BWNB - Living On Passive Income For Life

2023-11-17 14:58:48 ET

Summary

• Strategies for generating passive income include income investing, real estate investment trusts, master limited partnerships, exchange-traded debt, bonds, value-add property, joint ventures/REITs, and peer-to-peer lending.
• Preferred stocks, REITs, MLPs, and exchange-traded debt offer attractive yields for income investors.
• Investors should consider factors such as credit ratings, diversification, interest rate risks, and market conditions when selecting these investments.

Living off passive income is a dream for many, and achieving it is entirely possible with the right strategies and investments. This article delves into various approaches to generate a substantial passive income, primarily focusing on investments that yield approximately 10% in average annual yield.

Income investing is a strategy that involves buying securities that produce cash income, typically with little to no capital appreciation. This approach can include a variety of investment vehicles:

Preferred Stocks

These securities pay dividends and are a popular choice for retirement portfolios, offering yields of up to 8.8%. The following are the criteria I use to screen for preferred stocks.

• Minimum yield of 6.5%.
• Minimum credit rating of A1.
• Minimum yield-to-call of 6%.
• Callable date of at least two years from present.
• Net income/preferred dividends of 4 or above to ensure the company's earnings can meet its dividend obligations.
• Debt to total capital ratio < 0.70. This reduces the risk of insolvency.
• The ratio of common dividends to preferred dividends >=4. This cushion offers protection for preferred stock investors.
• Debt to EBITDA ratio < 6. It indicates that a company can service its debt effectively.

• The company should be operational for at least ten years.

• The company should not have more than three losses in the past ten fiscal periods.
• The company should have paid consistent dividends for the past seven years.

Some preferred stocks that I like are: Algonquin Power & Utilities Corp. Equity Units with a yield of 18% ( AQNU ), Brookfield Property Partners L.P. 6.5% preferred, with a yield of 12.2% ( BPYPP ), and Chimera Invmt. Corp. 7.75% Series C with a yield of 10.9% (CIM-C).

Real Estate Investment Trusts (REITs)

REITs are required to pay out 90% of taxable income to investors as dividends, though they tend to have lower yields, averaging 4-5%?.I look for the following criteria while screening for REITs.

• Net operating income annual growth: It indicates core operating profits of the REIT. For REITS, this measure is more important than EBITDA.

• Funds from Operations ((FFO)): This measure adjusts GAAP net income to a more consistent measure of profit for REITs, reflecting cash generated from operations?.

• ?.Adjusted FFO ((AFFO)): It accounts for nonrecurring expenses and capital expenditures, providing a clearer picture of cash available for distribution?.

• ?.A well-diversified portfolio: A mix of residential, commercial, industrial, and retail properties helps mitigate risks. The location and condition of properties also impact rental income, occupancy rates, and capital appreciation potential.

• Assessing rental income and occupancy rates: Rental income is a significant performance driver for REITs. Factors like lease terms, rental rates, tenant mix, and market demand are crucial. Higher occupancy rates typically indicate strong demand, leading to increased rental income and potential for higher returns?.

• Analyzing Financing and Capital Structure: These include the balance between debt and equity financing, the cost and availability of financing, debt management, and refinancing risks.

• Management expertise: The skill of the management to identify investment opportunities, manage property operations, and adapt to market conditions are vital.

• Monitoring economic and market Conditions: Economic factors such as interest rates, inflation, and GDP growth influence the demand for real estate and rental rates. A REIT’s ability to adapt to these conditions is crucial for maintaining profitability and maximizing returns.?

• Consistent year-over-year dividend growth.

• FFO Payout ratio below 90%.

• Tenant Diversification: Diversification among tenants reduces revenue concentration risk. Additionally,

• Growth strategy: A REIT’s strategy for growth, such as acquisitions and property development, is important for future dividend growth?.

Leverage and debt maturity schedules: Understanding a REIT’s leverage and reviewing debt maturity schedules are crucial to assess the risk of interest costs impacting profits. Current debt levels and access to capital markets are indicators of financial health?.

Some REITs that I like are: Medical Properties Trust ( MPW ) with a 13% yield, Annaly Capital Management ( NLY ) with a yield of 14.6%, and Apollo Commercial Real Estate Finance ( ARI ) with a yield of 13.1%.

?Master Limited Partnerships, MLPs

These partnerships, usually in the energy sector, often have higher dividend yields, typically in the 8-10% range.

MLPs offer the following advantages for income investors:

• Attractive Distributions: MLPs are required to distribute a significant portion of their earnings to investors, thus offering a steady cash flow to investors.
• Tax Efficiency: The pass-through structure of MLPs offers unique tax advantages, as they do not pay corporate income taxes. Additionally, MLP investors benefit from depreciation and depletion deductions, offsetting taxable income?.
• Inflation hedge: MLPs are often viewed as an inflation hedge due to their connection to energy and infrastructure. As inflation rises, the cash flow generated from these assets may increase, potentially outpacing inflationary pressures. This makes MLPs an attractive addition to an income investor's portfolio, especially during times of economic uncertainty.

What to look for while investing in MLPs:

• Interest rates: Like many income-focused investments, MLPs can be sensitive to interest rate changes. Rising interest rates may increase borrowing costs, impacting profitability and distribution levels.
• Regulatory risks: MLPs, especially those in the energy sector, operate in a highly regulated industry. Regulation changes or government policy shifts can affect MLP profitability and operational capacity. Staying informed about regulatory developments is crucial for assessing the potential impact on investments.
• Commodity price volatility: Most MLPs operate in the energy sector and are influenced by fluctuations in commodity prices. Sharp declines in energy prices can adversely affect the cash flow and profitability of MLPs, potentially impacting distributions to investors.?
• Non-GAAP Financial Metrics: It’s essential to understand the non-GAAP financial metrics used by MLPs, such as distributable cash flow, which assesses the cash available for MLP distributions.
• Distribution coverage ratio: The distribution coverage ratio, defined as the ratio between an MLP's distributable cash flow and its total distributions paid, indicates the sustainability of distributions. I look for a ratio above 1, which indicates sustainable distributions.

Some MLPs that I like are: NextEra Energy Partners ( NEP ) with a 15.2% yield, Antero Midstream Corp. ( AM ) with a yield of 6.9%, and Enterprise Products Partners ( EPD ) with a yield of 7.6%.

Exchange-Traded Debt

The average yield of these investments is 16.9% but they also come with risks.

I look for the following criteria while selecting these investments:

• Credit rating: A minimum credit rating of A1.
• Sustained dividend payout (coupon rate), which aligns with cash flow needs (monthly, quarterly, annually).
• Maturity date at least two years from now.
• Highly liquid securities: A minimum average daily trading volume of 100,000 or above.

In addition, investors in these investments should look for the following:

• Interest rate risk: This can be managed by laddering strategies or investing in floating-rate securities.
• Monitor the creditworthiness of the company by keeping an eye on credit rating changes and market news.
• Diversification across various sectors.
• Monthly portfolio rebalancing.

Some exchange-traded debt investments that I like are: Babcock & Wilcox Ent. 6.5% Senior Notes due 12/31/2006 ( BWNB ) with a yield of 19.7%, Harrow Health 8.6% Senior Notes due 4/30/2026 ( HROWL ) with a yield of 13%, and Runway Growth Finance Corp. 7.5% notes due 7/28/2027 ( RWAYL ) with a yield of 11%.

Bonds

These include municipal, corporate, and high-yield or “junk” bonds, and can form a significant part of an income-focused portfolio?.

Municipal bonds are suitable for taxable accounts since they are exempt from federal and potentially state income taxes. Corporate bonds usually offer higher yields, but lack tax benefits, and are suitable for retirement accounts.

Investors should consider the following factors while investing in bonds:

• Interest rate risk: Higher interest rates lower the value of bonds by increasing the discounting rate?e. Bonds have not done well this year due to rising rates. However, with the interest rates having peaked, bonds are a good investment at present for income investors.
• High credit rating of at least A1.
• Diversification: Not more than 2% allocation in each company. This also applies to other investments mentioned above.

Some attractive bond investments at present are: Geo Group 2028 notes (CUSIP 36162JAC0) with a yield of 10.4%, Global Partners 2029 notes (CUSIP 37954FAJ3) with a yield of 7.5%, and Medical Properties Trust 2027 5% notes (CUSIP 55342UAH7) with a yield of 6.4%.

Value Add Property

Here, investors improve properties (e.g., through renovations) to increase cash flow or market value, balancing risk and reward.

I look for the following factors while screening for these investments.

• Identifying potential: I look for properties with below-market rents, deferred maintenance, low occupancy rates, or outdated amenities. Properties in emerging markets are prime candidates, especially if local revitalization or infrastructure developments are underway. It's crucial to understand local zoning laws and regulations for potential property expansion or repurposing?.

• Proper due diligence: Investors should conduct property inspections, financial analysis, and market research. Understanding a property's condition, market potential, and financial performance can significantly affect investment decisions.

• ?Financial feasibility: Estimate the cost of improvements, potential rent increases, and expected property value increase. Utilize financial metrics such as net operating income ((NOI)), internal rate of return ((IRR)), and cash-on-cash returns. Consulting with experienced real estate professionals is essential for accurate cost and revenue estimates?.

• Community enhancement: Renovations should aim to improve both the individual units and the community at large. Enhancements to exteriors and shared spaces can foster a stronger sense of community, thus increasing the property's appeal?.

• Efficiency improvements: Implementing green initiatives and shared services can decrease operational costs, thereby increasing profitability?.

• Strategic planning: Develop a detailed plan outlining the scope of work, timeline, budget, and expected outcomes. Revisit and adjust the plan as necessary?.

• Tenant experience: Incorporating tenant preferences into improvement plans and providing excellent property management can reduce turnover and vacancy rates. Focus on amenities and features that cater to the target demographic?.

• Market adaptability: Stay informed about market trends to adjust strategies accordingly. This helps maximize returns and minimize risk.

• Effective property management: Partner with experienced property management companies to ensure efficient operations and positive tenant relations?.

• Diversifying investments: Diversify your portfolio to reduce exposure to market-specific risks.

• Avoid overleveraging by maintaining a conservative debt-to-equity ratio and ensuring adequate cash reserves for unexpected expenses or market fluctuations?.
• Joint Ventures and REITs: These allow indirect ownership and can be a more hands-off investment approaches.

A good read on this topic is: Lumbarjack Landlords' course .

Peer-to-Peer Lending

Look for a good P2P lending platform, which facilitates loans by connecting lenders directly with borrowers. The average yield on these investments ranges from 5% to 9%.

Some good P2P lending platforms are: LendingClub, Prosper and Upstart. These platforms handle the logistics of the lending process, including finding creditworthy borrowers, verifying identities, transferring funds, and collecting repayments?.

Investors should consider risks like the potential for borrower default, fees that can reduce returns, and funds being tied up in loans until repaid. It’s crucial to understand that high returns are never guaranteed?.

Conclusion

Achieving a life sustained by passive income requires careful planning, research, and diversification. By combining strategies from income investing, real estate, and other avenues, it is possible to build a portfolio that not only sustains but also grows wealth over time. Remember, the key is in balancing risk with potential rewards, staying diversified, and staying informed through continuous learning and adaptation.

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