Investor appetite for UK shares seems to be improving, but there are still plenty of impressive dividend yields to capitalise on. In fact, even with the FTSE 250 up by double digits since October, many of its constituents continue to trade at discounted valuations.
But one company in particular is offering a 6% dividend yield with earnings still growing, despite what the share price would suggest. That’s why I added it to my income portfolio late last year. So let’s take a closer look at Warehouse REIT (LSE:WHR).
A sustainable 6% dividend yield?
As the name suggests, Warehouse REIT is a warehouse operator. The company owns a portfolio of 90 strategically-positioned urban logistics facilities scattered across the UK that play a critical role in the e-commerce industry.
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The firm leases its properties to 567 corporate tenants, including Amazon, Screwfix, and DHL, generating a steady stream of rental income. Today, its portfolio contains around 8.8 million sq ft of leasable space, translating into £46.8m of contracted annual rent.
Since the interest rate hikes started, the firm’s market capitalisation has somewhat stumbled. So much so that in the last 12 months, the share price is down nearly 35%. And today, it’s even trading at a 28% discount to its net asset value (NAV). This is partly why the stock boasts an impressive 6% dividend yield.
With mortgages on commercial properties becoming more expensive, the value of the firm’s real estate portfolio is dropping. And it seems investors are pricing the stock with expectations of further declines. Looking at the latest interim results, revaluations of its properties translated into a loss of £46.4m.
However, the effects of property value fluctuations are ultimately non-cash charges. It doesn’t affect the firm’s cash flow, which ultimately determines whether the dividend yield can be sustained. And rental income for the period is actually up, along with dividends per share.
With further significant property valuation declines already priced into the share price paired with rising underlying earnings and shareholder dividends, Warehouse REIT looks like a screaming buy, in my mind. Plus, with e-commerce set to continue driving up warehousing demand over the next decade, I intend to hold my shares for a long time.
Nothing is risk-free
As attractive as this income opportunity seems, there are always risks to consider. The rising interest rates don’t just affect Warehouse REIT’s property values but its debt as well. After all, buying commercial real estate isn’t cheap, and the group has around £333.5m of loan obligations on its books.
With more cash flow being eaten up by debt-servicing charges, added pressure is being applied to dividends that could slow future increases. In the last 12 months, the firm’s average cost of debt has shot up from 2.1% to 3.6%, and continued rate hikes could carry this much further.
So far, cash flows have generated sufficient coverage to absorb this increased interest rate cost without impacting shareholder payouts. That all points towards a sustainable dividend yield. However, this may change if the cost of debt continues to rise. Nevertheless, I remain optimistic about the long-term potential of this business.
That’s why, despite the risks, I’ve already added these income shares to my portfolio.
