REITs, BDCs and MLPs as income instruments: coverage, leverage and risks for a euro investor

What you will learn

• How REITs, business development companies (BDCs) and master limited partnerships (MLPs) are built to pay out most of their cash.
• The coverage ratio used for each structure and the leverage limits that apply.
• Why a euro investor faces withholding, access and currency problems that a US investor does not.
• A quick safety check for each of the three.

Explanation

REIT mechanics, NAV, FFO and loan-to-value were explained in the course Real Estate & REITs. This lesson compares REITs with two other pass-through structures and focuses on income safety for a non-US investor.

Real estate investment trusts (REITs) own income-producing property and, in the US, must distribute at least 90 percent of taxable income to stay tax-exempt at company level. The German G-REIT has a similar 90 percent rule and must finance at least 45 percent of its property with equity (as of 2026, check the current law). The safety ratio is the AFFO payout ratio (lesson 2); leverage is read as loan-to-value (LTV), with 35–45 percent typical and above 55 percent risky.

Business development companies (BDCs) are US closed-end funds that lend to small and mid-sized private companies, usually at floating rates, and also distribute at least 90 percent of taxable income. Their safety ratio is net investment income (NII) coverage = NII per share / distribution per share; below 100 percent the distribution is paid from gains or capital. Since the 2018 Small Business Credit Availability Act, US law requires an asset coverage ratio of at least 150 percent (previously 200): total assets must be at least 1.5 times debt, roughly a maximum debt-to-equity of 2 to 1. BDC risk is credit risk: in a recession, defaults reduce NII and net asset value together.

Master limited partnerships (MLPs) are US partnerships, mostly owning pipelines, that pay no corporate tax if at least 90 percent of their income is qualifying natural-resource income. Their safety ratio is distribution coverage = distributable cash flow (DCF) / distributions paid; 1.2× or more is healthy, below 1.0× unsustainable. Net debt / EBITDA of 3.5–4.5× is common for pipelines with long-term contracts.

The euro investor's structural risks. First, withholding tax: US REIT and BDC dividends are generally withheld at 15 percent for a German resident with form W-8BEN on file (lesson 8). MLP distributions are partnership income, withheld at the top US rate of 37 percent, and since 2023 brokers also withhold 10 percent of gross sale proceeds under Section 1446(f); reclaiming requires a US tax filing. Second, access: under the EU PRIIPs regulation retail products need a key information document (KID); many US BDCs, MLPs and US-domiciled ETFs have none, so German brokers will not sell them. Third, currency: a 1,000 dollar distribution is worth €909 at 1.10 dollars per euro and €833 at 1.20. Fourth, tax classification of BDC and MLP distributions by German brokers varies; check with a Steuerberater.

Worked example

Hypothetical example: three instruments, figures in US dollars, fees excluded.

Step 1 – net income for a German investor. Each pays you 1,000 dollars a year. REIT and BDC: 1,000 × (1 − 0.15) = 850 dollars (the 15 percent is usually creditable against German tax). MLP: 1,000 × (1 − 0.37) = 630 dollars; the excess over 15 percent is not creditable without a US filing.

Step 2 – currency. At 1.10 dollars per euro, 850 dollars = €773 and 630 dollars = €573. At 1.20 they become €708 and €525: a 7.5 percent fall in euro income with no change at the company.

Step 3 – what the BDC coverage hides. Coverage of 105 percent assumes current interest rates. With a 90 percent floating-rate loan book and assets at 2.2 times equity, a 1-point fall in rates could cut NII per share by 15 to 20 percent and push coverage below 90 percent. BDC distributions are more rate-sensitive than REIT dividends.

Common mistake

Practice activity

On paper: a BDC reports NII of $1.80 per share and pays $1.92. Total assets $1,500 million, debt $950 million. (a) Calculate NII coverage. (b) Calculate the asset coverage ratio and state whether it meets the 150 percent legal minimum. (c) A German investor receives $2,000 of distributions; what does she keep after 15 percent US withholding, in euros at 1.08 dollars per euro?

Key takeaways

• REITs, BDCs and MLPs pay high distributions because they pass through cash, not because they are safer.
• Check the right coverage ratio: AFFO payout for REITs, NII coverage for BDCs, DCF coverage for MLPs.
• BDCs must keep 150 percent asset coverage; REIT LTV above 55 percent and MLP net debt / EBITDA above 5× are warning levels.
• For a euro investor, 37 percent MLP withholding, missing KIDs and currency moves can remove much of the headline yield.

Next step

Lesson 6 examines preferred shares and hybrid bonds, which sit between debt and equity and offer fixed income with their own call and deferral risks.