What it means
An income trust sits between the assets and the investor. The trust owns something that produces steady cash, such as buildings, pipelines, oil and gas royalties or a mature operating business, and it distributes that cash on a regular schedule.
Investors hold units rather than shares, and receive distributions rather than dividends. The attraction is the tax treatment.
A normal company pays corporate tax on profit and shareholders then pay tax again on dividends, whereas an income trust that distributes its income generally avoids the entity-level charge, so only a single layer of tax applies. That structural advantage is why yields on income trusts often look higher than dividend yields on comparable companies.
Investors use them for income rather than growth. Because most of the cash goes out of the door each month or quarter, little is retained to fund expansion, so unit prices tend to move with interest rates and with the reliability of the underlying cash flow.
When rates rise, a fixed-looking distribution becomes less attractive and unit prices usually fall. The main analytical task is judging whether the distribution is sustainable.
Distributions are paid out of cash rather than accounting profit, so trusts report a measure such as distributable cash or funds from operations, and the payout ratio compares the distribution with that measure. A trust paying out more than it generates is funding distributions from borrowings or new unit issues, which cannot continue for long.
Rules vary by country and have changed over time. Canada taxed most business income trusts as companies from 2011 under the specified investment flow-through rules, which pushed many of them to convert, while real estate investment trusts survive in many markets subject to conditions on asset type and distribution levels.
Always check the specific regime before assuming the tax advantage applies.
In practice
Real-world examples.
Example
A retiree building an income portfolio buys units in a listed retail property trust yielding 6.5%. The monthly distributions cover part of her living costs. She monitors occupancy and the payout ratio each quarter, because a fall in either would threaten the distribution well before the market noticed.
Example
An oil and gas royalty trust holds the right to a share of production revenue from a set of mature wells. Its distributions rise and fall with commodity prices and with declining well output. Investors treat the headline yield with caution because the asset base is depleting rather than permanent.
Example
A pension fund allocates $40 million to infrastructure income trusts to match long-dated liabilities. The predictable cash distributions suit the fund's payment obligations better than growth shares would. The trustees accept lower capital appreciation in exchange for that reliability.
Formula
Calculation
Distribution yield = Annual distribution per unit / Unit price
Payout ratio = Annual distribution per unit / Distributable cash per unit
A property income trust pays $0.125 per unit each month and its units trade at $20.00. Over a year it distributes $0.125 x 12 = $1.50 per unit.
Distribution yield = $1.50 / $20.00 = 7.5%
The trust reports distributable cash of $1.80 per unit for the same year.
Payout ratio = $1.50 / $1.80 = 83.3%
The trust is paying out about 83% of the cash it generates, leaving roughly $0.30 per unit as a cushion for vacancies, repairs or a rise in borrowing costs. A payout ratio above 100% would mean the distribution was being funded from somewhere other than operations.Case study
Seen in the real world.
Kesterly Logistics Trust is an illustrative, fictional income trust holding eight distribution warehouses let to national retailers on long leases. It paid $1.44 per unit a year against distributable cash of $1.60, a payout ratio of 90%, and marketed itself on a yield close to 7%.
When two tenants renewed at lower rents and the interest on a maturing loan reset three percentage points higher, distributable cash fell to $1.30 per unit while the distribution stayed at $1.44. The trust funded the gap from its credit facility for two quarters before cutting the distribution by 20%, and the unit price fell sharply on the announcement.
The illustrative lesson is that a high yield is only as good as the cash standing behind it. Investors who tracked the payout ratio rather than the headline yield had roughly a year of warning.
Watch out
Common mistakes.
- Treating the distribution yield as a guaranteed return, when distributions are discretionary and get cut whenever cash flow falls.
- Comparing an income trust's yield with a bond's yield as if the two carried the same risk, when the trust makes no promise to repay capital.
- Assuming distributions are taxed like dividends, when depending on the regime parts may be ordinary income, capital gain, or a return of capital that reduces your cost base.
Questions
People also ask.
What is the difference between an income trust and a company paying large dividends?
The trust generally avoids tax at the entity level on distributed income, while the company pays corporate tax before any dividend is declared.
Why do income trust prices fall when interest rates rise?
Investors can earn more from bonds and deposits, so they demand a higher yield from the trust, and the unit price adjusts downwards to deliver it.
Is a payout ratio above 100% always a problem?
Not for a single quarter with a one-off timing effect, but sustained payouts above the cash generated mean the distribution is being funded by debt or new units.
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