Real Estate Investment Trusts (REITs) have long been a terrific way to gain exposure to the property market and earn some passive income. With the vast majority of net rental income paid out as dividends, REITs often provide shareholders with impressive yields.
But right now, Regional REIT Ltd (LSE:RGL) is wearing the crown for the largest yield. At 23.5%, shareholders are earning a pretty monumental income stream. What’s driving this enormous payout? And is this a trap or a buying opportunity?
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Investigating the yield
The percentage payout shareholders enjoy is driven by two factors. Either the underlying business is hiking dividend payments, or the stock price has collapsed through the floor. In the case of Regional, it’s the latter.
Like most REITs, Regional’s in the business of buying properties and renting them out to generate a reliable and consistent flow of cash. Across the first three months of 2024, the firm generated £65.5m in rent, with 97.2% of tenants paying on time. And with an occupancy just shy of 80%, business appears to be relatively stable from an operational perspective.
Sadly, the firm’s property portfolio has been hit fairly hard in terms of valuation. With interest rates going through the roof, market prices have tumbled, dragging down the share price. And the impact on Regional has been especially diabolical, given that 92.8% of its real estate portfolio is invested in office space – something that’s slowly falling out of fashion on the back of remote working solutions.
Nevertheless, management continues to pay dividends to shareholders, citing that the steady decline in inflation is making way for more favourable market conditions. So is this secretly a screaming buy?
Digging into the financials
Remote working opens the door to cost saving and some efficiency boosts for certain businesses. However, I’m not convinced office working is going to disappear. In fact, we’ve seen a lot of companies starting to encourage or even demand employees return to the office since the pandemic came to an end.
Therefore, the cyclical downturn in the office real estate market is likely to eventually bounce back. At least, that’s what I think. However, it’s difficult to predict when this might happen. And in the meantime, Regional’s in a bit of a pickle regarding debt.
As of March, the group’s net loan-to-value ratio sits around 55.2%. That’s a fairly significant amount of gearing for any business. And it’s significantly higher than management’s desired target of 40%.
The group’s started making progress in reducing its debt burden, which now stands at £413.2m versus £420.8m at the start of the year. And it’s also worth pointing out that all of its loans are now on fixed rates, providing clarity of future interest obligations.
But with an average debt servicing cost of 3.4%, it’s putting a lot of pressure on the bottom line. So much so that the firm’s being forced to sell some of its properties in a pretty terrible market, resulting in the destruction of shareholder value.
With that in mind, it’s no surprise that this REIT’s valuation’s plummeted. And while the firm appears capable of adapting, there are far less risky real estate opportunities elsewhere.
Therefore, personally, even with a 23.5% yield, this isn’t a stock I’m interested in buying right now.
This post was originally published on Motley Fool
