Property investments understandably have a lot of long-term appeal. Providing they remain occupied and tenants pay rent on time, it can be a reliable stream of passive income. And yet, in practice, being a landlord is far less ‘passive’ than many new real estate investors realise.
That’s why I personally prefer buying shares in UK real estate investment trusts (REITs). Apart from not having to deal with the everyday hassles of finding and retaining tenants, investing in these special stocks using an ISA eliminates any taxes from the generated income.
And best of all, thanks to the Bank of England raising interest rates, the majority of UK REITs are now on sale, some even offering a dividend yield in excess of 8%!
Property value vs dividend income
The corporate structure of a REIT is pretty straightforward. The company acquires properties, and the management team ensures they’re maintained and occupied. The collected rent is then used to cover the costs of mortgages, and the excess is returned to shareholders through dividends. And unlike typical stocks, REITs must pay out 90% of net rental profits. In exchange, these firms are immune to corporation tax.
Because a REIT is essentially just a real estate portfolio, the stock price is almost entirely driven by the estimated value of its properties. And it’s no secret that higher interest rates mean higher mortgage payments, even for corporations. That’s why so many of these property investments have been in free fall these past 12 months, with dividend yields reaching new highs.
Under normal circumstances, a high-yield income stock is often a sign to stay away. But for some REITs, that may not be the case. Several commercial-facing real estate groups are actually seeing cash flow increase despite the devaluation of properties. And with more money rolling through the door, dividends have also been rising.
So while stock prices are currently dropping, dividends, in some cases, are actually growing. And for long-term income investors, it’s the latter that ultimately matters.
An 8% dividend yield buying opportunity?
Warehouse REIT (LSE:WHR) is one example from my income portfolio that looks like an attractive opportunity today. The group owns and operates a network of urban logistics warehouses, primarily for e-commerce.
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The slowdown in discretionary consumer spending has undoubtedly indirectly impacted the firm. And looking at the latest results, gross property income has fallen slightly from £48.7m to £47.8m. Meanwhile, its real estate portfolio has taken a £193.4m valuation cut. Consequently, shares are down 40% in the last 12 months.
This aggressive sell-off means that the stock currently trades 35% lower than the net asset value of its real estate portfolio, signalling that most investors expect valuations to drop even further. While that is a valid risk, there are some factors seemingly being overlooked.
For starters, the e-commerce sector has actually started to slowly ramp back up. And after eliminating some underperforming properties from the portfolio, Warehouse REITs occupancy now stands at 95.8%. Moreover, the group’s contracted rent for the next 12 months is actually increasing.
From an income perspective, this FTSE 250 stock looks solid, in my opinion. So, for investors with a stomach for short-term volatility, Warehouse REIT’s impressive dividend yield might be a fine addition to a passive income portfolio.
