Forget buy-to-let! Here are two 5% dividend stocks I’d buy instead

Roland Head looks at two mid-cap dividend stocks with exposure to the housing market.

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Buy-to-let investing is often billed as the road to retirement riches for ‘ordinary’ Brits. But I’ve known plenty of buy-to-let landlords who’ve lost money, ended up in tax disputes, or suffered repeated damage to their property.

Personally, I prefer to gain exposure to the housing market by investing in listed companies with exposure to UK property. Today, I’m going to look at two such firms, both of which offer attractive 5% dividend yields

A guaranteed profit from buy to let?

One way to make money from buy-to-let property is to provide mortgages for landlords. Paragon Banking Group (LSE: PAG) is a specialist buy-to-let lender with more than 20 years’ experience. During the year ending 30 September, the value of new loans to landlords rose by 6.8% to £1,495.5m.

This increase helped to lift the group’s adjusted pre-tax profit by 25.3% to £181.5m last year. Paragon’s return on tangible equity — a key measure of profitability for lenders — rose from 13.4% to 16.1%.

Demand from buy-to-let landlords is said to remain strong. The firm’s pipeline of new lending opportunities rose by 28.9% to £778.9m last year. One reason for this may be that tougher government rules on lending to landlords have prompted some smaller lenders to exit this market. This could make it easier for larger players like Paragon to increase their market share.

Why I’d buy

Paragon’s main focus is on what it calls “professional landlords.” This generally means borrowers with more than three mortgaged rental properties, or those renting houses of multiple occupation.

As a potential investor, this looks more attractive to me than pinning my hopes on a single rental property.

I’m also attracted by Paragon’s valuation. The shares currently trade at just 1.2x their tangible net asset value of 359p per share. Alongside this, broker forecasts indicate a dividend yield of 5.1% for 2018/19. Overall, these shares look good value to me. I’d rate Paragon as a buy.

Bricks, but no mortar

Many new-build houses are sold to rental landlords. Although you can invest directly in house-builders, one way to spread your exposure more widely is to buy shares in a brick maker.

One of my favourite stocks in this sector is Forterra (LSE: FORT). Shares in this firm have fallen by nearly 30% this year, but I think this sell-off may have gone too far.

The group’s latest trading update reported “good levels of activity in the new build residential sector.” Sales so far this year are said to be “marginally ahead” of last year. Although rising costs from energy, fuel and carbon credits put some pressure on profits, the company still generated enough cash to reduce net debt by 8% to £56.1m.

Unfortunately, problems with a kiln mean that this facility will have to be rebuilt before operations resume. This means that operating profit this year will be £2m-£3m lower than expected.

I don’t see this one-off problem as a huge concern. Broker forecasts indicate that earnings are expected to rise by 4%, to 25p per share this year. This earnings figure should cover the forecast 10.4p dividend 2.5 times, providing a good margin of safety for income seekers.

At the time of writing, Forterra shares were trading at 218p. This puts the stock on a forecast price/earnings ratio of 8.3 with a dividend yield of 4.9%. I believe this could be a good buy, despite the risks of a housing slowdown.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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