With the stock market having plummeted last year, it has become much easier to find an investment with a high dividend yield. Traditionally, high levels of shareholder payouts are a sign of unsustainability. But it’s not always the case. And when you look at the real estate industry today, the opportunities for lucrative income seem to be everywhere.
Buy REITs
Generally speaking, one of the most popular ways to generate passive income with a property is through buy-to-let. And an investor who can identify prime undervalued residential real estate can make a fortune.
However, this approach comes with some headaches, especially if dealing with unreliable tenants. Not to mention the hassle of paying off a mortgage in a rising interest rate environment. And to top it off, the UK government seems to be making life harder by steadily raising taxes.
Fortunately, there is an alternative. Buying shares in a real estate investment trust (REIT) achieves virtually the same result. Around 90% of net rental income is returned to shareholders via dividends, resulting in a high return. And individual investors can even tap into opportunities in the industrial property segment, such as warehousing. Additionally, investing through a Stocks and Shares ISA means that all such dividend income is tax exempt.
High Yield Real Estate Investments
With interest rates on the rise, property valuations have steadily fallen over the past 12 months. And that added some pressure on the share prices of most real estate stocks.
But this price drop has helped raise the average dividend yield to mouth-watering levels. And two warehouse operators who seem to be thriving are Londonmetric Property (LSE: LMP) and Warehouse REITs (LSE: WHR).
Both UK stocks are down around 35% from a year ago. Yet their yields stand at 5.4% and 6.1% respectively. So the next question is, is this payment sustainable? Yes. Or at least that’s the impression their cash flow gives.
Remember that REIT dividends are paid out of free cash flow generated from rental income. Both companies cater to established businesses rather than consumers. And their customers’ deeper pockets coupled with longer multi-year contracts provide greater revenue reliability compared to the residential real estate industry.
That’s why, although both stocks fell by double digits, the rental cash flow that funds dividends actually increased. So much so that in November 2022, both companies actually increased payouts to shareholders, further increasing the dividend yield.
take a step back
The recent slump in real estate prices is undoubtedly creating lucrative opportunities for patient long-term investors. However, like any investment, it is not without risk.
Economic forecasts predict that the UK is likely heading into a recession. And if it turns out to be bad enough, the risk of customers not paying their rent increases. After all, recessions don’t exactly provide an ideal selling environment for businesses.
Needless to say, this could jeopardize rental income for REIT investors. And, therefore, today’s high yields could be reduced. Nonetheless, the impressive track record of Londonmetric Property and Warehouse REIT makes me cautiously optimistic. And while their stock prices may experience increased volatility, the potential for long-term passive income makes them a risk worth taking, in my opinion.
Please note that tax treatment depends on each client’s individual situation and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and obtaining professional advice before making any investment decisions.
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Zaven Boyrazian holds positions at Warehouse REIT Plc. The Motley Fool UK recommended LondonMetric Property Plc and Warehouse REIT Plc. The opinions expressed on the companies mentioned in this article are those of the author and may therefore differ from the official recommendations we give in our subscription services such as Share Advisor, Hidden Winners and Pro. At The Motley Fool, we believe that considering a wide range of ideas makes us better investors.
Motley Fool United Kingdom 2023