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Forget buy-to-let! Why I think income investors will love these cheap UK REITs

Real estate investment trusts (REITs) offer good portfolio diversification for the wise investor. Because 90% of any UK REIT’s net rental earnings must be paid out every year, there’s both growth and income potential.

I think that’s a simpler, more profitable passive income stream than complicated buy-to-lets with their hidden ongoing costs. Recent tax and regulatory changes mean buying properties to rent out yourself are also less of a money-spinner than they used to be.

So where to start? There’s more value outside the FTSE 100 big boys, in my opinion. The much-discussed death of British high street retail has hurt both British Land and Landsec, which reported declining profits in the first half of 2019.

Big winners for income investors

It makes the most sense to invest in REITs with the lowest exposure to retail. We’re also looking for well-managed portfolios with tidy yields for the best long-term potential.

I’ve covered Amazon warehouse supplier Tritax Big Box before and it still looks undervalued with rising profits and a 4.5% dividend, but there are other prospects we need to talk about.

AEW has only 14.2% of its portfolio in retail, with a greater focus on letting out office and industrial spaces.

The share price has declined around 5% since its 2016 AIM float, giving it a very attractive 8.3% dividend yield. Earnings cover has risen from 1.01 to 1.06 this quarter, the highest yet. It trades at 9.3 times earnings which is good value compared to the sector average, and analysts think it could be undervalued by as much as 50%.

AIM-listed Warehouse REIT comes with a tidy 5.7% dividend, although it is trading at 15 times past earnings which is at the top of my normal range. Half-year results to 30 September showed revenues jumped 27% through higher rents on its 43 properties, with operating profits almost double last year at £9.7m. Its loan-to-value ratio is higher than AEW at 42% and above the board’s own 40% target, but WHR says it will sell off “non-core” assets to get this level down by next year.

Get a-shed

Urban Logistics (LSE:SHED) is a warehousing specialist offering 5.2% dividends. It recorded another strong set of interim half-year results on 14 November backed by “a healthy acquisition pipeline,” according to Chairman Nigel Rich, and its portfolio value and net asset value (NAV) keep climbing. SHED’s portfolio value rose 3.8% to £195m in half-year results to 30 September, with net asset value up 5.2% since March.

Net rental income is up 31% and earnings per share up 25.2% with the group handing shareholders a 25% dividend increase to 3.75p per share.

NAV per share was 145.2p in the six months to 30 September and shares are trading around the 137p mark, so you’ll enjoy a 5% discount right now despite strong growth.

CEO Richard Moffitt pointed to the group “selling ahead of book values and increasing rents across core locations” as being behind the “strong performance” across the half.

Snapping up six parcel depots with a 7% yield for £9.9m from Connect Group, and buying two warehouses already let to German courier DHL with a 5.9% yield contributed to those totals. Management knows how to secure deals, evidenced by the sales of three properties in Nuneaton, Bedford and Dunstable for £18.4m, a profit of 57%. I think there’s still plenty more upside potential in SHED to come.

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Tom currently has no position in the shares mentioned. The Motley Fool UK has recommended Warehouse REIT. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.