Real estate investment trusts (REITs) have long been one of the most popular vehicles for generating passive income from property without the hassle of being a landlord.
And right now, with higher interest rates weighing heavily on valuations, some genuinely attractive yields have popped up for long-term investors.
Two that stand out in May are Supermarket Income REIT (LSE:SUPR) and Primary Health Properties (LSE:PHP).
At current yields of 7.52% and 7.67% respectively, every £1,000 invested in Supermarket Income REIT generates £75.20 a year in passive income, while the same amount in Primary Health Properties delivers £76.70.
That’s more than double the rougly 3% payout UK index investors are earning today! So why are these yields so high? And where exactly is the risk?
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.
The investment thesis
Starting with Supermarket Income REIT, this commercial landlord owns a portfolio of large-format supermarket properties, predominantly leased to grocery giants such as Tesco and Sainsbury’s on long-duration rental contracts linked to inflation.
The appeal for income investors is quite intuitive. Supermarkets are among the most essential retail formats in the country, often continuing to trade profitably through even recessions. And with a client list of healthy industry titans, this REIT’s income stream looks exceptionally secure.
What’s more, the business has been quietly diversifying its target market. Several of its properties now double as fulfilment hubs for online grocery orders, increasing their operational value to tenants and paving the way for stickier, longer-lasting relationships.
Primary Health Properties tells an equally compelling story. Over 90% of its rental income is funded directly or indirectly by the NHS, effectively translating into cash flow backed by the British government.
But it also has a bit of a secret weapon. Many of its older leases are currently priced below open market rent levels. This means there’s a material pipeline of future rent uplifts on the horizon or, in other words, the group’s income looks set to grow even without acquiring a single new property.
What’s the catch?
As promising and secure as these cash flows and, in turn, dividends seem, there are some important risks to highlight.
Most notably, each REIT carries significant debt on its balance sheet. And with interest rates still remaining elevated, it’s already translated into notable pressure on margins as well as property valuations. The result has been higher loan-to-value ratios and tighter dividend coverage.
For the time being, shareholder payouts remain relatively secure. But if interest rates start to tick back up due to higher-than-expected inflation, that coverage could get strained.
The bottom line
The macroeconomic risks surrounding the entire REIT sector is tough to ignore. But while some businesses could struggle under increased pressure, there are always exceptions. And finding these exceptions today could result in earning substantial yields in the long term.
In my opinion, both these REITs could be in this winning category. That’s why I’m already investigating both as potential additions to my passive income portfolio.
