Following the recent turmoil in the banking sector, both growth and dividend shares have endured further volatility. The latter is typically more resistant to external market forces.
But fears of further bank failures as central banks continue to raise interest rates have investors on edge. This is especially true when it comes to real estate investment trusts (REITs).
As a reminder, REITs invest in various rental assets and return 90% of net earnings to shareholders as dividends. This high payout ratio means these firms are immune to corporation tax. But it also makes these dividend shares highly dependent on external financing solutions, like mortgages.
With the cost of debt rising with each interest rate hike, property values suffer, sending REIT stocks down the drain. But this may have created a rare income opportunity for patient long-term investors. And that seems especially true for one particular real estate mogul.
Capitalising on a 7% yield
Over the last 12 months, the Warehouse REIT (LSE:WHR) share price has suffered quite a tumble. Its shares have dropped by around 47%, in line with its expected property portfolio devaluation. Since REIT stocks typically trade close to their net asset value (NAV), this downward trajectory isn’t exactly surprising.
However, for investors focused solely on the sustainability of income, this sharp tumble may not be worth worrying about. Why? Because from a cash flow perspective, Warehouse REIT continues to chug along nicely. As a company that leases last-mile urban warehouses, the firm’s tenants are primarily small- and medium-sized businesses. Most of whom remain in a strong financial position.
Looking at its latest results, rental income is still rising, with operating profits following suit. Subsequently, management raised dividends by 6.4%. And when paired with a drastic decline in price, these shares now offer a dividend yield of just over 7%.
With occupancy remaining strong at 92.7%, disruption to cash flows, while not impossible, seems unlikely. And even if a few smaller tenants break their rental contracts early, the group has £11.2m in cash on the balance sheet to act as a buffer.
Dividend shares still have risks
As lucrative as this income opportunity seems, there are obvious risks to consider. Particularly when it comes to Warehouse REIT’s existing debt.
A good chunk of its loans is variable. Meaning when interest rates go up, more pressure is applied to underlying profit margins which directly impacts the affordability of dividends. Furthermore, higher-rate loans also increase the cost of expansion, making growth more challenging in the future.
It’s also worth pointing out that the firm has deliberately targeted e-commerce enterprises for tenants. This worked wonders when the market was booming, sending these dividend shares through the roof. But now that the economic slowdown has caused consumer discretionary spending has a been volatile, demand for warehouse space may have plateaued, at least for now.
The bottom line
All things considered, the near-term outlook for Warehouse REIT is uncertain. But in the long run, as online shopping steadily gains popularity, demand for well-positioned logistics facilities will undoubtedly rise. Therefore, buying these dividend shares today, while they may be volatile, could unlock substantial long-term passive income.
