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Why this share could be one of the best income ideas on the ASX

I’m always on the lookout for quality income share ideas. If a business is paying out a dividend or distribution then that’s an obvious sign it’s already profitable and is looking to reward shareholders.

One of the better ideas for income on the ASX could be Arena REIT No 1 (ASX: ARF), it’s a real estate investment trust (REIT).

The business says that its investment strategy is to invest in sectors such as childcare, healthcare, education and government tenanted facilities leased on a long term basis with the objective to generate an attractive and predictable distribution to investors with earnings growth prospects over the medium to long term.

Most of its properties are indeed childcare properties, leased to large childcare tenants like Goodstart and G8 Education Ltd (ASX: GEM).

Here are some of the main reasons to like Arena:

Income

The first thing to consider, and for most people the most important thing, is the current yield on offer.

It paid a quarterly distribution of 3.2 cents per security over the past year, which currently equates to a yield of 5.9% for the share price of $2.16.

Distribution Growth

A key part to Arena’s success is the growth that it has delivered. Any income stock must be supported by profit growth of the underlying business.

Arena has grown the distribution by a compound annual growth rate (CAGR) of 9.3% since FY13. In each year it has kept the payout ratio under 100% and grown each year. The operating earnings per share (EPS) has also grown in each year.

Rental growth

Arena manages to increase its rental income each year. In the first half of FY18 it achieved a like-for-like rent review increase of 2.5%. It also said that all of the FY18 market rent reviews have been completed

The majority of the rental increases for FY19 in the contracts are either fixed or the greater of 2.5% or CPI.

Long leases

At the half-year result it had a weighted average lease expiry (WALE) of 13.1 years. Only 2% of portfolio income is subject to expiry prior to June 2022.

It has a 100% occupancy rate of its buildings and maintained it during the half-year to December 2017.

Low gearing

Arena actually has a pretty low gearing rate compared to most other REITs. At December 2017 its gearing was 24%, which had reduced from 27.5% at June 2017.

Its current cost of debt is 3.8%, which is a very good rate. Its average facility term is 4.9 years and this was extended by 2.4 years from the FY17 result.

Risks

The biggest risk to REITs at the moment is rising interest rates. This could have a negative effect in two ways, firstly it could increase the interest cost over time and it could also lower the value of the buildings.

There has been a bit of negative discussion surrounding the childcare sector with increased supply and also pressure on occupancy at some centres. As long as Arena maintains its 100% occupancy rate and achieves its rental increases then it should be okay.

There is additional government funding for the sector from July 2018 focussed on improving affordability for lower and middle income working families which is expected to increase childcare participation over time.

Foolish takeaway

I think Arena is a solid option for income with almost a 6% yield and growth of the distribution expected for the upcoming years.

For people just looking at the income I think Arena is a pretty good option, however rising interest rates could decrease Arena’s valuation and mean you could pick it up at a better price over the next year or two with a higher yield.

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Motley Fool contributor Tristan Harrison owns shares of ARENA REIT STAPLED. 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 Scott Phillips.

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