A popular way of generating passive income is from rental properties. A real estate investment trust (REIT) does this with a view to returning a large proportion of its profits to shareholders by way of dividends, another common method of earning a second income.
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Generous returns
The Supermarket Income Real Estate Investment Trust (LSE: SUPR) operates a very simple business model. It buys stores and then leases them to supermarkets. It currently owns 73 shops in the UK and France.
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For the year ending 30 June (FY24), it looks likely that the trust will pay a dividend of 6.06p. With a current share price of around 74p, this implies a yield of 8%.
However, to buy more supermarkets it has to borrow. This means its earnings are sensitive to movements in interest rates. And any increase in costs is likely to affect the value of the dividend paid.
But higher borrowing costs are unlikely to impact on the proportion of its profits that are returned to shareholders. That’s because a REIT must pay annual dividends equal to at least 90% of its profits for it to avoid having to pay corporation tax.
For FY24, analysts are expecting earnings per share (EPS) of 6.05p, which is more than the anticipated dividend.
Looking further ahead, EPS is forecast to be 6.14p (FY25) and 6.23p (FY26). In both years, the payout to shareholders is expected to be 98% of these figures.
As experienced investors know, dividends are never guaranteed. But with a REIT there’s some certainty as to the percentage of profits that are returned.
Balance sheet review
A look at the trust’s accounts, since it was formed in 2017, shows that it has spent £1.9bn (including acquisition costs) on buying supermarkets.
During the same period it’s written down these assets by a cumulative amount of £235m. This isn’t a cash item and doesn’t affect the rents received as these amounts are secured by contracts.
But a reduction in net assets could restrict its ability to borrow in future. And the commercial property market can be volatile, which could lead to further reductions in the value of its portfolio.
I suspect the level of write-offs explains why the trust’s share price has fallen by more than a quarter since June 2019.
| Financial period (months) | Amount spent on buying stores (£’000) | Increase / (Decrease) in value of stores (£’000) |
|---|---|---|
| FY18 | 268,653 | (3,753) |
| FY19 | 102,317 | 1,013 |
| FY20 | 157,263 | 13,917 |
| FY21 | 570,340 | 38,630 |
| FY22 | 388,413 | 24,797 |
| FY23 | 377,311 | (253,211) |
| HY24 (6 months to 31.12.23) | 38,496 | (56,276) |
| All periods combined | 1,902,793 | (234,883) |
Checking out
I’m a big fan of passive income and the idea of earning money from supermarket rents seems like a good one to me. Despite the threat of the internet, I think large grocery stores are here to stay.
Although the trust requires access to funds to expand, as of 31 December 2023, it had a loan-to-value figure of 33%. This tells me there’s plenty of headroom to borrow more.
And there appears to be an increasing trend towards sale and leaseback arrangements. Under these contracts, supermarkets sell their stores to third-parties and then rent them back. I think there will be plenty of opportunities for Supermarket Income REIT to expand its portfolio.
For these reasons — along with its generous dividend — I’m going to seriously consider taking a position when I next have some spare cash.
