The last few years have been hard on real estate investment trusts and master limited partnerships, two high-yield vehicles that tend to underperform when interest rates are on the rise. Some think the Federal Reserve's recent dovish tone regarding further rate hikes will help lift both asset classes out of their doldrums, but there is disagreement about which of the two — real estate or energy infrastructure — offers more upside.
REITs, which own and operate income-producing real estate, had a strong post-recession run, buoyed by rising property values and the perception that the asset class provides diversification from the broader stock market. But rising interest rates since 2016, alongside accelerating secular shifts in homeownership, consumer behavior and workplace dynamics that have disrupted whole swaths of commercial real estate — retail and office in particular — spooked investors and undermined REIT share prices.
MLPs, meanwhile, have had to endure their own bout of structural change around the "shale revolution," the run-up in hydraulic fracturing and horizontal drilling over the last decade-plus that has generated massive demand for new pipeline infrastructure. Like REITs, MLPs distribute the bulk of their income, which is the big draw for investors. But low energy prices and high leverage closed equity markets for many MLPs, prompting some to cut distributions. The MLP's historically narrow investor base, comprising mostly older, wealthier Americans, got burned, and many have stayed away.
"Once a company cuts its dividend, that name just kind of goes into a different bucket," Brian Nelson, president of equity research at Valuentum Securities Inc., said. "It loses the investor base it spent years and years building."
Nelson said the volatility in oil prices has compounded investor fears in the MLP space. Even with all the necessary infrastructure in place, one has not been able to count on stable energy prices.
"The swoon in energy resource prices in 2015 exposed a lot of the fragility in the pipeline arena," he said.
After a multiyear stretch of stock market volatility brought on by the distribution cuts and structural changes at MLPs, investors are warming to the group again, according to Simon Lack, managing partner at SL Advisors, an asset manager specializing in midstream energy infrastructure. Lack said the opportunity with MLPs is more significant given the sector's disproportionate decline. He estimated the yield spread between REITs and MLPs to be about 4%, with MLP's returning 10% and REITs returning 6% on average.
"If you told a REIT investor he could pick up a 10% funds-from-operations yield, he'd be all over that," he said, citing the principal REIT earnings metric. "And he can, it's just the pipeline business. It could be a really good time for those investors to upgrade. They get a big valuation improvement."
One factor that Lack said has stymied investor migration to MLPs from REITs is the tax reporting consequences of investing in MLPs, which, unlike REITs, issue the onerous Schedule K-1 form that requires more detailed, itemized accounting than a Form 1099. Many MLPs have converted to corporations in the last few years precisely so they could ditch the K-1 and attract a broader investor base, Lack said. He expects the conversion trend will drive more real estate investors to energy infrastructure investment, broadly.
"It's actually never been easier for a REIT investor to switch over," Lack said.
Valuentum's Nelson thinks real estate will maintain its edge with income investors for the foreseeable future. He cited the growth in popularity, over the last decade, of dividend growth strategies, a more conservative approach to investing that prioritizes slow but steady, above-inflation dividend gains, which REITs generally have been better able to provide than MLPs.
Real estate is more transparent and easier to understand, Nelson said. Moreover, the negative headlines around retail downsizing make things appear worse for landlords than they probably are, he added.
"While the outlook for pipeline infrastructure is much better than it was a number of years ago, and fundamentally we're a lot more optimistic on it, I think there's still a lot to be said about the comfort and sustainability of above-ground assets," he said.
Ultimately, Nelson thinks the memory of the last few years' trials in the MLP arena — the distribution cuts, the volatile energy prices — will linger.
"It's just going to take more time for MLPs to regain that footing, to regain that trust, within the investor community," he said.