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Supermarket Income REIT (LSE:SUPR) has a 7.75% dividend yield. That means a £1,000 investment is set to return £77 in cash in the next 12 months.
A high dividend yield and a share price below £1 make the stock look cheap and there’s a lot to like about the business. But can passive income investors do better?
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First impressions
A high dividend yield can mean investors are concerned about something. But at first sight, it’s not easy to see what that might be in the case of Supermarket Income REIT.
The firm has a fully occupied portfolio of 73 properties with all the major supermarkets as tenants. This has led to reliable rent collection in recent years.
With the average lease having over 10 years to expiry, it’s likely to stay that way for some time. And for investors worried about inflation, uplifts are built into most of its contracts.
There’s always uncertainty, but a 7.75% return from a durable source of passive income looks like a nice opportunity. But a closer examination reveals what investors might be concerned about.
Debt
Those long leases definitely help remove a lot of uncertainty, but there’s also a downside to them. It means Supermarket Income REIT has limited scope to increase rents above inflation.
By contrast, the firm’s loans have an average time to maturity of less than four years and it’s likely to have to refinance its debts when they come due. There’s a real risk this could involve higher interest payments. But with tenancies still having years to run, Supermarket Income REIT might not be able to increase rents to offset this.
With the company’s profits currently below its dividend, higher costs aren’t something the firm needs. And this might be a serious concern over the viability of the dividend.
Growth
Another potential issue is growth. That can be a real challenge for REITs that are required to distribute 90% of their taxable income to shareholders.
That means the firm has to use debt to expand its portfolio. And with initial yields just over 7% compared to a cost of debt that’s just above 5% makes margins relatively tight.
But the company has been working to bring down its costs through a series of organisational changes. And this could also provide a valuable boost to profits.
Risks and rewards
With Supermarket Income REIT, loans that mature before leases expire are a potential risk. And the firm’s cost of debt isn’t far below the rental yields it has been achieving recently.
There is, however, something that could change this quite dramatically. Falling interest rates could boost the value of the company’s portfolio while lowering its debt costs.
That’s been the direction the Bank of England has been heading in recently and I think it could well continue. So a fully-occupied portfolio with reliable tenants means an investor with a spare £1,000 might consider 1,259 shares in Supermarket Income REIT.
