For investors targeting passive income, I think real estate investment trusts (REITs) are well worth considering. And there’s one in particular that stands out to me right now.
Shares in Land Securities Group (LSE:LAND) currently come with a 7.5% dividend yield. While that’s true of a lot of REITs, there’s something that sets this one apart.
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REITs
REITs were first introduced in the 1960’s in the US. The ambition was to allow ordinary people to gain exposure to booming real estate prices.
With property prices going ever higher, they arguably still serve that function. Instead of buying bricks and mortar, investors wanting exposure to property can buy shares in a REIT.
Different REITs do different things, but they all have a few things in common. Most obviously, they generate income by owning and leasing properties to tenants.
REITs don’t pay tax on their profits. Instead, they return 90% of their income to shareholders via dividends, providing ordinary people a way of earning passive income from property.
Risks with REITs
Being required to distribute their profits means REITs can’t easily use their cash to buy more properties. And this means that growth opportunities can be limited.
To get around this, they typically do (at least) one of two things. The first is issue debt and the second is raise money via equity. But there are drawbacks to both.
In the case of debt, it can put the company’s balance sheet in danger. Rising interest rates can make servicing debt more expensive and cut into earnings – and dividends.
The trouble with issuing equity is it makes the existing shares worth less. If the number of shares outstanding goes up by 10%, the value of each share decreases 10%.
A best-in-class example?
Land Securities Group has done an extremely impressive job of keeping its share count steady, with the number of shares outstanding is roughly where it was 10 years ago.
Compared with other FTSE 100 REITs, like LondonMetric Property (+80%) and Segro (+58%), this is very impressive. These companies have achieved better growth, but this has come at a cost.
At first sight, Land Securities Group doesn’t have the most attractive portfolio. It contains more offices and fewer warehouses than some of its competitors. And with a big chunk of retail in its portfolio, there’s an undeniably risky sector it has to deal with.
Despite this, the company’s focus on Central London real estate has meant occupancy levels are above 96%. And unlike some REITs, the dividend’s well-covered by earnings.
Dilution
When it comes to REITs, I think investors have to account for dilution. The effect of getting a 9% dividend yield’s dampened if they have to reinvest half of it to offset a rising share count.
That’s where Land Securities Group really shines. It doesn’t have the most exciting growth prospects, but – while there are no guarantees – the 7.5% dividend looks reasonably durable.
I think REITs can be a great choice for passive income investors. And Land Securities Group is definitely one that warrants a closer look.
This post was originally published on Motley Fool
