REITs and MLPs: why I abandoned these strategies

REITs and MLPs are financial instruments found primarily in the United States that are particularly generous in terms of their distributions. They are something like cousins — similar in their operating mechanism, yet distinct in their structure.

Historically, the stability of their business model, their relative independence from the stock market, and the attractive income they generate made them an interesting opportunity for investors seeking passive income. These instruments also had a feature that was often overlooked: a degree of protection against US dollar exchange-rate risk.

Let's first look at what lies behind these two terms, before examining why these strategies have become obsolete for European investors.

REITs: how they work and the different types

A REIT (Real Estate Investment Trust) is a company whose assets and revenues are primarily derived from real estate. It must distribute at least 90% of its net income annually in the form of dividends. What makes this particularly interesting from a US tax perspective is that it can deduct dividends paid from its taxable income before tax is applied. It is therefore naturally incentivised to distribute its entire earnings.

Real estate activities do not generate returns as high as those of companies listed in other sectors. The US government therefore favours them by avoiding double taxation: once on the company's earnings and again on the dividends received by shareholders. That said, while returns are lower than in other sectors, they are also historically more stable and sustainable.

Equity REITs vs Mortgage REITs

The return on Equity REITs (which own and lease physical property) reaches around 12% per year in total return when the investment horizon exceeds the length of a real estate cycle (approximately ten years). These companies generate revenue from renting out physical properties and benefit from asset appreciation.

Mortgage REITs (which invest in mortgage-backed instruments) can distribute particularly generous dividends. They sometimes post extreme returns, such as 77% in 2001. But this comes at the cost of off-putting volatility, with severe drawdowns (‑42% in 2007). Mortgage REITs are built entirely on debt, backed by assets that can evaporate rapidly. Unlike Equity REITs, they do not benefit from property appreciation. Their annual return over a 10-year holding period is a modest 4% in total return.

Sector specialisations within REITs

REITs offer a wide range of choices across the real estate spectrum, with specialisations by sector and region. Generally speaking, the more focused a REIT is on a particular market, the better — as it can capitalise on a competitive advantage or a niche market.

Each sector has its own characteristics:

• Hospitality is highly sensitive to the economic cycle.
• Office is slightly less growth-dependent, with occupancy rates typically between 90 and 95%.
• Residential is even less exposed to economic ups and downs.
• Retail is the least profitable sector, but also the most stable thanks to strict regulations on lease duration and rent indexation.
• Healthcare is barely affected by the economic cycle and typically posts occupancy rates between 95 and 100%.

For solid long-term income, it is better to focus on Equity REITs rather than Mortgage REITs. The retail, healthcare, and residential sectors are also less exposed to economic volatility.

Key risks of REITs

Despite these precautions, all investments carry risk. The greatest threat to the real estate sector remains a rise in interest rates. A sharp and sudden surge in inflation could force the Fed to tighten monetary policy and put REITs under pressure.

Another risk specific to REITs is that cash may simply not flow in. This can happen if properties cannot find tenants, or if an existing tenant can no longer meet rental payments. To mitigate these risks, a REIT should diversify heavily across both its tenant base and its property portfolio.

Finally, REITs are generally highly volatile, even when focused on the retail, residential, and healthcare sectors. Their standard deviation can easily be double that of a standard listed equity. Historically, this volatility was relatively uncorrelated with equities, which helped reduce market risk. Since the subprime crisis, however, this advantage has faded considerably.

MLPs: the energy cousin of REITs

As interest rates on traditional fixed-income instruments fell sharply during the 2000s and 2010s, investors turned to specialised investment vehicles. MLPs (Master Limited Partnerships) gained considerable popularity because they offered very high yields, thanks to the tax advantages they enjoyed — much like their REIT cousins.

Structure and tax advantages (up to 2023)

MLPs paid no tax before distributing their profits, which allowed them to be more generous with investors. To qualify for this tax treatment, 90% of an MLP's income must come from real estate, commodities, or natural resources (mining, timber, or energy).

Important note: MLP and PTP (Publicly Traded Partnership) are used interchangeably. Any exchange-listed MLP is technically a PTP. This distinction becomes critical for understanding the 2023 tax changes.

MLPs are controlled by a general partner, who typically holds a 2% stake. These general partners are usually private companies, though some are also publicly listed. Take Kinder Morgan (NYSE: KMI), the general partner of the MLP Kinder Morgan Energy Partners (NYSE: KMP). While Kinder Morgan offered a yield of 4.5%, Kinder Morgan Energy Partners distributed 6.5%.

Focus on the energy sector

MLPs were particularly attractive to major natural gas and oil producers. Many transferred their assets and pipelines into MLPs, which they control as the general partner. Pipeline operator fees are regulated and based on the volume of products transported — not on the price of oil. Long-term earnings growth therefore tracks the broader economy rather than oil prices.

For natural gas operators, margins can fluctuate with commodity prices. Some operators use hedging strategies to reduce their exposure to price swings, though this also limits their upside potential.

Shared characteristics with REITs

Like REITs, MLPs are highly volatile and may not suit every investor's risk profile. In return, they were relatively uncorrelated with equity markets — which made them an interesting diversifier.

One technical detail worth noting: MLPs do not pay dividends but distributions, which consist of a small income component and a large capital gain component. In theory, for Swiss investors, a significant portion of these distributions was not taxable. In practice, the tax treatment remains complex and often ends up being treated similarly to standard US dividends.

Why I abandoned REITs and MLPs

1. Punishing tax rules on MLPs since 2023

This was the final blow. Since 1 January 2023, the IRS applies a withholding tax of 10% on the gross sale proceeds (not just the gain) for all non-US investors holding PTPs/MLPs.

In concrete terms:

• You buy 200 units at $50 = $10'000 invested
• You sell at $51 = $10'200 (a $200 gain)
• Withholding tax: 10% × $10'200 = $1'020
• Net loss: $820 (when you thought you were making $200)

Add to this a 37% withholding on distributions for non-US individuals, and it becomes clear that MLPs are now completely unworkable for Swiss and European investors.

I had to update my Determinant Portfolio at the end of 2022 to avoid this particularly nasty "Christmas gift" from the US tax authorities.

2. Excessive volatility and growing correlation with equities

Historically, REITs and MLPs showed low correlation with equity markets, which justified their inclusion in a diversified portfolio. This advantage has eroded significantly since the 2008 subprime crisis.

US REITs now display:

• Volatility often double that of standard equities
• Increased correlation with markets during major crises
• Marked sensitivity to interest rate cycles

This evolution dramatically reduces their appeal as a diversification tool.

3. Swiss real estate: a superior alternative

In my in-depth analysis of real estate ETFs and listed funds, I showed that Swiss real estate significantly outperforms US REITs on every relevant metric.

Comparison by the numbers (2011–2024):

Metric	US REITs (VNQ)	Swiss real estate (SRFCHA)
CAGR	7.8%	5.2%
Volatility	19.2%	8.1%
Sharpe ratio	0.40	0.65
Maximum drawdown	-42%	-12%
S&P 500 correlation	0.72	0.31

A Sharpe ratio of 0.65 for Swiss real estate versus 0.40 for US REITs means a better risk-adjusted return. A combined portfolio of 60% US equities / 40% Swiss real estate achieves a Sharpe ratio of 1.01 — well above a 100% equity portfolio.

Decisive advantages of Swiss real estate:

• Volatility 2.4× lower than US REITs
• Very low correlation with equity markets (0.31)
• Swiss franc stability (no USD exchange-rate exposure)
• Robust and predictable regulatory framework

My current alternatives for real estate exposure

For Swiss and European investors seeking real estate exposure within a FIRE strategy, here are my current recommendations.

For beginners: SRFCHA

The SRFCHA ETF (SXI Real Estate Funds) remains my preferred choice for anyone starting out in investing. This ETF bundles the main listed Swiss real estate funds (SIMA, ANFO, etc.) and offers:

• Beginner-friendly volatility (8.1%)
• An average annual return of 5.2% in CHF
• Automatic diversification across Swiss real estate as a whole
• An accessible entry point

It is one of the simplest and most accessible portfolios available, combining moderate risk with a solid return profile.

For more sophisticated portfolios

In the Determinant Portfolio, I have opted for a targeted selection of individual listed real estate funds rather than the broad ETF. This approach allows for a slight improvement in the Sharpe ratio while maintaining excellent diversification.

Conclusion: the evolution of a FIRE strategy

REITs and MLPs, despite operating in different sectors with distinct structures, share a tax treatment that allows them to pay generous distributions. Historically, I was sceptical of high yields — usually a sign of irresponsible management. In the case of these instruments, however, those generous distributions were the product of a genuinely favourable tax mechanism.

But the landscape has changed radically:

1. Punitive taxation: the 10% withholding on gross proceeds makes MLPs unworkable
2. Disappointing performance: chronic underperformance since 2014
3. Superior alternatives: Swiss real estate offers a better risk-return profile
4. Excessive complexity: K-1 forms, IRS filings, regulatory uncertainty

Transparency is a cornerstone of my FIRE approach. Keeping this article while explaining why I abandoned these strategies illustrates the importance of adaptability in long-term investing. The best strategies evolve alongside regulatory, tax, and market changes.

For optimal real estate exposure in a European FIRE portfolio, I now recommend:

• SRFCHA for a simple and effective approach
• A targeted selection of listed Swiss funds to optimise the Sharpe ratio

Discover my precise selection in the Determinant Portfolio and go deeper with my full analysis of real estate ETFs.

Recommended next read: The portfolio wars: ETFs — understanding why some popular ETFs are not optimal.

Frequently asked questions

Are US REITs still viable for Swiss investors?

REITs (unlike MLPs) are not subject to the 10% gross-proceeds withholding. They remain technically investable. However, their high volatility, growing correlation with equity markets, and underperformance relative to Swiss real estate make them unattractive. At equivalent risk, Swiss real estate offers better risk-adjusted returns.

Can I reclaim the 10% withholding tax on MLPs?

In theory, investors can file a US tax return (Form 1040-NR) to potentially recover part of the withholding if it exceeds the actual tax owed. In practice, this process is complex, costly (US tax advisor fees), and the outcome is uncertain. For most individual investors, the effort is simply not worth it.

Are European real estate ETFs (IPRP) an alternative to REITs?

No. The IPRP ETF (European real estate) has delivered disappointing performance with high volatility over the 2010–2024 period. It has significantly underperformed its Swiss counterpart SRFCHA, and the depreciation of the euro against the Swiss franc (‑25% over the period) makes the picture even worse. European real estate was hit particularly hard by the post-2021 rate hikes, in contrast to Swiss real estate, which was cushioned by the stability of the franc.

Are individual real estate stocks like Realty Income worth it?

Individual real estate companies such as Realty Income (O), Prologis (PLD), or STAG Industrial have posted excellent historical performance. However, they carry significantly higher volatility than real estate funds and increased concentration risk. They can have a place in a diversified portfolio for an experienced investor, but should not make up the bulk of a real estate allocation. For the FIRE investor seeking stability and predictability, listed Swiss funds remain preferable.

Are there any MLPs exempt from the 10% withholding?

Some PTPs/MLPs can be exempt from the 10% withholding if they issue a "Qualified Notice" certifying that less than 10% of their income is derived from US commercial activity. These exemptions are valid for 92 days and must be renewed regularly. The lists change constantly and even brokers cannot guarantee their accuracy. This permanent uncertainty adds a level of complexity and risk that is unacceptable for most investors.

Sources and data

• IRS – Section 1446(f): withholding tax on PTPs for non-US investors (effective 1 January 2023): irs.gov
• SIX Swiss Exchange – SXI Real Estate Funds Index (SRFCHA): six-group.com
• Vanguard Real Estate ETF (VNQ) – historical performance and volatility data: vanguard.com
• Backtesting data and Sharpe ratios: FactSet