Here’s how to invest £20,000 in an ISA for a £1,240 second income

With inflation constantly eroding our salaries and the cost of living continuing to rise, the need for a second income is more important than ever. One way of creating an additional revenue stream is to invest in dividend shares. And I’ve found a fabulous stock that’s currently offering an annual return of 6.25%.

This would produce dividends of £1,250 for every £20,000 invested. Want to find out more?

Bricks and mortar

A popular way of earning a second income is to invest in property. But with the need for a large deposit this is becoming increasingly unaffordable. And very few individuals have access to the funds required to buy commercial premises. However, for those who are attracted to the property sector there’s an alternative approach available, one that doesn’t require as much up-front capital.

For example, one share in Land Securities Group (LSE:LAND), the FTSE 100 property company, currently (13 February) costs £6.53. And based on amounts paid over the past 12 months, it could earn 40.8p (6.25%) in dividends.

Okay, 40.8p doesn’t sound like much of a second income. But instead of having one share, £20,000 would buy 3,063 of them and potentially generate dividends of £1,250 a year.

Now, here’s the clever bit. Rather than banking the payouts each year, by reinvesting them to buy more shares in the group, it’s possible to take advantage of compounding. Assuming the 6.25% yield is maintained, doing this for 25 years would turn £20,000 into £91,044.

At this point, a return of 6.25% would produce an impressive second income of £5,690 a year, or £474 a month.

Buyer beware

But it’s wise to be cautious. Dividends cannot be guaranteed. That’s because they are paid out of earnings, which can be volatile. This is especially true in the commercial property sector.

Land Securities Group invests primarily in offices in Central London and shopping centres. And as the table below shows, there’s no real pattern to its net rental income or earnings.

The group’s profit is particularly sensitive to occupancy rates. If the UK economy struggles, the chances of one of its tenants going bust increases. And sluggish GDP means the scope for rent rises is limited. Also, with relatively large borrowings, it’s vulnerable to interest rates staying higher for longer.

Good prospects

But Land Securities is a real estate investment trust (REIT). To retain certain tax privileges, it must pay dividends equal to at least 90% of its rental profit each year. This helps ensure a healthy payout ratio but, even so, 90% of nothing is zero.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.

However, I think the group’s dividend looks reasonably secure. Nearly 98% of its properties are let and its prestigious portfolio, which includes Liverpool One, MediaCity, and the Bluewater Shopping Centre, means there should be strong demand on a change of tenant. Also, most of its leases contain provisions for inflation-linked rent increases. Over the medium term, it’s planning to pivot away from offices towards residential developments, which offer better returns.

On this basis, I reckon Land Securities is a share that income investors could consider. In fact, it’s one of many REITs on the UK stock market that currently pay above-average dividends and offer investors the chance to gain exposure to the property sector without having to find large up-front sums or borrow.