UK REITs: a rare passive income opportunity right now

I’ve always loved the idea of owning REITs (real estate investment trusts). The ability to earn rental income like a buy-to-let landlord without having to do any of the work is phenomenal. And unlike a direct investment into real estate, there’s no need to go into debt, nor am I limited to the residential sector.

REITs open the door to investing in national infrastructure like logistics, energy, hospitals, retail outlets, and even car parks. And thanks to higher interest rates, these shares are currently trading at dirt cheap valuations, resulting in mouth-watering dividend yields.

However, time might be ticking to capitalise on this rare opportunity. The FTSE 350 Real Estate Investment Trust (FTSE 350 REIT) index still trades firmly below pre-inflation levels. Yet over the last 12 months, it’s up almost 20%. That suggests the real estate market cycle is slowly ramping back up, and with it, the chance to lock in enormous yields might be going with it.

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Investigating opportunities

Inside my income portfolio, I’ve already snapped up four REITs: Safestore Holdings (LSE:SAFE), Warehouse REIT, Londonmetric Property, and Greencoat UK Wind. And thanks to dividend hikes since my initial investments, these companies are now generating yields as high as 7%. Yet, this might be just the beginning.

Each firm sits on a multi-year streak of dividend hikes, with Safestore leading the charge at 14 years in a row. And since each owns a portfolio of critical economic assets from warehouses to wind farms, the long-term demand isn’t likely to disappear in my opinion. That means there is plenty of future cash flow to fund passive income.

Let’s zoom in on Safestore. As the UK’s largest self-storage operator, the firm leases its facilities to individuals and businesses alike. Renting out a storage facility doesn’t sound like a lucrative endeavour. Yet, this business’s track record of dividend growth and market dominance speaks for itself.

Right now, management’s trying to replicate its success across Europe. The self-storage market in countries like Belgium and Germany is still in its infancy compared to Britain. But by investing early, the group’s attempting to give itself a first-mover advantage. And if management’s strategy works out, then the enormous dividend growth seen to date could just be the tip of the iceberg.

No reward without risk

These companies are not the only REIT opportunities British investors can capitalise on today. But while I’m bullish on the overall sector, I cannot ignore the abundant risks facing the industry.

An international expansion is expensive, especially when chasing an underdeveloped market. Suppose European demand for self-storage solutions fails to materialise or grow sufficiently in the long run? In that case, Safestore’s proactive investment could backfire spectacularly, potentially compromising its balance sheet.

Zooming out to macroeconomic risks, REITs are highly sensitive to interest rates. With the bulk of rental income being paid out as shareholder dividends, these firms are almost entirely dependent on debt financing. So when rates go up, besides dragging down the market value of their asset portfolio, interest expenses can often surge through the roof.

With that in mind, it’s no surprise that the FTSE 350 REIT index was almost slashed in half between 2022 and October 2024. But assuming we’ve reached the bottom of the cycle, considering an investment today, while risky, could unlock tremendous long-term passive income, in my opinion.