One key aspect of an excellent passive income producing portfolio is that it must be well-diversified. With almost all privately owned companies trading on one stock exchange or another, diversification, both geographically as well as among industries, isn’t a problem for most dividend growth investors. Real estate, however, is one of the key areas that used to be difficult to capture for most investors, but not anymore. Enter the Real Estate Investment Trust or REIT.
Real Estate Investment Trusts are companies that own and operate income producing real estate, and distribute most of that income to shareholders for tax purposes. Many long-time dividend growth investors boast at least one or two REITs in their portfolio, mainly because it offers them easy exposure to real-estate and because the trusts often yield quite well compared to the rest of the market.
Although the more popular REITs are located in the USA because of their monthly distributions, the same corporate structure also exists in Europe. For example, in Belgium REITs have been known under their former French name Sicafi or Société d’investissement immobilière à capital fixe publique for years. Recently, much of the legislation on Regulated Real Estate Companies has been harmonized by the EU to the extent that REITs are popping up all over Europe.
Together with Befimmo (EBR:BEFB) and Cofinimmo (EBR:COFB), one of Belgium’s more well-known REITs is Home Invest Belgium (EBR:HOMI), the first private initiative regulated real estate company for residential housing in Belgium. As a purely residential player, 74% of Home Invest Belgium’s assets are apartments and houses that generate a stable income, that can easily be sold per unit, and that generate capital gains over time. HIB moreover strongly focusses on the Brussels region because it believes it’s an enormous growth area in the coming years. As such, the majority of the REIT’s new buildings are located in Brussels.
Home Invest’s market cap currently stands at €260 million and it is mostly owned by the Van Overstraeten family and AXA Belgium. Together they own almost 47% of the shares, with the other 53% free floating on the NYSE Euronext Brussels stock exchange. With a daily average trading volume of about 800 shares it shouldn’t be too difficult for both Belgian and international investors to purchase a small position in the REIT even though the spread might be relatively high.
Investors looking for real estate opportunities will agree that Home Invest Belgium’s growing funds from operations (FFO) metric looks attractive. Furthermore, over the past few years the REIT also managed to reduce its FFO payout to just over 80%, down from 95% in 2010. Together with an occupancy rate of 95% and low debt ratio of just 38%, there is lots of room for future growth.
Some potential headwinds this Belgian REIT might be facing are a negative impact on rental market demand, a drop in occupancy rate, and the loss of its REIT status. However, the 2013 financial report shows that Home Invest closely monitors these risks and has put corrective measures in place. Another issue for all Belgian real estate companies could be unfavourable tax regime changes, although that is rather unlikely with the newly seated right-wing federal government.
Because new legislation requires an 80% payout ratio for REITS, which is up 20% from a few years ago, Home Invest Belgium significantly increased its dividend distributions the past few years. A couple of years ago the REIT increased its dividend payment about 2.8% on average, but the past few years distributions have grown by almost 10% on average. For the dividends of financial year 2014 the board of directors believes in renewed upward momentum.
Currently Home Invest Belgium yields 3.46%, which amounts to €3.5 in gross dividends per share at the current share price of €86, which is close to its 52-week high. Because REITs are treated favourably from a tax perspective in Belgium, the income tax on dividends is only 15% instead of the usual 25%. One major downside to the REIT’s dividend policy is the yearly payout, which slows the compounding effect.
When considering all of the above, it becomes quite clear that there’s a lot to like about Home Invest Belgium. On the one hand, the REIT is able to present sound financial fundamentals because of its efficient operations. On the other hand, there are some systemic risks inherent to all real estate investment vehicles, such as unpredictable changes in market demand and legislation, that could hamper HIB’s future growth.
On top of that, Home Invest is a rather small company when comparing its market cap to Belgian industry leader Cofinimmo, which is valued at €1.8 billion. Risks associated with its size range from a high supply and demand spread on the stock exchange to competitive disadvantages. As a result, many institutional investors might not be interested in HIB.
There’s an upside to these disadvantages, however. First, because the general public doesn’t know much about this REIT, only investors taking the time to dive into the financial nitty and gritty are likely to become fellow shareholders. As such, management is much more likely to put stringent reporting and transparent early-warning mechanisms in place that help keep the company on track.
Second, even though HIB doesn’t enjoy the same advantages as large corporations, its higher flexibility also offers many avenues of growth. It’s far easier to grow exponentially when you have just one rental property under management than a thousand, for example.
How would you feel about owning a rather small REIT with a decent dividend yield in your portfolio? I know that many dividend growth investors are put off by Real Estate Investment Trusts after the recent debacle at American Realty Capital Properties (NYSE:ARCP), but these two companies hardly compare, of course. Is the extra effort of keeping tabs on the performance of an investment this size worth it to you?