frequent sentiment at the conference expressed by many of the family offices speaking at the event was that the real estate cycle was approaching a top, and that we may be in the eighth or ninth inning. Some suggested that it was time to begin cashing in. In contrast, MLPs are in the early stages of a recovery.
An irrational, unwarranted sell-off
The Alerian MLP index peaked in August 29, 2014, at 539.85. It bottomed on February 11, 2014 with an intraday low of 199.1. Today the index is trading around 310, 42% off of its high. Market technicians view MLPs now in an uptrend. Master Limited Partnerships were caught in a negative feedback loop from August 2014 through February 2016. Even though mid-stream MLPs are engaged in the transportation of oil and not the ownership of oil, and even though many MLPs are more involved with natural gas and natural gas liquids, and even though the price of oil had little-to-nothing to do with many MLPs, the prices of MLPs became directly correlated with the price of oil and fell to insanely low levels.
Looking back to those days, investors have seen and felt extreme unease, fear and anxiety because MLPs were historically compared with steady, non-volatile investments like REITs and utilities. Investors felt this was not supposed to happen. In the 1990s, when I first began investing in MLPs, oil was priced in the teens and twenties and MLPs had been steady, growing and reassuring investments. While the share price volatility of MLPs has increased due to the correlation with oil, the volatility of the underlying cash flows has not increased to nearly the same level.
Looking at yield spreads help unveil the opportunity
Historically low interest rates over the last eight years has caused investors to search for yield outside of the traditional methods, and this has put downward pressure on the yields of REITs and utilities as these two sectors have reached near all-time high valuations. Putting this into perspective, the MSCI REIT index is yielding 4.54% while the yield on the Alerian MLP index is 7.32%. By comparison, the yield on the Dow Jones Utility Index is 3.53% and the ten-year treasury is yielding 1.72%. Over the last ten years, the spread between REITs and MLPs has been 2.46 percent and is currently 2.79 percent. The spread between utilities and MLPs has averaged 2.93% and is currently 3.8%.
The spread between the ten-year treasury and MLPs has averaged 3.96% and is currently 5.6%. However, when the ten-year yielded 6% and the MLP index yielded 9%, there was a 50% difference. Now the yield on the ten-year is 1.72% and with MLPs yielding 7.3%, there is a 325% difference in yield. This massive spread limits MLPs vulnerability in a rising rate environment. Combined with the fact that MLPs are in the early stages of their cycle and their substantial yield over the ten-year treasury, MLPs make for a compelling total return proposition.
Historical yields of MLPs, utilities and REITs
For those who recognize that midstream MLPs are businesses that transport, store, process and distribute the natural gas and the oil we use every day, the value becomes clear. DeWitt Capital Management is committed to continuing to uncover the best of these businesses while others fear to venture into the space. In a yield starved and politically unstable world, what better place could there be than in the vast energy infrastructure of the greatest, most profitable democracy on Earth?