Earning a high dividend yield can be a vastly superior way to earn a second income stream compared to buy-to-let. The latter is undeniably a viable strategy. But it demands a lot more effort and attention.
After all, buying a rental property requires the investor to become a landlord dealing with finding a tenant, collecting rent, paying for repairs, as well as buying a mortgage – something that’s quite expensive right now.
Alternatively, all these can be handed to a team of professionals at very little cost, thanks to real estate investment trusts (REITs). These businesses are publicly traded much like any other stock. And by owning them for the long run, shareholders can enjoy a steady stream of high-yield dividends without going into debt.
Looking at my own portfolio, Greencoat UK Wind‘s (LSE:UKW) a perfect example of what I believe to be a superb and reliable source of income. Here’s why.
A future Dividend Aristocrat?
There are lots of different types of REITs. Some focus on the debt markets by buying up mortgages from the private sector and collecting interest payments. But most tend to be equity-focused, investing in properties and collecting rent. Greencoat’s an example of the latter. However, instead of buying car parks, office buildings or warehouses, the firm specialises in wind farms. In fact, it’s the largest publicly traded wind farm owner in the UK.
The turbines generate electricity sold to the energy grid, creating a rent-like income stream that’s used to fund a 7.3% dividend yield. As business models go, it’s pretty straightforward. But the focus on renewable energy is what makes Greencoat so promising.
The barriers to entry for energy infrastructure are much higher compared to residential or commercial properties. At the same time, demand for clean electricity’s skyrocketing as the electrification of vehicles and homes accelerates.
This trend’s unlikely to change for decades. And it serves as a powerful tailwind for this enterprise to capitalise on. In fact, Greencoat already appears to be doing just that. The steady expansion of cash flows has translated into nine consecutive years of dividend hikes at an average growth rate of 8.7%. In other words, the company’s on track to becoming a Dividend Aristocrat.
Every business has its weaknesses
The income-generating capability of this enterprise is clear. However, as with every investment, there are always risks. And Greencoat’s no exception.
By operating in the energy sector, the company’s subject to the same regulations as other energy businesses. That includes the price caps enforced by regulator Ofgem. And with electricity prices determined by the market, Greencoat ultimately has no pricing power.
Relatively speaking, turbines don’t require much maintenance and rarely break down. But regular inspections are required, landing the company primarily with fixed costs. This is a bit of a double-edged sword. When electricity prices are high, Greencoat’s profit margins can reach exceptional highs too. In fact, in 2022, operating margins reached around 95%!
Today, energy prices have come down, taking the group’s margins down to 83%. That’s still nothing to scoff at. But it demonstrates how sensitive Greencoat is to energy prices. Should they continue to fall, margins will follow, placing pressure on dividends.
Nevertheless, with a superb track record of navigating fluctuating energy prices, I feel this risk is worth taking for my portfolio.
