Local Shopping for income

When markets start to wobble, look for yield. The returns may not be exciting, but provided the income stream is secure, they are at least more certain than capital gains. Local Shopping Reit, which owns £190m of high-yielding corner shops around the UK and pays out 100 per cent of its rental income in dividends, looks a sensible small-cap bet for today's nervous market environment.

The company operates in the 'convenience retail' sector. That's not as bad a place to be in as it sounds. Yes, high street retail chains are downsizing, faced with both a structural migration of shoppers to the internet and a cyclical squeeze in disposable incomes. But Local Shopping Reit does not own the kind of high street shops that are expensively let to fashion brands. It owns small neighbourhood food stores, newsagents, charity shops, cafés and takeaways.

That's a resilient niche, as such shops typically sell cheap or necessary goods that consumers keep buying in tough times. Indeed, the supermarket chains believe local 'top-up' shopping is a growth market and have been expanding their small format store numbers aggressively. Of the five properties, Local Shopping Reit bought in the six months to 31 March, four were convenience stores let to Tesco or Martin McColl.

But national brands are the exception rather than the rule in this market. The group collects roughly 70 per cent of its rent from individual traders or local businesses, with over 2,000 tenants in total. The advantage of this model is diversification: the risk from the bankruptcy of any single tenant is small. The disadvantage - and the reason why yields are high - is that tenants are constantly on the move. Management has to work hard to re-let vacant units and minimise arrears, and the 10.8 per cent vacancy rate is high by the standards of the larger real-estate investment trusts.

Still, the group's rental income stream looks relatively secure - and investors' dividends with it. Finding growth will be tough, however. The group collected £8.1m in rent over the six months to 31 March 2011 - up 7.2 per cent year-on-year - but the gain was entirely down to acquisitions in the previous half. Like-for-like income was flat, and open market rents actually fell 0.4 per cent, which will make it harder to extract rent increases in the future. Further reductions in the vacancy rate may help, but with the UK economy barely growing, this cannot be taken for granted.

That leaves the company's growth trajectory dependent on a new income stream: fees for managing properties it doesn't own. Things are looking up here. Management signed a joint venture with a fund called Pramerica last year to invest in local shopping assets. Local Shopping Reit will provide just 20 per cent of the equity, but manage all the assets - a capital-light way of boosting returns. Similarly, the company has teamed up with two banks to manage properties they have taken over from delinquent borrowers.