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3 reasons why I own Rural Funds Group shares

I am always on the lookout for shares that will produce a good total return (dividends and capital growth combined) whilst also being on the more defensive, less risky side.

I believe this business will provide safe, yet delightful returns:

Rural Funds Group (ASX: RFF) is a real estate investment trust (REIT) that is focused purely on agricultural property, it’s the only one of its type on the ASX.

You might not think a REIT could be one of the best stocks, but here are my top three reasons why I think it’s a great buy:

Diversification of farms

Rural Funds Group has an array of different types of farms, diversification is a key facet of investing after all. It owns poultry, almonds, vineyards, cotton, cattle and macadamia farms. I think it’s very likely that it will continue diversifying as long as each new purchase is a good investment.

Weather conditions are one of the biggest factors that could affect farms, so it’s a good move on Rural Funds Group’s part to have farms in the states of Queensland, New South Wales, Victoria and South Australia for geographical diversification.

Strong income stream

Rural Funds Group’s strategy is to own agricultural assets that are leased to experienced counterparts, which provides a stable revenue stream, this supports the quarterly distributions to shareholders. It has tenants such as Select Harvests Limited (ASX: SHV) leasing its almond farms, and Treasury Wine Estates Ltd (ASX:TWE) leasing vineyards.

Over the long term, capital growth should occur thanks to increasing competition for farmland for food security, an emerging Asian middle class and the growing global population.

It has a clear rent indexation mechanism with each of its tenants, which almost guarantees rising income. The indexation with Select Harvests is 2.5% per annum plus a rent review, with Olam Orchards Australia Pty Ltd its rental increased are matched with consumer price index inflation and with Treasury Wine Estates it’s 2.5% per annum plus a rent review. All of its other leases have reasonable rent increase similar to these ones.

The strong lease agreements have allowed management to confidently predict that distributions to shareholders will grow by 4% in FY18 and beyond.

Water

Water is one of the key aspects for tenants, which is why Rural Funds Group has secured a lot of water entitlements for tenants. This factor is recorded in the statutory accounts at cost value. Water made up around 25% of its assets at 30 June 2016.

Risks

Changing weather conditions and drought will always be one of the main risks to Rural Funds Group. Hopefully the water and diversification strategy that I mentioned above will help with any potential droughts, which is of course a potential major issue.

If another listed agricultural entity comes onto the market, that could drive prices higher, making good value acquisitions hard to find.

Time to buy?

Rural Farm Funds shares have grown by 124% since it listed on 14 February 2014 and it’s offering a dividend yield of 5.72% for FY17. I’m not expecting anywhere near the same share price growth over the next three years, but acquisitions and income increases should see it be a solid performer.

It’s one of my favourite ‘income’ share choices, but if you’re after more dividend choices you should check our favourite dividend stock pick.

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Motley Fool contributor Tristan Harrison owns shares of RURALFUNDS STAPLED and Select Harvests Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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