Dividend shares are all the rage at the moment. Investors are looking for ways to boost their income.
Look at how strongly the share prices of some typical income shares have performed like Wesfarmers Ltd (ASX: WES), Centuria Industrial Reit (ASX: CIP) and Charter Hall Long WALE REIT (ASX: CLW). Dividend shares shouldn't normally be expected to achieve such strong growth.
The problem with many of these dividend shares is that they are now trading on stretched valuations and their forward yields are hardly worth taking all of the capital risk for.
But I think there is one real estate investment trust (REIT) in-particular that would make an attractive buy for income at the current valuation – Rural Funds Group (ASX: RFF).
What is it?
It's a farmland REIT that owns a variety of farm types across different states and climactic conditions. Those farms include cattle, almonds, macadamias, vineyards and cotton. It has been listed on the ASX since early 2014.
How does it earn rental profit?
It leases out its farms to various tenants which are leaders in their industries such as Select Harvests Limited (ASX: SHV), Treasury Wine Estates Ltd (ASX: TWE), Olam, JBS and Australian Agricultural Company Ltd (ASX: AAC).
The farmland is leased to these high-quality tenants with long-term rental contracts. The current weighted average lease expiry (WALE) is 11 years, which gives peace of mind for both Rural Funds and the tenant. But don't forget, it's the tenant that carries the operational risk on the farm such as drought, although Rural Funds does own substantial water entitlements for the tenants to use.
Rental growth is built into the contracts. The rental indexation is linked to either a fixed 2.5% annual increase or it's linked to CPI inflation, with market reviews for most contracts. It can generate further growth through acquisitions as well as the 20% cash profit it retains each year for productivity investments.
What is the distribution yield?
Rural Funds has a FY20 distribution yield of 5.8%. However, the REIT tries to grow its distribution by 4% a year so we can quite confidently predict that the FY21 distribution is going to be 6% based on the current share price.
What is the valuation?
At 30 June 2019 it had a pro forma net asset value (after the sale of the poultry farms) of $1.79 per share, meaning it's currently only trading at a 5% premium – which is pretty cheap compared to most other REITs on the ASX.
The REIT is expected to make a net cash rental profit of 13.4 cents per share in FY20, mean it's trading at 14x FY20's estimated cash profit. Not bad in my opinion when you consider it will be generating earnings growth and hopefully long-term capital growth over time. I'd be happy to buy some shares of Rural Funds today for income.
