I think the best way to fend off the constant threat of inflation is by earning a second income. Ideally, one that you don’t have to work for.
Fortunately, the UK is a good place to look for these kinds of opportunities. And that’s especially true in the real estate investment trust (REIT) sector.
Inflation: the gift that keeps on taking
Inflation was supposed to be at 2% by now. Instead, it’s closer to 3% and the Bank of England isn’t ruling out 4% by the end of the year.
Meanwhile, the Ofgem price cap rises again from 1 July. And the average grocery shop is around 40% higher than it was five years ago.
Governor Andrew Bailey described higher prices as “unavoidable” which isn’t a strong sign. So what people need is a strategy.
A 3% salary increase helps, but it doesn’t go far enough when energy bills jump 13% in a year. In this kind of environment, I think investors need a second income.
This is where dividend stocks come in and REITs are a great example. They have to distribute 90% of their taxable income, making them relatively consistent income investments.
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A closer look at an under-the-radar REIT
Value and Indexed Property Trust (LSE:VIP) – known as VIP – is a small REIT focused on long UK commercial property leases. And it comes with a 7.5% dividend yield.
That’s high. But it’s partly the result of decades of consecutive increases, with the latest being a 4.3% lift to 14.4p per share.
The portfolio is only 26 properties. These, however, form a strong diversified group, avoiding offices and high street retail.
Like a lot of REITs, VIP has a duration risk. Its average lease is longer than its average debt maturity, so the firm won’t automatically be able to renegotiate its leases when the time comes to refinance.
That means higher interest rates are a threat. But the question for investors is what the company can do to limit the overall effect of this.
Risk management
There are a few things investors should pay attention to when assessing VIP’s duration risk. They mostly come in two categories.
- Things that wll help limit the extent of higher borrowing costs.
- Things that will help offset the effects higher borrowing costs.
Long leases are actually helpful in terms of the first point. Having relatively predictable future income helps in negotiations with lenders.
On the other side of the coin, it’s worth noting that VIP’s leases are linked to inflation. That’s extremely important in the context of the risk of higher interest rates.
If interest rates do go up, there’s a strong chance inflation is going to be a big reason. But VIP is already likely to be collecting extra cash as a result of the terms of its leases.
I think this is worth paying attention to. Investors should be alive to the firm’s duration risk, but they also need to think about its prospects for dealing with it.
One to consider
With living costs still going up, it’s good to think about how to get on the other side of the equation. In other words, how to benefit from inflation.
VIP is an interesting company. It isn’t the most well-known name in the industry, but I certainly think it’s worth a closer look.
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Stephen Wright does not own shares in any of the companies mentioned.
