The UK stock market’s filled with awesome real estate investment trusts (REITs). By capitalising on these unique financial vehicles, investors can indirectly own a small piece of lucrative assets that are often prohibitively expensive as a direct investment.
Most REITs own and operate a commercial or residential real estate portfolio. However, some focus on alternative assets, such as renewable energy infrastructure.
While fossil fuels aren’t likely to disappear any time soon, the rising threat of climate change is sparking a lot of investment in renewables. And even the new British government’s targeting the creation of 650,000 clean energy jobs by 2030.
With that in mind, I’m looking at two REITs that look set to thrive under a renewable-friendly government, Greencoat UK Wind (LSE:UKW), and Foresight Solar Fund (LSE:FSFL).
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Wind and solar-powered REITs
Both firms have almost identical business models. They invest in renewable energy infrastructure (wind for Greencoat, solar for Foresight), generate clean electricity, and sell it to energy suppliers.
The constant and rising demand for electricity has enabled both companies to be highly cash-generative. And both significantly benefited from the sharp rise in energy prices over the last few years. As a result, dividends have been hiked nine years in a row, keeping up with inflation and helping shareholders build chunky passive incomes.
This trend should continue, in my opinion. As previously mentioned, energy demand’s climbing thanks to the rising popularity of electric vehicles (EVs) and power-hungry artificial intelligence (AI) models. Needless to say, this could be a lucrative opportunity, attracting investment from the private sector, even if Labour falls short of its targets.
What could go wrong?
Looking across the renewable REIT landscape, these two stocks appear to offer terrific value. While they operate as leveraged businesses, both generate sufficient cash to comfortably meet interest expenses as well as dividends. And to top things off, both trade at a double-digit discount to their net asset value, indicating a potential buying opportunity.
That’s obviously an encouraging trait. So much so that I’ve already added Greencoat to my income portfolio, with plans for Foresight to join the mix once I have more capital at hand. However, these investments, while promising, are far from risk-free.
Like many businesses operating within the energy sector, neither Greencoat nor Foresight have any pricing power. Electricity prices are determined by supply and demand imbalances while being kept in check by regulators like Ofgem. And as a result, energy’s long been a cyclical sector.
When energy prices fall, the earnings of these REITs fall as well. And while the management teams can execute a bit of price hedging with fixed-rate customer contracts, prolonged drops in energy prices could compromise dividends, especially if debt‘s left unchecked in a higher interest rate environment.
Nevertheless, both these businesses are seemingly in a strong position right now. And with a solid track record of navigating fluctuating market conditions, it’s a risk I feel is worth researching, given the long-term passive income that could be unlocked.
