GHI - Earn Tax-Free Passive Income - Yields Up To 9%

2023-09-12 07:35:00 ET

Summary

• When you earn a lot of income as a professional income investor, it's nice to have some portfolio holdings that pay no federal tax.
• You're able to help the nation grow and be strong, all while receiving excellent income.
• Retirement should be a time of ease and relaxation, not dealing with complicated projects and reading.

Co-authored by Treading Softly.

Very few of us love to pay taxes.

I had a good friend who was very well off financially, who used to famously and repeatedly tell me that "paying taxes is just the price of success." Typically, every one of us has to pay some level of taxes between sales tax at a store to income tax annually. Many people will try to find clever ways or means to avoid paying taxes, which could result in jail time. Others find completely legal loopholes that eventually get closed because of abuse.

When it comes to the market, there are very few investments that pay strong dividends but also help you avoid being heavily taxed. As a rule of thumb, I try to avoid discussing taxes or helping people avoid taxation simply because one's tax situation is unique and personal to each individual.

I am not a tax expert. I am an income expert.

I am fantastic at helping you grow your income stream and develop a portfolio to provide you with all the income you'll ever need.

Today, I want to highlight two strong portfolio holdings of mine that can provide you with excellent income that is significantly or completely tax-free income. For those of us who pay a lot in taxes, portfolio holdings like these can be invaluable tools to earn income and not have to worry about taxes later.

Let's dive in!

Pick #1: GHI - Yield 9.1%

Greystone Housing Impact Investors LP ( GHI ) is a publicly traded partnership with a focus on multi-family real estate. GHI 's investment strategy centers around two core strategies.

1. Mortgage Revenue Bonds

The first is investing in "mortgage revenue bonds," or MRBs. These are loans originated by government housing agencies for the purpose of encouraging the construction of low-income housing. Investors in GHIs get a secured mortgage, with a first lien interest on the property.

Mortgage investments make up the bulk of GHI's total assets. Source

GHI provides capital and profits from the "spread," the difference between GHI's cost of capital and the interest rate paid by the borrowers. The interest from these loans is Federal Tax Exempt, a benefit that GHI passes along to shareholders. So a portion of your distributions will be tax-exempt, though it should be noted that the size of the tax-exempt portion can vary considerably from year to year.

Note: GHI issues a Schedule K-1 at tax time.

The MRB segment has been pressured as rising interest rates have been a negative for net interest income. GHI's net income is reduced by approximately $0.015/year for each 50 bps increase in base rates.

With interest rates likely near peak, this headwind should dissipate. When the Fed pivots, GHI will experience rising interest income. In the meantime, GHI has relied on its second strategy to make up the difference:

2. Vantage Joint Venture

GHI has seen fantastic returns from its "Vantage" joint venture. GHI provides capital to develop multi-family properties, their partner manages the property and once the property is leased up, it is sold.

GHI gets a little bit of income during the holding period, but the real money is in the gain recorded when the property is sold. A fully leased apartment building is more valuable than vacant land plus construction costs. The timing and the size of these gains are inconsistent, but they have been a substantial portion of GHI's earnings over the past two years.

It is this strategy we can thank for the special and supplemental dividends that GHI paid in 2021 and 2022. For 2023, GHI has already produced CAD (Cash Available for Distribution) of $1.43 in the first half, compared to a regular distribution of $0.74 during the same period. This puts GHI's distribution on very solid footing, and a supplement or end-of-year special distribution is a realistic possibility.

Looking forward, GHI has three properties where construction is complete and will be ready to be sold when they are leased up. This is consistent with the three property sales per year GHI saw in 2021-2023. Source

Another five properties are already under construction and two more are in the planning phase. This pipeline is strong enough to support 2-4 property sales per year. In June, GHI also entered into a joint venture agreement with Camden Securities Company which will follow a similar strategy starting with construction in Huntsville, Alabama. This strategy has produced outsized returns for GHI with limited capital investment.

The Income

By diversifying geographically and with different partners, realized gains will continue to be lumpy, but they should become more frequent. As shareholders, we can expect our distributions to consist of a "regular" distribution that matches what GHI is able to produce consistently, primarily covered by their mortgage investments, plus special or supplemental distributions in years where they have several property sales.

During COVID, it was GHI's MRB business that provided stability when all property sales stopped. GHI wasn't willing to sell properties at poor prices in a disrupted market. Shareholders were richly rewarded for this patience when properties sold at much higher valuations in 2021 and 2022. As interest rates have risen, putting pressure on earnings from their mortgage strategy, property sales have more than filled in the gap. When a company has two distinct strategies, this is exactly what you want to see. One strategy thrives when the other struggles, providing consistently high returns to cover the distributions for shareholders.

GHI management has recognized how successful the Vantage Joint Venture has been, and so they are increasing their capital allocation to this strategy. That will create substantial upside potential for the company in the future.

Pick #2: DMB - Yield 4.6%

BNY Mellon Municipal Bond Infrastructure Fund, Inc. ( DMB ) is a municipal bond fund that focuses on buying infrastructure-backed Federal tax-free bonds. A major advantage to these bonds is that they're typically issued by state governments to fund infrastructure projects, and thus the revenue to pay the bonds comes directly from the projects themselves. If you've ever driven on a toll road or crossed a toll bridge, these projects are usually funded directly by a municipal bond, and then those revenues pay the bond interest.

The largest negative with DMB is an exceptionally long duration, which is simply the length of time until a bond is redeemed at maturity. When you have a fund like DMB that buys municipal bonds, they historically have an extremely long duration. It's not surprising to see muni bonds sometimes with 40 or 50-year durations from when they are first issued. Whenever you have a bond fund that has a long duration, it is always impacted most heavily by interest rates. If interest rates are climbing, long-duration funds typically see an erosion of their trading value. When interest rates fall, then a long-duration fund receives better benefits and rapidly climbing prices. Likewise, a short-duration fund has reduced impacts from changing interest rates.

DMB clearly falls into the long-duration category with its holdings, and so the income it's receiving from its holdings is largely unchanged, but their value has shifted due to the rapidly climbing interest rates. Now interest rates have normalized and are likely to stay steady before falling again. This makes DMB even more attractive for when they do fall.

Last year we saw a dividend cut from DMB. This was driven primarily by the higher cost of its leverage, which, adjusted with interest rates, reduced its overall income that it can pay out. That slight dividend cut allowed DMB to pay dividends only from earnings and without eroding its NAV by having to sell positions to pay for its dividend. DMB has shifted its holdings and now generates an average SEC yield of above 5% to pay its 4.6% yield - showing that it is now out-earning what it is paying out.

We find DMB to be highly attractively priced, trading at a generous discount - 8.1% - plus paying a tax-free 4.6%. Assuming a 35% tax bracket, DMB yields the equivalent of a 7.0% fully taxed investment. With a fully covered dividend and a strong outlook when rates fall, DMB is an attractive means to gather tax-free income.

Conclusion

With GHI and DMB, we can help fund various necessities around our nation and be paid strong income in doing so. The United States as a nation is in grave need of additional infrastructure investment as well as more housing for those of us who live here. These two investments allow you to receive tax-free income while helping fund both of those needs. The beautiful aspect of this is that it's not heavy work for you. You don't need to go out and buy individual mortgage revenue bonds or municipal bonds yourself, but you can provide your funds to these skilled portfolio managers or company management teams and allow them to do the legwork while providing you the benefits of tax-free income.

When it comes to retirement, the last thing you want is a complicated lifestyle. You don't want to have to be hunting down different bonds and reviewing different projects. You want to be able to enjoy your time doing what you love and enjoy. For most of us, that's not going to be reading the prospectus of a new municipal bond offering. Instead, it's going to be drinking a cup of coffee and spending time with our family. With two portfolio holdings like these, you can have that and get tax-free income.

That's the beauty of my Income Method. That's the beauty of income investing.

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