If you’re an avid income investor, then you’ve probably heard of MLPs or REITs.

Their “pass-through” structures make them an income investor’s dream.

We’ll skip covering the merits of these securities for today. Instead, I want to tell you about another unique security – one that most income investors don’t even have a clue about.

I’m talking about “yieldcos”.

If you’re not familiar with the term, this refers to a special class of securities that bundles the steady demand of a power utility with the contractual cash flows of a master limited partnership (MLP).

If that sounds appealing, you’re not alone. These unique securities have gained increasing attention over the years. But yet they get almost no coverage from the financial media. So let’s take a few minutes to get acquainted…

What The Heck Is A “Yieldco”?

We all know that massive amounts of capital are being thrown into the renewable energy space. So it shouldn’t come as a surprise that someone would engineer a nifty way to reduce funding costs and increase appeal to investors.

Back in 2011, Brookfield Asset Management did just that. Known for its creative use of capital, the firm launched a separate tracking company created for the sole purpose of operating its various green energy assets.

That subsidiary was called Brookfield Renewable Energy Partners (NYSE: BEP). And the rest, as they say, is history…

Today, BEP is no longer the only game in town (more on that in a moment). But before we go any further, let’s take a look at how these “yieldcos” work.

To understand this, it’s helpful to go back and think of MLPs and real estate investment trusts (REITs). In their simplest form, these businesses are built to own long-lived assets that generate high levels of tax-advantaged cash flow. But instead of pipelines or rental properties, in this case, we’re talking about renewable energy assets (think power plants, solar arrays, etc.).

Yieldcos always have a larger parent (or sponsor) that maintains an equity ownership interest. The parent is also entitled to receive incentive distribution rights (IDRs), which generally range from 25% to 50% of distributable cash flow beyond a certain threshold.

From our standpoint as investors, lower is better. But the IDRs do encourage the sponsor to keep building and “dropping down” renewable power assets to the yieldco in order to boost cash flows.

By issuing shares, yieldcos can raise low-cost capital with which to purchase more assets from their parent. And the parent can use the proceeds to acquire or develop new plants. The cheaper financing makes it a win-win for both public shareholders and the sponsor.

The sponsor often bears the expense (and permitting headaches) associated with the construction of these costly plants. But once they are up and running, variable operating expenses are minimal — the sun and wind do most of the work. And with electricity buyers already lined up, yieldcos haul in predictable, low-risk cash flows.

The Hidden Perk Of Yieldcos

Now here’s where things get interesting…

As I referenced earlier, it takes a lot of upfront expense to build a hydroelectric dam or offshore wind farm. Well, those costs can be depreciated over time. This means these companies will typically report GAAP earnings losses. Those losses not only offset any taxable income in the early years, but they can also be carried forward to reduce future liabilities.

Some yieldcos won’t owe a penny in federal income taxes until well into the next decade. This cuts out Uncle Sam at the corporate level, allowing yieldcos to typically pay out more than your average dividend stock.

Another benefit — without taxable profits, the dividend distributions are classified as a return of capital. As such, these dividends simply reduce your cost basis in the stock and aren’t taxable upon receipt.

Some people refer to yieldco dividends as tax-free. That’s not entirely accurate. They are really tax-deferred. But don’t let that deter you, because even when the tax bill comes due at the time the shares are sold, you will pay the lower capital gains tax rate rather than your ordinary income tax rate.

How To Invest

As you might imagine, several large, established energy companies have spun off their renewable operations into a separate arm to take advantage of these perks. And investors “in the know” have pumped billions into this new asset class.

Some notable players include: Brookfield Renewable Partners (NYSE: BEP), Atlantica Sustainable Infrastructure (Nasdaq: AY), Clearway Energy (NYSE: CWEN), and NextEra Energy Partners (NYSE: NEP).

If you’re interested yieldcos, then I encourage you to research these names further. Each of these companies is distinct and has something unique to offer.

But to give you an idea of what’s possible, I will say that we do own one of these names in our premium High-Yield Investing portfolio. We added it back in April of 2019 – and we’re sitting on a gain of about 88% (including dividends). That more than doubles the S&P 500’s 35% during that time…

Of course, the past is no guarantee of the future. But given the steady, reliable nature of these unique income securities — not to mention the overwhelming forces of demand for renewable energy – they’re a worthy option for any serious income investor.

Editor’s Note: You won’t hear about income opportunities like this from the mainstream financial press. But over I’ve dedicated my career to finding opportunities like this over at High-Yield Investing…

In fact, I just released a report about 5 “Bulletproof Buys” that have weathered every dip and crash over the last 20 years and STILL handed out massive gains. Go here to check it out now.