As income investors search for yield, sooner or later they will start looking beyond corporations. They will run screens on what the biggest yielders are. Admit it, you probably have done this, I know that I have. We want as much income as we can get and there is no crime in that. Its only yield chasing if you make your decision solely on the yieldt. Sooner or later the income investor will find that 10% to 25% yielding equity and not fully understand what they just bought. Not understanding the intricacies of a land trust will be disasterous. Its not an if, it will be disasterous to your portfolio. However when fully understood they can give incredible yields and worth your time.
A royalty land trust is essentially owning specific natural resource rights to a specific section of land for a limited period of time. A trust is created when the owner of the land wants to sell these rights. They are not wanting to wait to sell the natural resources over time they want lots of money now. In exchange for this, the investor of the trust gets payments over time hopefully in excess of what they paid for their stake in the trust. At some point in time in the future these rights revert to the owner of the land. All of the rules and guidelines of the trust are listed in the S-1 form the owner of the land gives to the SEC when creating the trust so the intelligent investor is not taken by surprise.
Differences between corporations and land trusts
To properly describe what ownership in a land trust entails it will be easiest to first list the differences between a standard corporation and a land turst. These are not mere terms of symantecs where a person is being a grammar nazi at correcting you. These are very important differences.
Units not shares: When you invest into a land trust you buy units of the company, not shares of the company. Shares in a company gives voting rights and you can bring motions forward to change the company. Units do not have this right. You only get the payment coming from the trust as your right to owning a unit of a land trust.
Distribution not dividend: A land trust pays a distribution, not a dividend. A dividend is paid with profits and has certain tax rates and tax laws. A distribution has different ones including but not limited to a different tax rate and part of the payment is a return of capital. The trust is required to send out instructions in how to calculate your taxes and this often comes as a 15+ page PDF through email and/or on the trust's website.
A trust has no employees: The trust does not have people drilling oil wells. There are no salesmen selling the iron, natural gas, or oil to a refiner. There are no corporate branch offices or headquarters. There are only bankers employed by another company that calculate the quarterly numbers and send out distribution payments. The extraction of natural resources is done by another company and their employees. The trust is paid a percentage of whatever that other company gets for the sale of the natural resources. Even the price that the natural resources sells for is determined by the other company. The trust has no control over any of that.
A trust has no board of directors looking out for investor interests: There is no board of directors that vote upon and decide major company changes. Everything is spelled out in the S-1.
There is no hedging of commodity prices: Corporations will often use the commodity and forex markets to hedge their revenue to smooth out their profits and minimize their losses. Since a trust has no employees to be making decisions they cannot hedge. Now when a trust first comes into existance there might be hedges setup by the owner of the land prior to the creation of the trust. However this will only cover the first couple of years of a trust. When those contracts and options expire they are not renewed. This is listed in the S-1.
A trust has no assets: As they have no employees, a trust doesn't have the heavy industrial equipment needed for the havesting and collecting of natural resources. There is no real estate for the employees to be working out of. A trust does not even own the land the natural resources are on or under. They only own the right to be paid for the sale of the natural resouces.
A trust cannot grow: A trust cannot expand into new land or buy new rights. They have clear restrictions listed in the S-1.
A trust will terminate: This is the most critical difference to understand. The rights to the profits from the natural resources have a termination clause of when those rights or terminated. When the trust terminates the unit price goes to $0. There are no assets sold and no payouts. The unit holder loses their units in their account and ends with $0 for that position. You will lose your entire position upon the termination of the trust. Ownership in a land trust is a game of hot potato. You want to take your turn holding it for a little bit and get some distribution payments, then pass it on to someone else. Whoever is left holding the units at termination gets screwed. Make no mistake its not pretty or nice but all the participants are willing participants that are yield chasing.
What are common stipulations of a trust termination?
Time duration: A trust will expire on a certain date. It does not matter how wealth is extracted from the ground. It does not matter if a new discovery finds x2 the estimated reserves. Everything ends on a date.
Total resources extract: Sometimes a trust will expire after a certain amount of natural resources has been collected. It does not matter how slow or fast this occurs. It might mean that this trust lasts 4 years or 40 years. New technologies that come up allowing for more extraction out of the land (fracking for natural gas) gives no benefit to these trusts. When the limit is hit the trust expires.
Amount of profit over a window of time: Some trusts will keep going until a certain $ amount of profit is hit within a 1 or 2 year time. This is perhaps the best type of trust because as new technology comes up to extract more resources or a new discovery is made, the trust benefits and its life is extended giving more future distribution payments.
A vote of the majority or % number of the unitholders: A trust can terminate if the owners of the trust vote on it. Why in the world would they want to do this? The owner of the land just may own a lot of shares and they can regain control of this income stream by terminating the trust. I have never heard of this happening but it is a possibility.
A combination of the above: Most trusts will have multiple reasons for termination. Some will have whatever clause happens first. Some will have which one happens last.
Lastly, I am sure there are other stipulations for a trust's termination and they will differ from trust to trust. They will clearly be listed in the S-1 form so there is no reason to be concerned as long as you are willing to do some research.
A trust must pay out 100% of its profit as a distribution: With all the above negatives, this is the one overiding reason to be investing in a land trust.
As the trust has no employees, there is no money spent on payroll.
As there are no assets like heavy equipment or buildings, there are no maintenance or replacement costs.
As the trust cannot grow, there is no money set aside to buy more land.
A small amount is kept to pay the bankers cutting the distribution checks but apart from that, all the money is paid out to the unitholder.
With all that said, what exactly is a land trust?
A land trust is a very specific contract giving the right to the profit from the sale of natural resources on a certain section of real estate. It might be oil, natural gas, iron ore, lumber, or other nautral resouce but usually only one or two, not all of them. There are little to no costs involved and you get virtually 100% of those profits sent to you as a monthly or quarterly distribution. Everything is spelled out in the S-1 form so investors know exactly the terms. Because you only own the right to the profit, that profit stream will run out at some point and you are left holding the bag with nothing.
At this point it probably seems crazy to even want to invest in a land trust. My next entry will be how to evaluate the fair value of this income stream.
Disclaimer: The investments and trades discussed are not recommendations for others. I am not a financial planner, financial advisor, accountant, or tax adviser. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.
A royalty land trust is essentially owning specific natural resource rights to a specific section of land for a limited period of time. A trust is created when the owner of the land wants to sell these rights. They are not wanting to wait to sell the natural resources over time they want lots of money now. In exchange for this, the investor of the trust gets payments over time hopefully in excess of what they paid for their stake in the trust. At some point in time in the future these rights revert to the owner of the land. All of the rules and guidelines of the trust are listed in the S-1 form the owner of the land gives to the SEC when creating the trust so the intelligent investor is not taken by surprise.
Differences between corporations and land trusts
To properly describe what ownership in a land trust entails it will be easiest to first list the differences between a standard corporation and a land turst. These are not mere terms of symantecs where a person is being a grammar nazi at correcting you. These are very important differences.
Units not shares: When you invest into a land trust you buy units of the company, not shares of the company. Shares in a company gives voting rights and you can bring motions forward to change the company. Units do not have this right. You only get the payment coming from the trust as your right to owning a unit of a land trust.
Distribution not dividend: A land trust pays a distribution, not a dividend. A dividend is paid with profits and has certain tax rates and tax laws. A distribution has different ones including but not limited to a different tax rate and part of the payment is a return of capital. The trust is required to send out instructions in how to calculate your taxes and this often comes as a 15+ page PDF through email and/or on the trust's website.
A trust has no employees: The trust does not have people drilling oil wells. There are no salesmen selling the iron, natural gas, or oil to a refiner. There are no corporate branch offices or headquarters. There are only bankers employed by another company that calculate the quarterly numbers and send out distribution payments. The extraction of natural resources is done by another company and their employees. The trust is paid a percentage of whatever that other company gets for the sale of the natural resources. Even the price that the natural resources sells for is determined by the other company. The trust has no control over any of that.
A trust has no board of directors looking out for investor interests: There is no board of directors that vote upon and decide major company changes. Everything is spelled out in the S-1.
There is no hedging of commodity prices: Corporations will often use the commodity and forex markets to hedge their revenue to smooth out their profits and minimize their losses. Since a trust has no employees to be making decisions they cannot hedge. Now when a trust first comes into existance there might be hedges setup by the owner of the land prior to the creation of the trust. However this will only cover the first couple of years of a trust. When those contracts and options expire they are not renewed. This is listed in the S-1.
A trust has no assets: As they have no employees, a trust doesn't have the heavy industrial equipment needed for the havesting and collecting of natural resources. There is no real estate for the employees to be working out of. A trust does not even own the land the natural resources are on or under. They only own the right to be paid for the sale of the natural resouces.
A trust cannot grow: A trust cannot expand into new land or buy new rights. They have clear restrictions listed in the S-1.
A trust will terminate: This is the most critical difference to understand. The rights to the profits from the natural resources have a termination clause of when those rights or terminated. When the trust terminates the unit price goes to $0. There are no assets sold and no payouts. The unit holder loses their units in their account and ends with $0 for that position. You will lose your entire position upon the termination of the trust. Ownership in a land trust is a game of hot potato. You want to take your turn holding it for a little bit and get some distribution payments, then pass it on to someone else. Whoever is left holding the units at termination gets screwed. Make no mistake its not pretty or nice but all the participants are willing participants that are yield chasing.
What are common stipulations of a trust termination?
Time duration: A trust will expire on a certain date. It does not matter how wealth is extracted from the ground. It does not matter if a new discovery finds x2 the estimated reserves. Everything ends on a date.
Total resources extract: Sometimes a trust will expire after a certain amount of natural resources has been collected. It does not matter how slow or fast this occurs. It might mean that this trust lasts 4 years or 40 years. New technologies that come up allowing for more extraction out of the land (fracking for natural gas) gives no benefit to these trusts. When the limit is hit the trust expires.
Amount of profit over a window of time: Some trusts will keep going until a certain $ amount of profit is hit within a 1 or 2 year time. This is perhaps the best type of trust because as new technology comes up to extract more resources or a new discovery is made, the trust benefits and its life is extended giving more future distribution payments.
A vote of the majority or % number of the unitholders: A trust can terminate if the owners of the trust vote on it. Why in the world would they want to do this? The owner of the land just may own a lot of shares and they can regain control of this income stream by terminating the trust. I have never heard of this happening but it is a possibility.
A combination of the above: Most trusts will have multiple reasons for termination. Some will have whatever clause happens first. Some will have which one happens last.
Lastly, I am sure there are other stipulations for a trust's termination and they will differ from trust to trust. They will clearly be listed in the S-1 form so there is no reason to be concerned as long as you are willing to do some research.
A trust must pay out 100% of its profit as a distribution: With all the above negatives, this is the one overiding reason to be investing in a land trust.
As the trust has no employees, there is no money spent on payroll.
As there are no assets like heavy equipment or buildings, there are no maintenance or replacement costs.
As the trust cannot grow, there is no money set aside to buy more land.
A small amount is kept to pay the bankers cutting the distribution checks but apart from that, all the money is paid out to the unitholder.
With all that said, what exactly is a land trust?
A land trust is a very specific contract giving the right to the profit from the sale of natural resources on a certain section of real estate. It might be oil, natural gas, iron ore, lumber, or other nautral resouce but usually only one or two, not all of them. There are little to no costs involved and you get virtually 100% of those profits sent to you as a monthly or quarterly distribution. Everything is spelled out in the S-1 form so investors know exactly the terms. Because you only own the right to the profit, that profit stream will run out at some point and you are left holding the bag with nothing.
At this point it probably seems crazy to even want to invest in a land trust. My next entry will be how to evaluate the fair value of this income stream.
Disclaimer: The investments and trades discussed are not recommendations for others. I am not a financial planner, financial advisor, accountant, or tax adviser. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.
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