The S&P/ASX 300 Index (ASX: XKO) share Rural Funds Group (ASX: RFF) is one that I've been steadily building my position in during 2023.
For readers who haven't heard of this business before, it's a real estate investment trust (REIT) that's invested in a variety of farmland properties producing cattle, vineyards, almonds, macadamias, and cropping (sugar and cotton).
Rural Funds is not one of the biggest positions in my portfolio but it's a business I believe can be very useful for diversification.
The ASX 300 is weighted towards ASX bank shares and ASX mining shares. The Vanguard Australian Property Securities Index ETF (ASX: VAP), an effective way of investing in just the ASX 300 REITs, is weighted towards industrial REITs, office REITs, and retail REITs. Rural Funds offers something quite different to other ASX 300 shares and most other REITs.
Why I've been buying Rural Funds shares
The higher interest rates have understandably had an impact on investor confidence about commercial property valuations. Since the end of 2021, the Rural Funds share price has fallen 35% and in the last 12 months, it has declined around 20%.
Interestingly, in the FY23 result, Rural Funds reported its adjusted net asset value (NAV) increased 8.9% over the year to $2.93 thanks to (external, independent) revaluations. These showed a rise for the macadamia farms (up 14%), almonds (up 12%), cattle (up 10%), cropping (up 7%), and vineyards (up 3%).
Despite the Rural Funds share price rising/recovering around 20% in the last three months, it's still trading at a 30% discount to the stated adjusted NAV. Even if the NAV were to fall, there's still a large margin of safety there.
The decline in the Rural Funds share price has pushed the guided FY24 distribution yield to 5.7%, which is a solid yield in the current environment.
The ASX 300 share has paused its 4% annual distribution increase for investors amid the higher interest rate environment, which is increasing the cost of debt. However, I like that the business has hedged a lot of its debt, at a good interest rate. For FY24, it has hedged $432 million at a weighted average hedge rate of 2.83%.
Rural Funds is benefiting from rental income growth. Its rent is growing annually thanks to fixed annual increases, as well as some farms that benefit from rental growth linked to inflation.
Developments at some of its farms, such as the macadamia developments, will help grow its total rent in the next few years.
The ongoing rental growth makes me believe the ASX 300 share will be able to afford the higher cost of debt and pay higher distributions.
The Rural Funds share price has largely been rising over the last three months, and I think it can keep rising in the long term. That may be sparked by growing rent profit and/or interest rates perhaps reducing at some point in the next year or two.