Why I think Rural Funds Group (ASX:RFF) is the best REIT on the ASX

There are a number of interesting real estate investment trusts (REITs) on the ASX like Goodman Group (ASX: GMG), BWP Trust (ASX: BWP), National Storage REIT (ASX: NSR) and Arena REIT No 1 (ASX: ARF).

However, I think the best REIT on the ASX is farmland landlord Rural Funds Group (ASX: RFF).

The four key things I’d want to know about a REIT are: how stable is its industry, does it have high quality tenants, the yield and the potential growth.

Farms are long-term investments

Farmland has been an extremely valuable investment for many hundreds of years. We all need to eat and that isn’t going to change any time soon.

Weather events can be a problem for farms, however the tenant carries all of the operational risk year to year, not Rural Funds.

Even so, Rural Funds has diversified its cattle, poultry, vineyard, almond, macadamia and cotton farms across different states and climactic zones.

Does it have high quality tenants

A lot of Rural Fund’s properties are leased by listed tenants such as Select Harvests Limited (ASX: SHV), Treasury Wine Estates Ltd (ASX: TWE), Olam Orchards and JBS.

Other tenants are either solely run or a joint venture by Rural Funds Management, the manager of Rural Funds Group.

I believe Rural Funds has very high quality tenants, as good as you could want.

The yield

Rural Funds expects to pay a total distribution of 10.43 cents per unit in FY19. This equates to a distribution yield of 4.9% at the current price of $2.14.

However, Rural Funds will achieve this distribution with a payout ratio of only 79%, leaving plenty of space for safety and re-investment.

The yield is solid enough, in my opinion.

Growth potential

Rural Funds has rental increases built into all of its contracts that are linked to either CPI or a 2.5% fixed increase.

Management believe the REIT can achieve solid distribution growth through a combination of lease indexation, re-investment of retained net rental profit and market rent reviews.

I believe Rural Funds will become more attractive over time as it increases its sector and climactic diversification.

Farms should become even more valuable over time, despite rising interest rates, due to the growing national and global populations. Rural Funds owns a significant amount of water entitlements to support its tenants, which should also grow in value due to the limited supply of fresh water.

Foolish takeaway

Rural Funds is currently trading at a fairly hefty premium to the underlying value, however I think the defensive characteristics and steady income growth make up for the premium. I’d be happy to buy a fairly small parcel at today’s price, though I’d prefer to buy with a yield of above 5%.

It is, by far, my favourite REIT and I believe it can grow its distribution for many years to come.

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Motley Fool contributor Tristan Harrison owns shares of ARENA REIT STAPLED and RURALFUNDS STAPLED. The Motley Fool Australia owns shares of and has recommended RURALFUNDS STAPLED. The Motley Fool Australia has recommended National Storage REIT. 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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