In my view, real estate can be a great source of passive income. And I think real estate investment trusts (REITs) are the best way for someone like me to invest in property.
As a UK investor, I can use a Stocks and Shares ISA to invest up to £20,000 per year in REITs without having to pay tax on the cash I receive. So here’s how I’d go about doing it in June.
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REITs
REITs are companies that lease properties to tenants and distribute their income to shareholders as dividends. Different REITs own different types of properties, from houses to hospitals.
Rising interest rates in the UK have been making mortgages more expensive. Right now, the cost of borrowing has jumped back to the levels introduced in response to the mini-budget last September.
This has been creating a headwind for the property market. Higher borrowing costs have reduced the number of buyers and the prices they’re able to pay.
As a result, a number of REITs have seen their share prices fall as the market value of their assets has declined. And they’ve reached a point where I think there are some great opportunities for investors.
E-commerce
Top of my list is Warehouse REIT. The company owns and leases warehouses and industrial distribution centres in the UK.
In the short term, a recession presents a significant risk to the company. If its tenants go out of business, it might find it hard to re-let its properties with the UK oversupplied for warehouses at the moment.
Over time, though, I expect e-commerce to gather momentum and demand for distribution centres to increase as a result. So I see the headwinds as short-term in nature.
The stock has a dividend yield of 6.41%, which is high compared to its US counterparts Prologis (2.84%) and Terreno Realty (2.64%). I’d invest £7,000 to aim for £454 in annual dividends.
Traditional retail
Despite the rise of e-commerce, I think Realty Income looks good. It’s a US REIT that leases retail properties and comes with a 5.17% dividend yield.
The company focuses on attracting high-quality tenants, which limits the risk of defaults. It also concentrates on retailers that are immune to the rise of e-commerce, such as convenience stores.
This is good, but it brings a degree of risk. Quality tenants are desirable, so it makes them difficult to negotiate with, limiting Realty Income’s ability to increase rents.
Despite this, the company has an impressive track record of increasing its dividend over time. I’d invest £5,000 today to aim for £257 in dividend income.
The best of both
Lastly, LondonMetric Property has a portfolio that offers the best of both worlds. It combines industrial distribution properties (73%) with retail facilities (27%).
Around 3.5% of rental income comes from Amazon.com. This looks to me like a risk, given that Amazon has excess warehouse capacity of its own.
But LMP’s portfolio in general looks to me to be in good shape. With an average of 12 years left on leases and contractual rent increases built in, the outlook seems to be positive.
The company’s focus on properties in key locations gives it a degree of pricing power, differentiates its product, and introduces switching costs for tenants. I’d invest £8,000 to aim for £427 in passive income.
