Real estate investment trusts (REITs) are a special type of stock that focuses on property. Some investors include REITs in their income portfolios due to the attractive dividends paid by these stocks, which pass on rental cash flows to shareholders. Here’s one I’ve spotted that looks worth considering.
One of the industry titans
I’m talking about the Schroder Real Estate Investment Trust (LSE:SREI). The stock’s down 10% over the past year, with a dividend yield of 7.58%. It owns a portfolio of UK commercial property, which is predominantly modern logistics and industrial assets, and earns money from long-term rental agreements with corporate tenants
Straight away, there’s a good reason why I like the company. The trust’s revenue is largely contractual, in that tenants pay rent (often with inflation-linked uplifts), and after expenses the remaining cash flow is distributed to shareholders as dividends. It’s a simple business model that’s easy to follow and monitor.
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Dealing with higher borrowing costs
The stock’s down in the past year, but I believe this has less to do with the quality of the property assets and more to do with the environment facing property companies.
Given worries around higher inflation in recent months due to the energy price shock, many expect UK interest rates to rise later this year. This negatively affects REITs because they must borrow to fund new projects. As a result, higher interest rates increase borrowing costs and reduce profit.
Even with this risk going forward, I’m still optimistic about the dividend. The latest half-year report showed it has “a sector-leading debt profile underpinning earnings stability”, with a low average interest cost of 3.4%.
This should help to protect it against any interest rate swings in the immediate term. Further, the trust has been allocating capital to higher-growth sectors, with 64% of capital allocated to industrial and retail warehouses. Given higher rents can be charged in this area, with higher average occupancy rates, it bodes well for future earnings.
Talking numbers
Given the elevated yield, an investor can make use of compounding dividends over time to enhance the yield even further. For example, let’s say someone bought £3k worth of the stock now. This could pay £227.4 over the coming year. If this were reinvested, it would now be £3,227.40. So in the following year, even with the same yield, it could generate £244.64.
If this were kept up for 15 years, it could pay £678 the following year, even without adding any more funds! The accrued interest from day one could be £6,318. Of course, planning this far in advance is tricky. It could be that the dividend gets cut further down the line.
But in principle, it shows how effective compounding yields with a sustainable stock can be. On that basis, I think it’s a stock for investors to consider.
Should you invest £5,000 in Schroder Real Estate Investment Trust right now?
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Jon Smith has no positions in the shares mentioned.
