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Use Caution when Seeking Yield with Non-Traded REITs and MLPs

Low interest rates have led some investors to seek retirement income from non-bond investments that they don’t fully understand.

Two such investments, non-traded REITs and MLPs, seem to have attractive “yields”, but carry unique risks and tax consequences. Here are a few to be aware of:

Non-traded REITs (Real Estate Investment Trusts not listed on a stock exchange)

  • Price vs. Value: The price of your units is set by the sponsor. Unfortunately this price may not reflect the value of the underlying investments in the REIT.
  • Not Liquid: You may be locked into an investment anywhere from several years to a decade or more. Even newer funds that provide more frequently updated prices can be subject to liquidity caps.
  • High Fees: You may pay an upfront commission of 5% or more.  This is in addition to other layers of fees that resemble something from the world of hedge funds.
  • Blind Pools: You may not know what you will own. Some non-traded REITs may have made several acquisitions; while others are pools where you don’t know what properties management will be buying.
  • Approach vs. Opportunity Set: Your REITs approach may not fit the investment landscape. For example, it may be buying single tenant triple net properties when all the good deals in the space have dried up.

MLPs (Master Limited Partnerships)

  • Tax Prep Costs: MLPs avoid double taxation, but issue K-1s that your CPA will have to wade through.  Also, larger shareowners may have to file tax returns for multiple states.
  • Potentially No Tax Benefit: MLP investments are touted for their tax benefits. However, if you trade them short term or invest in an MLP mutual fund, you basically give up the benefits by paying recaptured income taxes or corporate taxes, respectively.
  • Poor Fit in an IRA: If you invest in an MLP inside your retirement account, you will probably have to pay unrelated business taxable income (UBTI); thus giving up the tax deferral benefit of the account.
  • Not Alike: Your MLP may invest in more stable energy pipelines, or it may be focused on riskier exploration activities.

As investors clamor for anything providing higher yield, Wall Street has been happy to create and sell more esoteric and risky investment products. Given the limitations, risks, and added costs of these products, it’s critical you know what you are buying.