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Regional REIT (LSE:RGL) shares are trading at around half the firm’s net asset value (NAV). And I think that means passive income investors have to take a look at the real estate investment trust’s 9.45% dividend yield.
Let’s be realistic – there’s no way to get a risk-free return of 9.45%. But there’s a real chance the stock market is overestimating the significance of the firm’s challenges at the moment.
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No, no, no?
Regional REIT looks like a pretty unappealing business on the surface. As the name suggests, it owns a portfolio of commercial properties – mostly offices – largely located outside the M25.
Now, artificial intelligence (AI) might mean that nobody ever goes to an office again and this would be a big problem. But more realistically, demand for office space has been weaker than it was before the pandemic.
This shows up in the firm’s metrics. The worst thing for a landlord is empty buildings and around 25% of the firm’s portfolio is vacant – and that’s a lot compared to other REITs.
There’s also a debt maturity coming in August 2026 and the average lease has around three years, which isn’t long. Given all of this, why on earth would anyone take a second look at the stock?
But…
One thing to note about Regional REIT is that its shares trade at a 50% discount to the firm’s net asset value (NAV). And I think that’s hugely important from an investment perspective.
While the firm’s overall occupancy rate is around 75%, it has a class of high-quality assets that are much more popular. Occupancy in this part of the portfolio is around 88%.
These core assets are valued at £458m by themselves. And that’s about £35m more than the entire firm’s market value (£162m) and its net debt (£262m) combined.
I think that means investors don’t really need to worry about the weaker parts of the portfolio. The company’s looking to sell them off and anything it gets is a bonus.
Dividend yield
From a passive income perspective, the stock looks very attractive. The 9.45% dividend’s fully covered and it looks set to remain that way even with the portfolio divestitures.
Selling off assets should result in lower rental income. But if Regional REIT uses the proceeds to pay down debt, the net result should be that earnings go up. This is because the net initial yields in this part of the portfolio are below the firm’s average cost of debt. So it should be able to more than offset the falling income.
As a result, I expect Regional REIT’s dividend to stay covered for the foreseeable future. And that makes an opportunity for income investors that’s actually hard to ignore.
Appearances can be deceptive
Regional REIT isn’t exactly a looker. When I look closely at the business though, I think the stock’s impossible to ignore. The discounted valuation means the weaker assets can largely be left aside.
The company’s plan to sell these off should strengthen earnings and dividend coverage. That’s why the stock’s going on my list of shares to buy next year.
