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AEW UK REIT (LSE:AEWU) is a real estate investment trust (REIT) with a portfolio of 34 properties. And I think investors looking for a second income should take a closer look.
Right now, the stock comes with a 7.5% dividend yield. While this might ordinarily be a warning sign, the company has a differentiated approach that makes it stand out in the UK REIT industry.
The requirement to return 90% of its taxable income to investors can give REITs limited growth opportunities. But AEW has found an unusual way around this problem.
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Differentiated strategy
For obvious reasons, passive income investors typically look for long leases in industries where demand is high. The company, however, does exactly the opposite of this.
Instead of long leases, it focuses on contracts that are closer to expiry. Where others see risks, the firm sees the chance to renew on better terms, repurpose the property, or redevelop to add value.
The usual concern is that tenants can leave when their leases expire, creating a risk of unoccupied buildings. But AEW looks to offset this by focusing on opportunities where supply is limited.
Balance sheet
It operates with unusually low debt levels. Its loan-to-equity ratio is around 25%, which is well below the level of some of its larger – and more conventional – counterparts.
This doesn’t, however, mean the company’s balance sheet is entirely without risk. The business has a £60m loan at less than 3% interest that’s set to mature in 2027.
That’s over a third of AEW’s portfolio value and it’s unlikely to be able to refinance that on the same attractive terms. And this makes it a threat to the firm’s profitability in the short term.
Investors shouldn’t underestimate this risk. But with the average lease having around four years to the first break opportunity, it shouldn’t be long until it’s able to try and offset the extra cost.
Passive income
Despite the risks, I think a 7.5% dividend yield makes AEW an interesting passive income stock. As a result, I’m looking seriously at it as a potential addition to my Stocks and Shares ISA.
I think a lot of companies – and investors – focus on sectors where demand is strong, with industrial distribution being a good example. But that’s only half the equation.
The other side of the coin is supply. As a result, there’s been a lot of building in the warehouse industry recently, which investors also need to pay attention to.
Demand might not be as strong in the areas AEW focuses on, but there’s also less supply. And I think that could mean the equation is just as favourable – and possibly even more so.
Breaking the mould
By conventional metrics, AEW doesn’t look like a particularly attractive opportunity. But sometimes being a good investor is about looking for businesses that do things differently.
AEW is a lot smaller than a number of other REITs, but this gives it more flexibility and better opportunities for future growth. That’s why it’s on the list of stocks I’m looking at right now.
