If you’re an avid income investor, you’ve probably heard of MLPs or REITs. Their “pass-through” structures make them an income investor’s dream. But have you heard of “yieldcos”?

We’ll skip the merits of these other securities for a moment. Instead, I want to tell you about yieldcos and how they work – because most income investors don’t even have a clue about them.

If you’re not familiar, this 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…

The Birth Of “Yieldcos”…

We all know that massive capital is getting thrown into the renewable energy space. So it shouldn’t be surprising 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 to operate 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 look at how these “yieldcos” work.

How Yieldcos Work…

Let’s 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), ranging from 25% to 50% of distributable cash flow beyond a certain threshold.

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

By issuing shares, yieldcos can raise low-cost capital 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 shareholders and the sponsor.

The sponsor often bears the expense (and permitting headaches) of constructing 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.

A Hidden Perk…

Now here’s where things get interesting…

As I referenced earlier, building a hydroelectric dam or offshore wind farm takes a lot of upfront expense. Well, those costs can be depreciated over time. This means these companies will typically report GAAP earnings losses. Those losses offset any taxable income in the early years and can 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. Even when the tax bill comes due when you sell, 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).

One thing to keep in mind. Like traditional utilities, yieldcos are sensitive to interest rates. And since rates have been rising recently, most of these names have taken a hit. But if you’re a believer in the long-term potential of renewable power, you may find these elevated yields enticing.

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

But we do own one of these names in our premium High-Yield Investing portfolio. 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 I’ve dedicated my career to finding opportunities like this over at High-Yield Investing…

In fact, I just released a report about 12 simple stocks that pay out every month. There’s no day trading involved, no crypto, no fancy options plays… Just simply put these 12 securities in your portfolio and watch the money roll in. Go here learn more.