A Stocks and Shares ISA is a terrific asset for investors trying to earn a second income. And this has become more and more important as dividend taxes have gone up over time.
As a result, I think there’s a real opportunity for investors looking for passive income to target a 7.5% annual return. And on a £20,000 contribution limit, that’s £1,500 a year.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Real estate
UK real estate investment trusts (REITs) look good value at the moment. That’s not just my view – there’s been a lot of institutional interest in the industry in the last few months and years.
One example is AEW UK REIT (LSE:AEWU). The company leases a mixed property portfolio and the dividend yield is just over 7.5%.
The reason this firm stands out is that it takes a different approach to most REITs. The usual path is to focus on long leases in areas where demand’s high, but AEW looks for the opposite.
Leases that have less time to expire can bring opportunities. Renewing brings chances to increase rents, which is a key source of growth in an industry where this can be a challenge.
As with other prices, rents are a function of supply and demand. But instead of looking for high demand, AEW focuses on the supply side of the equation and focuses on limited competition.
In this way, the company hopes to be able to generate above-average growth without getting into overcrowded markets. It’s a really interesting strategy that I think is well worth a closer look.
Balance sheet
Stocks with 7.5% dividend yields don’t usually come with risks. The key for investors is to figure out what they are and work out how to accommodate them in a portfolio.
With AEW, one of the things to consider is its unusual debt profile. Its entire facility expires in 2027, while the average tenancy has another four years until its first break. When a REIT’s debt matures before its loans expire, this creates risk. Having to refinance at higher rates can increase borrowing costs without being able to raise rents to compensate.
That’s something for investors to keep an eye on with AEW at the moment. But the firm’s focus on short leases means that it should be in this situation less often than other REITs over the long term.
On top of this, it’s worth noting that AEW’s borrowings are relatively low for a REIT of its size. And a strong balance sheet should help it attract favourable terms when it comes to refinancing.
Given this, I think it’s one of the few stocks with a 7.5% yield that income investors should consider seriously. In an industry that can be somewhat undifferentiated, it offers something unusual.
Diversification
Whether it’s building wealth or earning passive income, building a diversified portfolio is a key part of investing well. That means finding stocks to buy across industries and geographies.
Given this, investors targeting a 7.5% dividend in a Stocks and Shares ISA need to find more opportunities than just AEW. But I think there are others available for those who can find them.
