UK real estate investment trusts, or REITs, can be a very lucrative way for investors to unlock a passive income. These special businesses invest in a portfolio of properties that generate rent each month, which is then paid out as dividends.
This means that beyond buying and holding shares, shareholders don’t have to do any of the work of finding tenants, maintaining properties, or dealing with contractors.
Best of all, with higher interest rates making real estate less popular, there are some enormous dividend yields on offer right now. And it’s why I’m eager to buy more shares in one REIT that’s already in my income portfolio.
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A hidden compelling opportunity
Out of all the REITs on the London Stock Exchange, it’s LondonMetric Property (LSE:LMP) that stands out as my personal favourite.
The REIT owns and manages 680 commercial property assets across a combined £7.4bn portfolio, specialising in triple net leases (NNN) rental contracts. That means it’s the group’s tenants that are responsible for maintenance, insurance, and taxes in addition to paying rent.
The result? LondonMetric is enormously cash generative and diversified across multiple sectors, including urban logistics, retail, healthcare, hotels, and even a few theme parks.
Digging a bit deeper, its long list of tenants include Amazon, Tesco, and Marks & Spencer, among others, almost all of which deal in long-duration lease agreements.
For LondonMetric, this enterprise-scale clientele means that, beyond having reliable tenants that pay on time, the group also benefits from 98% occupancy and a 16.4-year average lease duration from capital-light lease agreements that contain annual contractual uplifts.
All in all, by combining a steady expansion of its property portfolio with higher rental income from its existing tenant base, LondonMetric is on track to deliver its 11th consecutive year of dividend increases. And with the shares trading at a 6% discount to its net asset value, the REIT currently pays a chunky 6.7% dividend yield.
Too good to be true?
As dividend stocks go, LondonMetric ticks almost all the boxes.
- It’s a highly cash-generative business with a reliable and sticky customer base.
- Dividends have been steadily and consistently increasing while still being covered by underlying earnings.
- The shares trade at a discount to their intrinsic value, offering a higher yield.
But even the most promising income opportunities have their weak spots. And in the case of this business, those weak spots are acquisition integration risk and debt.
As a serial acquirer of other smaller commercial landlords, LondonMetric has vastly expanded its portfolio in recent years. And just last month, management started targeting another REIT (Picton Property Income) in a joint bid with Schroder REIT to further expand its empire.
So far, this strategy has proved quite lucrative, transforming the business into the second-largest REIT on the UK stock market. But acquisitions are expensive and can backfire if rental performance later fails to live up to expectations.
This risk is only amplified by the firm’s substantial pile of outstanding debts. While management did recently refinance a large chunk of its loan obligations, granting some valuable financial flexibility, leverage needs to be monitored carefully, especially if interest rates start rising again.
Nevertheless, with a proven leadership team and a high-quality property portfolio, the risk looks well worth the potential reward to me. That’s why LondonMetric is on my personal buy list right now.
