Master Limited Partnership - Explained
What is a Master Limited Partnership?
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What is a Master Limited Partnership?
A master limited partnership also known as MPL, refers to a limited partnership traded publicly in an exchange. The operation of the MPL is generally in the financial services, natural resources, and real estate industries. However, the use of MPL was effectively limited to the natural resources sector and the real estate by the Congress in 1987. The limitation was set in place because of the too much corporate tax revenue that was lost as a result of MPL being exempted from federal income taxes.
How is a Master Limited Partnership Used?
The MLP is a unique legal structure which combines partnership and corporation elements. For instance, rather than it being considered to be a distinct legal entity, it is instead considered the aggregate of its partners. Also, what you need to know is that MLP does not have employees and so, it is the partners who take the responsibility of providing all the required operation services. Note that the stake that general partners hold in the venture is 2% and they are still free to raise more ownership whenever they feel like. Just like a partnership which issues units in the place of shares, so does MLP. The only difference is that the units have significant liquidity offer, something that traditional partnership does not offer, and that they are also frequently traded on national stock exchanges. Note that publicly traded units are not part of stocks shares. Therefore, investors who venture in MLP are known as unitholders. On the other hand, those who purchase into an MLP are known as limited partners. Limited partners are usually assigned a share of the MLPs deductions, income, are well as credits.
How Master Limited Partnership Works
Generally, there are two MLPs partner classes. They are as follows:
Limited partners This refers to investors who provide the operations capital to MLP, and also purchase shares from the MLP. The investors do receive from the MLP periodic distributions mostly after every four months (quarterly). Also, units for limited partners are publicly traded.
General partners These are owners of MLP who have the responsibility of overseeing the MLPs daily operations. There is always a compensation for general partners. The amount of compensation given to general partners is highly dependent on the business performance of the partnership. Also, note that units for general partners are not publicly traded. Basically, MLPs are exempted from paying corporate taxes. This is the reason why they always have good returns available for distribution to investors. For MLPs to benefit from this tax-exempt, they are required to generate a percentage of not less than 90 of their revenues from qualifying activities. The qualifying activities include commodities, real estate or natural resources.
Market Limited Partnership Investment Benefits
- As an investor, you are likely to benefit from the following if you make decisions to invest in the market limited partnership. They are as follows:
- Investing in MLPs gives an investor more attractive returns compared to that of bonds.
- Also, because MLPs comes from an industry with slow-growth but stable, it generates long-term steady cash flows.
- Investors who invest in MLPs enjoy tax benefits. This is because MLPs limited partners only pay tax when they get distributions. The cash distributions they receive most of the time do surpass partnership income. If this is the case, then it is considered to be limited partners capital return. This then means that there is suspension of capital gain taxes until that time when the MLPs units are sold.
Market Partnership Investments Drawbacks
Just as there are benefits related to investing in MLPs, so are there limitations. Some of the limitations of investing in MLPs include the following:
- There is an emergence of unrelated business taxable income when you hold an MLP in your retirement account. When the amount of cash you own in the MLPs surpasses the set threshold, then it automatically qualifies for taxation.
- Also, MLPs is an investment not suitable to everyone as it is not straight forward like when you invested in bonds and the stock market. In other words, MLP is not suitable for those investors who prefer an investment that is straight-forward.
Characteristics of Master Limited Partnership
An efficient market limited partnership should have the following characteristics:
- Should have plenty of fee-based assets
Since there is a possibility of prices of commodity reducing significantly, those companies whose income is solely dependent on commodity prices will incur significant losses. For this reason, it is safe for investors who wish to invest in MLP, to choose that which generates most of its revenue from a fee-based asset.
- Should have a strong balance sheet
A strong balance sheet is another important feature for consideration when investing in an MLP. A balance sheet that has an investment-grade credit rating will help an investor to make an informed decision about investing in MLP. Note that credit rating of MLP investment is usually graded as either standard or poor for easy rating by an investor.
- Should have a strong distribution coverage ratio
Basically, any investor would lookout for an investment that has stable returns. It is, therefore, normal that when investing in MLP, a distribution coverage ratio that is strong is an important feature that cannot be ignored by an investor. A good MLP should have the capability of bringing in constant income into a portfolio of an investor. However, an MLP with a distribution offer above 100% for its cash flow is not good either. This is because in case of any hitch, it may lead to a significant cut in its distribution, which is not a good thing for an investor who anticipates constant distribution returns into his or her portfolio. It is, therefore, advisable for an investor to look out for an MLP that has a ratio coverage range of 1.05 to 1.1.
- Should have a history of distribution growth.
A good MLP is that which has a steady distribution growth. For an investor to be able to determine MLP with a good distribution growth, he or she will have to check the distribution growth history of each MLP.
- Should have a visible project backlog
Another important feature to look out for when investing in MLP is a backlog of a project. An investor should, therefore, look out for an MLP with a number of fee-based assets, in which he or she plans to build in the future.
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