Real estate investment trust (REIT)

British Land is a REIT that specialises in London-based property that it calls ‘campuses.’ At present, it manages a total of £13bn worth of assets, owning almost £10bn of these. Income-yielding property provides stable returns to shareholders, and REITs must return 90% of profits to shareholders. I own a few REITs already as a part of my holdings.

So what’s happening with British Land shares currently? Well, as I write, they’re trading for 395p. At this time last year, the stock was trading for 477p. This equates to a 17% decline over a 12-month period.

Passive income stocks have risks

I believe the biggest issue that could affect British Land currently is the economic outlook. Due to soaring inflation, a cost-of-living crisis has emerged. Because of this, rent collection could become a problem for British Land. This, in turn, could then impact performance as well as shareholder returns.

In addition to this, British Land currently has a diverse portfolio of properties, some with potentially uncertain futures ahead. An example of this is office buildings. Due to the pandemic, working habits have changed as companies adopt remote working. Could demand for office space fall and affect performance and returns?

British Land also has many retail outlets too. With the rise in e-commerce, there is a chance performance and returns could be negatively affected by dwindling demand for retail space too.

Why I like British Land shares

Away from the negative aspects, here’s why I like British Land shares. Firstly, the dividend yield on offer is close to 5.2%. This is higher than the FTSE 100 average of 3%-4%. I am conscious that dividends are never guaranteed, however. They can be cancelled at the discretion of the business at any time.

Secondly, British Land shares look good value for money right now on a price-to-earnings ratio of just four. A ratio below 15 is generally thought to represent value for money.

In addition to these two points, I’m buoyed by British Land’s historic track record, profile, and presence. In fact, it is one of the UK’s oldest property businesses with roots stretching back to the 1850s. This tells me it has the experience and knows how to navigate uncertain times, as well as unexpected events. Furthermore, it has moved with the times in the years gone by to continue evolving.

To summarise, I am aware of the risks involved when it comes to British Land, especially with the current economic climate and changing work and retail landscape. Despite these issues, I am always looking to optimise my portfolio, even if I can’t buy every stock I like the look of. British Land is a stock I would be willing to buy to boost my holdings.

REITs are liked by dividend hunters because they often generate regular income through rental agreements. Regulations also mean that they’re required to pay 90% of annual profits out in the form of dividends.

Right now British Land offers a larger yield than the 3.9% average for FTSE 100 shares. It sits at a decent 5.2%. But this is a property stock I won’t touch with a bargepole.

A plunging REIT

British Land’s share price has fallen 26% in 2022 as investors fret over its retail properties. News last week that retail sales slumped 1.6% month-on-month in August — the biggest drop since the end of 2021 — in response to surging inflation hasn’t improved the mood either.

In this environment British Land could struggle to collect rent if its tenants go to the wall. It also makes it tougher for the business to negotiate rate rises to mitigate the problem of rising costs such as energy.

The truth is that I’ve long avoided British Land shares even before inflationary pressures exploded. The growth of e-commerce means that the future of physical retail remains highly uncertain, creating huge uncertainty over British Land’s assets.

Fragile dividend forecasts

There’s also a big question mark over the firm’s office spaces as companies adopt more flexible working practices. British workers are only attending the office an average of 1.5 times a week. That’s according to consultancy Advanced Workplace Associates.

I’m particularly concerned for British Land given the huge amount of debt it has on its balance sheet. Net debt stood at a colossal £3.5bn as of March, latest financials show.

This adds extra uncertainty to current dividend forecasts given the company’s weak dividend cover. A predicted 21.4p per share reward is barely covered by anticipated earnings of 26.4p. This is well below a target of two times and above which provides a wide margin of safety.

Expensive but unexceptional

I like the steps British Land is taking to embrace the lucrative residential rentals sector. It’s currently developing its first build-to-rent asset in Aldgate, London. I also think its decision to invest in logistics and fulfilment centres is a good idea to capitalise on the e-commerce boom.

But I believe the risks facing the rest of British Land’s business far outweigh the benefits of these steps. And what’s more, I don’t believe the company’s current valuation reflects its high risk profile.

At just above 400p per share British Land’s share price carries a forward price-to-earnings (P/E) ratio of 15.3 times. To put this in perspective the broader FTSE 100 average sits at just over 14 times. I’d rather buy other REITs today.

But should I invest in British Land right now? This FTSE index share has soared in value in recent weeks. But as Britain teeters towards recession I think a fresh share price correction could be coming.

BNP Paribas has painted a gloomy outlook for the capital’s property sector. It says that investment in Central London commercial properties dropped 8% year-on-year in the second quarter. Investment in office spaces was particularly weak, slumping to £2.9bn from £5.3bn in quarter one.

Fragile dividend forecasts?

The darkening outlook suggests to me that British Land’s dividend forecasts could prove wildly optimistic. Based on current estimates the business sports a 4.4% dividend yield.

In particular I worry about the firm’s ability to pay market-beating dividends given the condition of its balance sheet. The business had adjusted net debt of £3.5bn as of March, up around half a billion pounds year-on-year.

At the same time British Land’s predicted dividend is barely covered by anticipated earnings. The projected 21.3p per share reward boasts dividend cover of just 1.2 times. A reading of 2 times is considered the minimum for investors to have peace of mind.

Risk vs reward

I might be prepared to buy British Land shares if the company’s long-term outlook remained robust. On the plus side the business has exposure to the white-hot residential property market that should boost earnings.

However, I believe demand for office and retail space is in a state of structural long-term decline. Many companies are adopting more flexible working practices, which is reducing the need for permanent office space.

Meanwhile the need for physical retail space going forward looks increasingly gloomy as e-commerce grows. In this landscape I struggle to envision firms like British Land generating robust shareholder returns in the years ahead.

7.2% dividend yield

I’d much rather get exposure to UK property by buying one of the FTSE 100’s listed housebuilders. In fact I already own several in my shares portfolio including Taylor Wimpey (LSE: TW).

And given the size of the company’s dividend yield I’m tempted to increase my holdings. For 2022 the construction business carries a mighty 7.2% yield.

What’s more, this year’s predicted 9.2p per share dividend is covered 2.1 times by projected earnings.

Now, Taylor Wimpey doesn’t come without its share of risk either. As well as the threat posed to homebuyer demand from rising interest rates, profits at homebuilders like this are also under threat from rising cost inflation.

Just today Mace Group boss Gareth Lewis warned of the “unprecedented” inflation facing the industry.

The right choice

That being said, I still believe stocks like Taylor Wimpey are great buys today. This is because property prices continue to soar (up 9.7% year-on-year in July, according to Rightmove), insulating the builders from rising costs.

The United Kingdom’s housing supply shortage is acute and looks set to persist for years to come. So I think property prices and housebuilder profits should keep moving steadily higher. This is why I plan to own my Taylor Wimpey shares for the long haul.

London is the economic heart of the country and a city with global appeal. So it’s no surprise that British Land investors expect the FTSE 100 stock to get back to winning ways as the threat of the pandemic recedes.

I’m not one who sits in this camp, though. Use of office space is recovering, as I say, but the long-term future of this sector is uncertain as flexible working takes off. The need for people to come into the office five days a week (if at all) could be nearing extinction for many many businesses. This raises the prospect of weak rents and empty premises for the likes of British Land.

A debt-laden FTSE 100 stock

But British Land is about more than office blocks. I like the company’s attempts to increase exposure to urban logistics and retail parks, property segments that look set for strong and sustained growth as e-commerce takes off. Last month the FTSE 100 business paid £157m to purchase three warehouse assets in North London, for example.

However, office space is the bread and butter of British Land and will remain so. I’m also concerned about the company’s exposure to other non-retail-park retail assets, which stand to suffer as online shopping continues to grow.

It’s also worth remembering that British Land has acres of debt sitting on its books following the pandemic. Latest financials in November showed this sitting at above £2.9bn as of September. Such a huge burden is likely to damage the company’s expansion into other fast-growing parts of the market. It could also hold back dividend growth in the near term and beyond.

Speaking of dividends…

Having said that, it’s worth mentioning that British Land carries a fatty dividend yield for the upcoming financial year. City analysts reckon the firm will pay a 20.75p per share dividend in the 12 months to April 2023. That results in an 3.9% dividend yield, a decent distance above the 3.5% average for FTSE 100 stocks.

I’m concerned though that this predicted payout is barely covered by anticipated earnings. Dividend cover sits at 1.2 times, well below the widely-considered safety benchmark of 2 times+ earnings. This is particularly concerning given that British Land’s massive debts mean it has little balance sheet wiggle room to meet these estimates.

Today British Land trades on a forward P/E ratio of 20.8 times. I think this is far too high given the threats it faces from flexible working and e-commerce. And that dividend yield isn’t enough to enourage me to buy, either. I’d much rather buy other FTSE 100 dividend stocks in April.

How can I make a passive income from a REIT?

A REIT is an investment trust that specialises in property investment. Property investment can be costly and time consuming. REITs offer the opportunity to invest in property without the hassle, management, or cost of traditional property investment. A REIT invests capital from shareholders into residential, commercial, or development properties that yield returns. These returns are paid to shareholders as dividends.

There are currently over 50 REITs in the UK. A REIT must distribute 90% of its tax-exempt property income profit each year as dividends. This is how shareholders make a passive income.

Risks of investing in REITs must be noted. General economic conditions affect rental income, which in turn affects any return. In addition to this, recent inflation and living costs could mean many REITs struggle to collect rent from people and businesses. This could also affect dividends.

Pick #1

Land Securities (LSE:LAND), known as Landsec, is one of the largest REITs in the UK. It has a diverse range of properties on its books currently. Landsec’s portfolio is currently worth £11bn.

As I write, Landsec shares are trading for 803p. At this time last year, the shares were trading for 638p, which is a 25% return over a 12-month period. Landsec’s current dividend yield stands at 4%.

I like Landsec shares for my holdings for three reasons. It has a large footprint with a diverse portfolio of properties, which I think is important to mitigate risk. Secondly, recent results show me that pandemic-related issues such as rental collection are a thing of the past. If a new variant occurs, this could place new pressure on rent collection and dividends, however. Finally, the property market in the UK is booming. Rising prices have led to many more consumers and businesses look towards rental properties. This should boost REITs like Landsec and my passive income.

Pick #2

The next REIT I would add to my holdings is British Land (LSE:BLND). British Land is one of the oldest property firms in the UK with roots dating back to 1856. As I write, it currently owns a portfolio of property worth £10bn plus an additional £2bn worth of assets it manages. BLND focuses on the lucrative London rental market and calls its properties “London campuses.” These are a mixture of work, living, and retail spaces in London.

As I write, shares in British Land are trading for 555p. At this time last year, shares were trading for 436p, which is a 27% return over a 12-month period. British Land’s dividend yield is just under 5% as I write.

I like British Land for three reasons. First, it has an excellent track record and roots that stretch back over 150 years. Second, it is one of the largest landlords in the country. Finally, its focus on the London market is attractive. The London property market is lucrative and British Land is currently building one of the country’s largest developments in Canada Water, London. This will boost performance, dividends, and my passive income.

Recovery shares to buy 

The first company on my list is the FTSE 100 bank Barclays (LSE: BARC). I want to own some banks in my portfolio for the year ahead. I think there are two tailwinds that should help this sector outperform next year. Rising interest rates and the economic recovery may provide the perfect environment for lenders to grow earnings. 

I would buy Barclays over its other peers in the sector as the bank has more diversification. Its international investment bank helped it pull through the early stage of the pandemic as it was able to take hefty fees from clients looking to raise cash from investors.

This diversification could come in handy next year. If there is another wave of fundraisings, it could even be a third tailwind for the group. 

Despite these growth factors, the stock looks cheap. Shares in the corporation are currently trading at a price-to-book value of around 0.6. Few other companies in the UK’s leading blue-chip index offer such potential for the year ahead while trading at such a depressed valuation. 

Of course, it seems unlikely Barclays will be able to navigate the year ahead without dealing with some challenges. These could include further pandemic lockdowns and disruption to its business. Inflation may also prove to be a challenge for the enterprise to navigate. 

FTSE 100 property champion 

The latest retail footfall figures show that consumers are moving away from shopping in city centres. Instead, they favour buying online, out-of-town retail parks and the local high street. 

These trends are good news for real estate investment trust (REIT) British Land (LSE: BLND). The company has been selling its commercial property assets in cities and reinvesting the proceeds in out-of-town parks. It has also been buying up property in the scientific and research sectors. These assets tend to be far more defensive than other types of property. 

As well as these portfolio changes, the company is also benefiting from a general recovery in the overall commercial property market across the UK. Asset values are rising again after two years of stagnation. 

These are the reasons why I would buy shares in the FTSE 100 company next year. As it pushes forward with its portfolio development plan, and property values rise, the market should begin to re-rate the stock. The shares are currently trading at a discount to net asset value, which I think is unwarranted. 

Some challenges British Land could face next year include higher interest rates which will increase the cost of the group’s debt and may reduce profits. 

They may benefit from both earnings growth and an improvement in market sentiment. This double tailwind could produce handsome profits for my portfolio. With that in mind, here are three FTSE 100 companies I would buy right now as recovery and value plays.

FTSE 100 value stocks 

The first on my list is the real estate investment trust (REIT) British Land (LSE: BLND). Shares in this company are currently trading at a significant discount to its book value. The book value is calculated by using the value of the firm’s property minus its debt. Therefore, the market capitalisation of the REIT is currently below the value of the property it owns. 

This is an exciting situation. I think many investors would jump at the chance of being able to buy a house for less than it is worth. However, it does not look as if the market is willing to take the same risk with this REIT. 

I can understand why. The corporation owns a portfolio of commercial retail and office properties. Both of these markets are facing pressure as the pandemic reshapes the retail industry and office market.

Still, for the most part, the valuations of these assets have held up relatively well. At the beginning of the pandemic, the FTSE 100 company struggled to collect all the rent due from its tenants. It now looks as if this issue is behind the enterprise.

It is also reshaping its portfolio to capitalise on the evolving property market trends. Management has bought in more flexible office space, and the group has been investing heavily in open-air retail parks. 

Of course, there will always be the risk that this strategy will not yield the desired results. That is probably the biggest challenge the company faces right now. Trying to change with the market can be pretty hit and miss. Its balance sheet could also face pressure from rising interest rates.

Overall, I think British Land is changing for the better. That is why I would capitalise on its current valuation and buy the stock while it looks cheap. 

Shares to buy for growth

When it comes to undervalued FTSE 100 stocks, I believe ITV (LSE: ITV) takes the crown. Shares in the company plunged at the beginning of 2020, as the pandemic effectively shut its production business and led advertisers to pull spend.

The firm has recovered almost all of its lost revenue nearly two years on. In a recent trading update, ITV’s management said the company is on track to report a record performance in 2021. Booming advertising revenue and growing demand for its studios business have helped the corporation return to growth. 

Despite this recovery, the stock continues to trade below the level it started 2020. This is the main reason why I would acquire ITV for my portfolio. The market seems to be overlooking the group’s recovery. It is also planning to restore its dividend, and management is looking for new growth initiatives. 

In one of these initiatives, the company is taking stakes in smaller businesses, which it thinks has growth potential. ITV is taking a stake in these enterprises in return for advertising time on its network, a strategy that seems to be working for both partners. 

The elephant in the room here is the company’s competitors. Deep-pocketed American streaming giants are fiercely fighting for market share, and ITV cannot compete with these operations.

So far, it has been able to hold its own. The group even produces some programmes on behalf of the streamers. However, there is no guarantee this trend will continue. The company does not have the financial clout, nor the global reach of these corporations. 

Even after considering this risk, I still think the company is an attractive investment for 2022. That is why it features on my list of the best FTSE 100 shares to buy for next year. 

International expansion

The final FTSE 100 company I would acquire for my portfolio as an undervalued growth investment in 2022 is Prudential (LSE: PRU). After splitting its US and UK businesses over the past few years, the company is now a pure-play-Asia growth enterprise. Hong Kong accounts for the vast majority of its sales, although an increasing percentage comes from other markets across Asia, including Vietnam. 

The stock is trading at a discount of around 11% to the level it began 2020. This does not make much sense to me. Thanks to strict virus control measures, many Asian economies have performed better than their Western peers throughout the pandemic.

These regions also have tremendous scope for growth in the financial space. Most have a low-level penetration for products such as life insurance and pensions. In some markets, the rate of penetration is a fraction of the level in the UK. 

This suggests companies like Prudential have an extremely long runway for growth in front of them. Therefore, its brand is already well known across the region, and it has a high level of customer loyalty. These qualities should help the business capitalise on the market opportunity. 

That said, the FTSE 100 company is not the only financial institution in Asia. It faces fierce competition from local operators, some of which have more capital and connections. These competitors may be able to grab market share from the group if it takes its position in the market for granted. Prudential needs to stay on its toes and keep advertising to keep fending off the competition. 

Even after taking these competitive forces into account, I think the stock has tremendous potential for the year ahead, and beyond.

REIT details

A REIT is an investment trust that specialises in property investment. It invests capital in a diverse array of property assets, and then pays a dividend to investors to reward them for the risk. The properties can be residential, commercial, or property developments. The REIT scheme launched in 2007 and there are currently over 50 REITs in the UK. 

Here are some of the rules a REIT must follow:

• Be listed on a recognised stock exchange with at least 35% of quoted shares held by the wider public, and not a closed group of five or fewer people
• Distribute 90% of its tax-exempt property income profit each year as a dividend — this is the part that makes investors a passive income
• Be diversified across at least three properties with each representing less than 40% of the total trusts’ assets
• Invest 75% of gross assets into property rental assets, which can include buy-to-rent property projects

In return for following the rules mentioned above, REITs are offered tax advantages compared to an ordinary investment firm. This relates to the way profits are taxed.

I believe there are some significant advantages to investing in a REIT. First, there is an element of double taxation when investing in ordinary firms and receiving a dividend. Firms’ profits are subject to corporation tax and then the dividend income I receive as an investor is also taxed. In addition to this, earning rent as an individual directly investing into property would also be liable for tax.

A REIT receives a corporate tax exemption for rental income. This allows net rental income to pass through to me as the investor without the double taxation mentioned earlier. Furthermore, I would not have to raise lots of capital to invest in a rental property myself. I could buy shares in a REIT and have access to a diverse portfolio of property investment without the hard work of managing anything myself. REITs also provide a higher shareholder return than any standard form of investment trust. REITs are popular investment vehicles, especially to make a passive income.

Risks of investing

The risks of investing in REITs that could threaten any passive income are similar for most right now. Of course, risks will differ slightly from firm to firm, such as size and diversity of portfolios. 

More common risks currently affecting REITs are macroeconomic pressures and Covid-19. Rising inflation and cost of rent could affect portfolios and any dividends that REITs can distribute. The pandemic was a tough time for REITs especially as growth slowed and rent was tougher to collect. The threat of new variants is not good news and could affect growth and profitability once more. This could affect the level of payout to me as a investor. 

Passive income opportunity #1

I would buy shares in Land Securities Group (LSE:LAND) for my portfolio. Often known as Landsec, it is one of the largest REITs in the UK and has a diverse portfolio of properties on its books. Diversity in a REITs portfolio is important for me as it means the risk is spread out. Landsec has property in the retail, leisure, workspace, and residential sectors. Currently its portfolio is worth £11bn.

As I write, shares in Landsec are trading for 733p. A year ago shares were trading for 712p, which is a 2% return. It is worth noting shares have not reached pre-crash levels of over 900p, making me think there is room for shares to continue upward.

I like Landsec for a few reasons. Firstly, its size, footprint, and diversity are positive. Next, recent half-year results showed me that recovery after the height of the pandemic is underway. Profit was up to £275m and further acquisitions for growth worth £616m had been purchased. Finally, it has a track record of success too, which I use as a gauge to review investment viability. I understand the past does not guarantee future success. From a passive income perspective, Landsec’s dividend yield is close to 4%, which is an attraction for my portfolio.

REIT #2

I would buy shares in British Land (LSE:BLND) for my portfolio. British Land has roots back to 1856, making it one of the oldest property firms in the UK. It owns close to £10bn of its own assets as well as managing a further £2bn worth of assets too with a 95% occupancy rate. British Land owns property throughout the UK but focuses on what it calls “London campuses” which is a mixture of work, living, and retail spaces in London.

As I write, shares in British Land are trading for 511p. A year ago, shares were trading for 496p, which is a 3% return.

I like British Land for a few key reasons. in my opinion, one of the best characteristics of a REIT is longevity. British Land ticks that box. Next, it is one of the largest landlords in the country. It has also been moving with the market recently in selling struggling retail assets and buying better yielding assets. Finally, it is currently undertaking a redevelopment scheme in Canada Water, London. This is one of the largest redevelopments in the country, which will boost performance and growth. From a passive income perspective, a dividend yield of over 3% is attractive too.

REIT #3

I would also buy shares in Big Yellow Group (LSE:BYG) for my portfolio. It is one of the largest self-storage firms in the UK. It has benefitted from the recent e-commerce boom that resulted from the changing face of retail and the pandemic.

As I write, shares in Big Yellow are trading for 1,644p. A year ago, shares were trading for 1,146p, which is a 47% return! At current levels shares look cheap with a price-to-earnings ratio of just eight. I like BYG as it is a bit different to other REITs. It specialises in self-storage solutions only, unlike than British Land or Landsec, which have a mixture of other properties. I like a bit of diversity in my portfolio.

Big Yellow has a successful track record of growth and success, which is positive. From a passive income perspective it has a dividend yield of close to 3% which is also attractive for me.

With that in mind, here are my five favourite FTSE 100 stocks, four of which I currently own in my portfolio but would buy more of today. 

FTSE 100 beverage giant 

The first organisation on my list is the drinks giant Diageo (LSE: DGE). I like this company because it has a portfolio of internationally recognised alcohol brands, many of which fall into the premium segment. The premium nature of these products means the group can charge customers more, and we see this in its profit margins and return on invested capital. 

The group is also using its cash resources to buy up smaller brands and expand its footprint around the world. I think this combination of existing flagship brands and acquisitions can help support the company’s earnings and sales growth for years to come.

Some challenges the group might have to overcome going forward include alcohol bans, regulations, and higher costs, although it should pass these on to consumers through higher prices. 

Quality shares to buy

Another company in the FTSE 100 consumer goods sector that I own is the bleach-to-Durex producer Reckitt (LSE: RKT). This organisation experienced windfall growth last year thanks to the pandemic. Rising demand for cleaning products helped the firm’s Dettol brand clean up, although some other parts of the business suffered. 

As the pandemic has receded this year, demand for these products has declined, and Reckitt growth has slowed. Investors have been quick to turn their backs on the business as a result. 

However, I have been buying the shares because I am encouraged by management’s plans to invest more in growth. The new CEO has hiked the firm’s research and development budget and committed to reducing costs, which should help improve profit margins, giving the firm even more cash to spend on growth. 

This additional spending is one of the main reasons I believe Reckitt is one of the best shares to buy now. But like Diageo, the organisation is not immune to challenges. Rising commodity prices are pushing costs higher. This may offset some of the group’s cost savings and weigh on growth. 

FTSE 100 property champion

Moving away from consumer goods, I think British Land (LSE: BLND) is one of the best shares to buy now. I own this real estate investment trust (REIT) because it provides some diversification for my portfolio.

The company is one of the largest landlords in the country, owning a portfolio of commercial, industrial and office assets around the UK. Over the past few years, as the retail industry has struggled to fight off the e-commerce threat, British Land has been selling off some of its retail assets and reinvesting the proceeds in areas of the market where it believes there are more opportunities.

One of its most extensive development opportunities currently is Canada Water. The east London development is said to be one of the largest redevelopment schemes in the country, with thousands of homes and three million square feet of retail and office space. 

This development is set to be a huge growth opportunity for British Land and its investors. It is not the only reason I own the company (I am also attracted to the stock’s 3% dividend yield), but it is a major one. 

One challenge the group will likely face in the next year or so is higher interest rates. This headwind will increase the cost of the REIT’s debt and could impact property values.

Insurance giant 

One of my favourite stocks in the blue-chip index is insurance giant Admiral (LSE: ADM). Insurance can be a risky business. But Admiral really does know what it is doing. Over the past few decades, the company has grown from a start-up into one of the UK’s largest financial services groups. It is laser-focused on high-quality customer service and offering value for customers through deals such as multi-buy insurance policies.

Further, its decision to give customers refunds as there were fewer vehicles on the at the height of the pandemic last year has paid off. Customer numbers jumped in the first half of 2021. 

Going forward, the company will focus on its international divisions. That will help diversify the enterprise away from its home market. This growth potential is the main reason why I own the stock in my portfolio and think it is one of the best shares to buy in the FTSE 100. 

Of course, expanding overseas is not without risks. The company could end up going into a market it does not understand, which could lead to significant losses. 

Recovery investment

The final FTSE 100 company I want to highlight in this article is the catering organisation Compass (LSE: CPG). As the largest catering group globally, the business has a substantial competitive advantage over its peers. 

Catering is a low-margin, high-cost business, and economies of scale can help keep costs low. That is why Compass has been so successful in taking over the market. Economies of scale have helped the firm take over smaller peers, which boost the group’s bottom line, freeing up more capital for profit and so on. 

Unfortunately, despite the company’s advantages, it could not escape the pain the rest of the catering industry felt last year. It is now in recovery mode, and that is why I would buy the stock for my portfolio as a FTSE 100 recovery play. 

Some challenges it may have to overcome in the next few weeks and months include further coronavirus restrictions, rising costs and weak demand. 

Three companies stand out to me as being undervalued right now compared to their potential. 

Cheap shares to buy

The first organisation on my list is real estate investment trust (REIT) British Land (LSE: BLND). I already own this company in my portfolio and wouldn’t hesitate to buy more. 

The commercial property sector has faced significant challenges over the past 18 months. However, it now looks as if the industry is starting to recover. Occupancy levels are rising, and property values are beginning to increase. The FTSE 100 business has also been able to restore its dividend. 

With the outlook for British Land improving, I’d buy more of the stock for my portfolio. It’s also trading at a discount to its last reported net asset value of 648p and offers a dividend yield of 3%. 

Risks the company may face as we advance include further economic lockdowns and higher interest rates, which could have a negative impact on property values. 

FTSE 100 income stock

Another company that also features on my list of the best shares to buy is home builder Persimmon (LSE: PSN). 

I think this company’s cheap compared to its potential. The UK is struggling to build enough houses, and it doesn’t look as if this will change anytime soon. That implies the demand for Persimmon’s new properties should continue to rise. 

But despite this potential, the stock’s trading at a relatively low price-to-earnings (P/E) multiple of just 12.4. More importantly, it offers a dividend yield of 8.5%. As the company continues to build properties to satisfy the UK’s insatiable demand, I think it can maintain and grow this payout. 

Those are the reasons why I would buy Persimmon today. Some challenges the FTSE 100 company may face include rising costs and higher interest rates, which could dent demand for properties. 

Growth potential

BAE Systems (LSE: BA) is the final company on my list of cheap FTSE 100 shares to buy. The stock’s currently trading at a P/E ratio of 11.9. That looks cheap compared to its international peers. It’s US rivals are selling at an average P/E of around 15.5. 

As well as its low valuation, the stock also offers a dividend yield of 4.2%. 

Demand for defence contractor’s services is booming. It has an order backlog of £44.6bn, underpinning sales for the next two years. A series of significant defence spending commitments from the government recently suggests this backlog will grow in the years ahead. That’s why I would buy the FTSE 100 corporation. 

Still, this company may not be suitable for all investors due to its exposure to the weapons industry. Its presence in this highly regulated industry also increases the risks of owning the stock.