Royalties are a form of real property ownership as defined by the IRS. As property owners, royalty investments could provide a complement to existing real estate portfolios offering similar benefits to REIT’s – including passive-cash flow and upside participation from any recovery in energy prices.
When a company, such as Exxon looks, to drill on a particular property they rarely buy the land outright. Purchasing the land would require a large upfront-capital commitment in addition to the costs to drill and complete the wells. Instead, the company will lease the rights to explore for oil and gas with the landowner. In return for granting access to their property, landowners will receive a set royalty rate based on production from on-site wells. The oil and gas company provides the technical know-how and capital, while deferring land costs through paying the royalty rate only if the wells are successful and productive.