Investing in property is one of the most popular ways of generating passive income.
Although there are significant regional variations, according to Paragon Banking Group, the average gross rental yield from UK residential property is currently 7.11%. But this doesn’t take into account service charges, ground rents, and borrowings costs. When these are considered, the return is closer to 5%.
It’s a similar story when it comes to commercial property. Savills reckons the sector’s present yield is 5.96%.
An alternative approach
But there’s another way of generating a similar level of return from property without having to purchase a physical asset. Namely, to buy shares in real estate investment trusts (REITs) which are, in effect, property rental businesses.
And they are good for passive income. That’s because to qualify for certain tax exemptions, they are required to return at least 90% of rental profits to shareholders by way of dividends.
Although these payouts can be subject to a withholding tax, if the shares are held within a Stocks and Shares ISA, this charge can be avoided.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
Plenty of choice
The UK stock market’s home to many REITs specialising in different sectors. It’s possible to invest in anything from warehouses and social housing to student accommodation and shopping centres.
And each one has a simple business model. In most cases, they borrow money to buy properties, rent them out, and then pay dividends to shareholders.
But this makes them vulnerable to higher interest rates. After the pandemic, when borrowing costs started to rise, the share prices of many REITs underperformed the wider market. And even during periods of relatively low interest rates, their stock market valuations tend not to move very much. This means growth investors often look elsewhere.
And for many of them, there’s now a significant difference between their market caps and the underlying value of their assets.
Something to consider
Tritax Big Box (LSE:BBOX) is one such example. It trades at an 18% discount to its net asset value. But the gap has closed recently as the Bank of England’s started cutting interest rates. In June 2024, the discount was around 10%.
This particular REIT specialises in logistics facilities — it calls them ‘boxes’ — and currently has a footprint of 37m sq.ft.
At 31 December 2024, Tritax had a loan-to-value of 28.8%. The group claims its properties would need to halve in value before it breached its banking covenants. This is important because commercial property values can be volatile.
But REITs also have to keep an eye on interest costs. Another condition for maintaining their tax privileges is that their profit must cover finance costs by a factor of at least 1.25. During the year ended 31 December 2024, Tritax had interest cover of 4.4 times.
A healthy return
But it’s the dividend that really matters. In FY24, Tritax paid shareholders 7.66p a share. This means the stock’s currently (6 June) yielding 5.3%.
As we’ve seen, this is similar to the average returns available from UK property. But there’s no need to buy a building, find a tenant, or collect the rent. Instead, do nothing. It really does meet the definition of passive income. For this reason, income investors could consider Tritax Big Box.
