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Equity Lifestyles Properties Inc. (NYSE:ELS)

Q3 2007 Earnings Call

October 16, 2007 11:00 am ET

Executives

Tom Heneghan - President and CEO

Michael Berman - CFO

Roger Maynard - COO

Analysts

David Bragg - Merrill Lynch

John Stewart - Credit Suisse

Craig Melcher - Citigroup

Paul Adornato - BMO Capital Markets

Richard Haley - ABP Investments

Steve Rodriguez - Lehman Brothers

Andy McCulloch - Green Street Advisors

Operator

Good day, ladies and gentleman and thankyou all for joining us to discuss Equity Lifestyle Properties' Third QuarterEarnings Results. Our featured speakers today are Tom Heneghan, our Presidentand CEO; Michael Berman, our CFO; and Roger Maynard, our COO.

In advance of today's callmanagement released earnings. Today's call will consist of opening remarks anda question-and-answer session with management relating to the company'searnings release. As a reminder, this call is being recorded.

Certain matters discussed duringthis conference call may contain forward-looking statements in the meanings ofthe Federal Securities Laws. Our forward-looking statements are subject tocertain economic risk and uncertainty. The company assumes no obligation toupdate or supplement any statements that become untrue because of subsequentevents.

At this time, I would like to turnthe call over to Tom Heneghan, our President and Chief Executive Officer.Please proceed, sir.

TomHeneghan

Thank you for joining us today. Goodmorning. I am Tom Heneghan, President and CEO of Equity Lifestyle Properties.Our results for the quarter reflect the stability of our core business. Wecontinue to show good growth in both revenues and net operating income.However, our sales operation is negatively impacted by disruptions in the stick-builthousing market.

Before we open it up for yourquestions, I would like to take a moment to discuss current stick-built housingissues. This is a little bit of a departure from our normal discussion, but Ithink it is helpful in understanding our business today and our futureprospects. There is a spectrum of property types in our industry ranging fromaffordable housing through lifestyle oriented housing. My comments have aparticular focus on affordable housing. However, we believe there are spillovereffects in the housing in general.

Although, we have some exposure toaffordable housing, our primary focus has been and continues to be onproperties that attract customers seeking an active adult lifestyle. We thinkthe current disruption in stick-built housing will be a net long-term positivefor our company.

I think a little history will helpexplain why. From 1990 through about 1996 inflation adjusted stick-built homeprices were relatively flat in most markets. Some markets, including California, actuallyexperienced nominal price declines during the 1990 to 1996 period.

Loan underwriting requirementsincluded significant down payments, good credit, income documentation and tighthousing expense ratios. All of this created a backdrop in which the home buyerwas at risk with respect to his investment and the lender at risk with respectto repayment. In addition, the underwriting standards acted as a barrier toentry for less qualified buyers.

Compared to stick-built homes, theless than $40,000 cost of a factory-built home was a viable alternative tocustomers seeking affordable housing. As it turned out so attractive,manufacturers and vendors took it to excess.

Securitization of manufactured homeloans, or chattel financing as it is called, began in the mid 1980’s. Duringthe 1990’s, the process of securitizing chattel loans became so popular thatone company, Green Tree Financial, became an industry darling, capturing over40% of the market. Its CEO was the highest paid executive in the country in1996, earning over $100 million.

The market for securitizations of chattelloans, which were essentially sub-prime loans, went from 0 to $12 billion ayear by 1998. At the peak, placements of homes almost doubled to over 370,000homes a year.

In the process, any semblance torational underwriting went out the window. No money down, variable interestloans, interest rate buy downs, teaser rates, longer amortization periods, nodocumentation, aggressive appraisals, loan fraud, etc. became the norm -- andso eventually did loan defaults, repossession, lender and manufacturebankruptcies and related investigations and losses.

By 1998 the gig was up. The rush in credit default andlong-term capital meltdown spelled the closing of the securitization window forchattel finance. With no funds to refinance or rollover non-performing loans,all the accumulated warts, pimples and blemishes from bad lending practicesbegan to show off in reported loan performance, exacerbating the downwardcycle. During this time, ELS was increasing its exposure to lifestyle-orientedproperties. We experienced a little of the turmoil that has impacted affordablehousing property owners since 1999.

Recent estimates are that 2007 factory-built shipments willbe around 100,000 units. Access to the securitization market for chattel loansremains essentially closed. The last seven plus years have been difficult forfactory-built housing participants focused on affordable housing. Theirsub-prime debacle began almost 10 years ago and they continue to struggletoday. Further frustrating, any recovery has been a strong competition fromstick-built housing. Yesterday's chattel borrower became today's stick-builtsub-prime borrower.

The corollaries are striking, although the numbers are quitea bit higher. Existing stick-built homes were less than 3.5 million units soldin each year from 1989 to 1992 and they reached their peak at 7.1 million unitsin 2005. Median home prices increased to $230,000 in 2007, from less than a$100,000 in 1990. Even after adjusting for inflation, home prices have almostdoubled.

In addition, new home sales volumes went from approximately500,000 homes to over 1 million homes a year in the period 2003 to 2006. Intotal, that's over $1 trillion a year of additional transactional activity. Newsingle-family home sales alone exceeded $300 billion a year. Sub-prime lendingwhich averaged over $600 billion a year in 2005, 2006, was a major factordriving this activity.

All this new leverage was achieved with household incomes adjustedfor inflation, essentially, unchanged since 1990 and rising less than 50% innominal terms.

The story is now front page news. ARM resets, interest only,no doc, no money down, longer and negative amortizing loans, aggressiveappraisals, teaser rates, loan fraud, etc., became the norm. And more recentlydefaults, repossession, lender and builder bankruptcies and relatedinvestigations and lawsuits.

Although the similarities are striking, there are alsosignificant differences. Primary among them is the fueling to stick-builthousing boom was a speculative fever. This speculation was absent in thefactory-built housing industry. Many unqualified borrowers obtained chattelfinancing but, at its essence it was a desire for an affordable home. The averagechattel loan exposure was less than $50,000 per borrower.

And the stick-built market, by comparison, homes werepurchased with the expectation of selling them for more later on. With higherleverage, came the expectation of higher returns. It was literally a no-brainerin more ways then one.

In the last few years, close to 20% of stick-built homesales were for speculative or investment purposes, exacerbating the overhang ofsupply. A no-money down wire loan for $300,000 or more makes the bad lending practicesof the chattel lenders look prudent.

In addition, factory-built homes can be moved to locationswhere there is demand, helping to liquidate excess supply. Moreover, many ofthe factory-built homes are replacing exciting older housing stock. There wasno significant development in most states. In many respects the issues thefactory-built industry dealt with were degrees lesser in severity, although itdidn't feel that way for those experiencing the decline.

As I indicated earlier, most of this turmoil has notimpacted our business. Over the years, ELS has been successful selling newhomes in our lifestyle-oriented communities despite a backdrop where investingin residential land was seen as a no-lose proposition combined with thenegativity of chattel lending's securitization problems.

We attracted customers either as a primary retirementhomeowner or affordable second homeowner wanting to limit their exposure toresidential real estate and preserve capital for other uses. In hindsight,these customers seem prescient.

In addition, despite the current disruption, the demographictrends remain unchanged. More and more people continue to look for a sense oflifestyle in their housing place as they approach retirement.

In the near-term, we are being impacted by the inability ofour potential customers to sell their existing stick-built residents, as wellas heightened price sensitivity for seasonal and second homebuyers. We do notknow how the current stick-built oversupply problem gets resolved, but we doexpect the overhang to impact our new home sales operation into 2008.

We also believe that as the oversupply issue is resolved andpsychology shifts, even more people will be attracted to the housing choice weoffer; an active, vibrant community that allows owners to limit their exposureto residential real estate, while still enjoying the detached single-familyhome and some of the most attractive locations around the country. For around$70,000 you can own a three bedroom, two bath home in the ELS community,offering an active lifestyle, a deal looking better and better.

Finally, I would like to update you on our discussion withJoe McAdams and Thousand Trails operating core. We have made significantprogress over the last few months and we believe we are on track to make anannouncement by year-end.

With that, now I think we will open it up for yourquestions.

Question-and-AnswerSession

Operator

Thank you very much, sir. (Operator Instructions). And ourfirst question comes from the line David Bragg of Merrill Lynch. Pleaseproceed.

David Bragg - MerrillLynch

Thanks, good morning. Just looking for a breakout betweenthe MH segment and the RV segment for this quarter, but also as we get closerto '08, given that your guidance is still intact, if you could just providesome more color on both of those segments going forward? Thanks.

Michael Berman

Hi, David. Overall our core was up 5.9% in the quarter,really three things going on there. One, on the core MH side we were up 4.4%,approximately 30 basis points came from occupancy. Most of our occupancy gainscame from Arizona.In our resort business, we were up a little over 5%, and there we have seen acontinuation of the trends we have had all year long with our annuals up over8%, roughly 6% from rate and about 2% from occupancy, in rough numbers. And theother thing that we have seen is our utility and other income programscontinuing to show results. They were up almost 20% in the quarter.

With respect to the fourth quarter, we see similar trendsgoing on. Really not much different than what you would see in the thirdquarter. In 2008, we would expect some of the revenue numbers to moderate. Wementioned on the last call, we see CPI going down for us. In 2008, ourexpectation is we would have core revenues on the MH side growing approximately3.8%, that's kind of the midpoint of a range assuming zero increase inoccupancy, and about 65% of our notices have gone out at that rate.

On the RV side, a little bit harder to predict in the futuregiven the seasonal and transient component that we have. But, assuming if it'sour expectations, we would expect order magnitude 4.5% to 5.5%, again driven byour annuals. And, again, on the utility and other income, we see that slowingfairly dramatically as we have no new plans right now to implement any of theseprograms in 2008, although that could always change sometime down the road. So,that gives you our revenue expectation, order magnitude 3.5% to 4% on revenues.

David Bragg - MerrillLynch

Great, thanks. And then, next on the rent control, do youhave an outlook there for costs expected in 2008? And could you provide us withany updates on this year, any progress that you have made? I understand thatyou have been at trial in recent months.

Michael Berman

We've had no update on the decisions from Judge Walker,timing of that is whenever he wants to let us know what his thoughts are. Withrespect to 2008, given that we are waiting for Judge Walker, I would say thatwe have fairly modest expectations of cost now. However, if we get a positiveresult, which we hope to happen, then we might invest more in that activity.

David Bragg - MerrillLynch

Okay. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of John Stewart of Credit Suisse. Please proceed.

John Stewart - CreditSuisse

Thank you. Tom, now that you have closed the Del Rey sale, can you give us an indication of how that price came, inrelative to where you had it under contract previously?

Tom Heneghan

Well, we had it under contract a couple of times, but theone that fell out of that in which we had $1 million dollar escrow deposit thatwe kept, I think was $16.5 million.

John Stewart - CreditSuisse

$16.5 million?

Tom Heneghan

Yeah.

John Stewart - CreditSuisse

Okay. Just to follow-up on your comments on the stick-builthousing market. Can you give us any color, are you seeing any impact on the RVbusiness?

Tom Heneghan

No, I don't think so, but I'll let Roger comment on. I thinkat the margin, our product on the cottage side boasts well for that. But Roger,why don't you...

Roger Maynard

Right. I would say in our RV business, as Michael said, ourannuals are up about 8%, our seasonals are up about 8%, our transients areflat. And what we're seeing, we had a business plan on our RV side to take ourexisting customer base and extend the length of stay. I think the deal isexecuted on that magnificently. We've created more annuals, we've created moreseasonals, and we like the opportunities we have in the RV business and theyare performing well.

John Stewart – CreditSuisse

Okay. And then, in terms of the acquisitions that you madeduring the third quarter, I mean it looked like several smaller deals. Can yougive us a sense for what type of properties those were?

Roger Maynard

They were three RV communities, we like what we did in thequarter. The one outside Bostonis a great property. They are in similar locations to where we have been,places that we like destination, resort locations. So, for us it was a prettygood quarter in terms of acquisition.

John Stewart - CreditSuisse

And what was sort of the weighted average cap rate onacquisitions for the quarter?

Roger Maynard

Well, we are seeing cap rates in the 6% to 7% range.

John Stewart - CreditSuisse

Okay. Mike, can you give us the breakdown specificallyrelated to your 2008 guidance? What does that contemplate in terms of volumeand pricing on new home sales?

Michael Berman

It assumes overall our sales operation for 2008, right nowas we look out, we are assuming will be a breakeven operation in terms ofvolumes of home sales. We don't really see, unless something dramaticallychanges, an up tick in terms of our overall volume, which we would anticipate tobe 400 to 500 depending on where you are in 2008. I think 2007 is going to bein that range.

John Stewart - CreditSuisse

Okay. Sorry go ahead.

Michael Berman

I was just going to say that, I don't really see a greatenvironment for pricing given what's going on reflecting in Tom comments.

John Stewart - CreditSuisse

Right. Okay. And then lastly, Tom, you touched on yourexpectation of an announcement by year-end for Privileged Access. Can you giveus an update in terms of what has gone on during the last 90 days?

Tom Heneghan

Just trying to clear all of the impediments that would causeus to be in a position to announce something, it's potentially what we've beenworking on for the last 90 days that involves negotiation with Mr. McAdams. Italso involves legal council and accounting review. So, I think what we aregoing to announce is going to be a positive event for the company and we arelooking forward to announcing some by the end of the year.

John Stewart - CreditSuisse

Okay, thank you.

Operator

Thank you very much, sir. Ladies and gentleman, your nextquestion comes from the line of Jonathan Litt of Citi. Please proceed.

Craig Melcher -Citigroup

Hi, it's Craig Melcher here with Jon. Can you go through theconnection between the home sales piece, as really it's the occupancy levelsand with home sales coming down and how is that you expect that to translate inthe occupancy in your communities?

Roger Maynard

Well, at the pace we are at right now. We are up in thequarter about 80 plus sites about a 160 year-to-date based on our home salesthat we're projecting now that Michael just spoke about, 450 or so for theyear. If we stay at that pace, we are looking at occupancy really to be flat in'08, but that's the fourth quarter.

Craig Melcher -Citigroup

Okay. And then what's the nature of the buyer of the Del Reyassets?

Roger Maynard

Stick-built home builder.

Craig Melcher -Citigroup

Okay. And last question just on the '07 guidance. What wasthe cause for the downward revision, assuming it's the home sales, is that nowbreakeven business in '07 may be the remainder of the downward revision?

Michael Berman

Well, we gave guidance at the beginning of the year at 295to 305, and our mission was to be within that. When you do the math on thefirst three quarters and what we expect to happen in the fourth quarter, it's295 to 297. From where we were on our last call our home sales operation isshowing a little bit less performance than we had anticipated. But, again, wefeel like given our target at the beginning of the year. We feel pretty goodabout where we are.

Craig Melcher -Citigroup

Thank you.

Operator

Thank you very much, sir. Ladies and gentleman, your nextquestion comes from the line of Paul Adornato of BMO Capital Markets. Pleaseproceed.

Paul Adornato - BMOCapital Markets

Hi, thanks. I was wondering if you could comment on thetransient business in the third quarter. I realized that a lot of thecommunities are out of season. But, are you thinking of ways to perhaps try toget some additional revenues out of these properties in the off season?

Tom Heneghan

In our summer season our transient business was about flat.But, as I said, we are trying to migrate our customers to a longer-term stay.We are taking a lot of transient guys and trying to convert them into seasonaland annuals. We are trying to do some rallies and some other things in ourbusiness trying to create some off season business, but we still saw verystrong demand on the weekends and holidays during the season. And we've gotsome work to do on the shoulder and the off-season just to pick some transientrevenue there.

Paul Adornato - BMOCapital Markets

And now just to follow-up on your stick-built comments,which I appreciate. I realized that you are focused on the high end, but yourcomments might indicate that there could be some stabilization on the low-endas well. Do you share that view?

Tom Heneghan

Like said it's question of timing and how does thestick-built housing issue get resolved. You've seen a lot of commentary withrespect to either monetary or fiscal policy being involved and how thestick-built housing issue does get resolved. So, it's a little difficult to sayhow it unwinds or how it does get resolved, but to the extent that capital thatwas once available to borrowers in the sub-prime lending environment is nolonger available. Certainly, the affordable housing factory-built communityowner should be net beneficiaries of that. A couple of cautions with respect tothat, location and population and job growth are everything to, one, resolvingthe stick-built housing issue and its oversupply. And two, the demand for anyfactory-built affordable housing community.

Paul Adornato - BMOCapital Markets

And finally on Del Rey, if you would look at it from a caprate perspective, what was the cap rate that you sold them?

Tom Heneghan

We had essentially closed the community, so it was anegative cash flow community by the time we sold it. By way of kind of justsome historical perspective we looked at selling it as an existing manufacturedhome community of roughly 70% occupancy and we couldn't see pricing gettingnorth of, call it $8 million to $9 million at some fairly aggressive assumptionin cap rates. So, the execution that we did embark upon closing the communityand selling it to stick-built housing turned out to be a pretty good execution.

Paul Adornato - BMOCapital Markets

Okay. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your nextquestion comes from the line of Richard Haley of ABP Investments. Pleaseproceed.

Richard Haley - ABPInvestments

Hey, guys. Thank you for the backdrop on the housing side.That was probably pretty much where I've been coming from that perspective. Tommaybe you can help me out with something, especially with respect to Florida. I here it's abloodbath down there on the stick-built side, and there's a lot of new productscoming on and not everything is age-restricted, but there is a lot ofage-restricted development going on down there on the sort of semi-attachedside.

What's happening with pricing there and how compelling isthat becoming compared to the manufactured housing alternative with a similarnice club house, a swimming pool and all the activities and stuff that goes withit, and similarly you are probably not cutting your lawn or anything like that.And seem like there are lot of speculators that are kind of dying to rent theirplace with whatever they can, that's going to stem the bleeding from theirpersonal cash flow perspective. So, is renting a villa in an age-restrictedcommunity becoming more of a competitive option for them?

Tom Heneghan

Well, I think anything out there in terms of oversupply thatbecomes available is going to be competitive supply. I would say a couple ofcomments. Location matters within Florida.We've seen and then focused our investments along the coast. Migration to Florida has consistentlybeen a positive statistic over the last 60 years. Given the demographics wedon't expect that to change.

This oversupply maybe being provided to the market at lessthan replacement cost. We do think there is some disruption with respect tothat and that's affecting our sales. But at its core, we believe we provide avery attractive community-based lifestyle that once the oversupply getsresolved and the migration patterns in Florida continues apace, we think we'llbe well positioned to get our share in that marketplace.

Richard Haley - ABPInvestments

Have you tracked where an all-in rent, the ground rent andmaybe an imputed price to purchase a house in your higher-end communitiescompares to competing product if they wanted to rent or buy something that'smaterially discounted in the, I guess, the stick-built category. What's goingto happening with the pricing dynamic?

Tom Heneghan

Well, a price discovery is a little difficult to come bygiven that there has been some cessation in activity. We do expect some supplyto come on either in rental stock or in deeply discounted pricing and that Ithink is that the margin is going to be affecting us in 2008.

Richard Haley - ABPInvestments

And how about, and then I don't want to dominate, but justalso sort of Phoenix and I guess California which are the other two areas thatyou guys have tended to have nice assets as well as, I guess, the competitionfrom housing now?

Tom Heneghan

Again, we believe population growth is going to continueapace in Arizona.Arizona's issues were more of an overallhousing supply than some of the pricing issues that happened in certainlocations in Florida.So, the question is how does this oversupply issue get resolved with respect toadsorption and I think that's going to be an overhang not on just factorybuilt, but also on the apartments and any other housing choice that exists inthose marketplaces.

Richard Haley - ABPInvestments

Indeed. Thank you.

Operator

Thank you very much, sir. (Operator Instructions). Our nextquestion comes from the line of Steve Rodriguez of Lehman Brothers. Pleaseproceed.

Steve Rodriguez -Lehman Brothers

Hi guys. I was wondering if you can talk about, yourthoughts on the impact of higher gas prices, specifically on your '08assumptions within your RV Parks?

Tom Heneghan

Well. Right now, we haven't really seen any impact on theprice of gas. You know for a winter season a lot of seasonal customers theycome down to Floridaand stay one to three to four months and really just haven't seen that impactyet from the fuel prices.

Steve Rodriguez -Lehman Brothers

True. But, I mean, with gas hovering around $86, would youagree it's fair to say that should increase going forward?

Tom Heneghan

Well, what I would say the margin, especially given thefocus on the demographic and retiree lifestyle that we show in our Sun Beltoriented properties, there the choice is stay home and hit the house, which isgoing up at double-digit rate. Or come down to Florida,or go to Arizona,enjoy the sun, reconnect with friends, enjoy good lifestyle, forget aboutshoveling, etcetera, etcetera. So, at the margin there can be some impact ofthe price of gas. We think net, net, net the cost to get down to Florida or Arizonafor our lifestyle oriented customers is not a significant factor in theirdetermination.

Steve Rodriguez -Lehman Brothers

Okay. That’s fair. And on your '08 assumption for expenses,are you able to provide some type of expense growth number, a range?

Michael Berman

I would say for the expenses, again, order of magnitudepoints recorded is the 5.25. We've seen a little bit of moderation this quarterin utilities and real estate taxes. We are keeping our fingers crossed thatthat continues in '08.

Steve Rodriguez -Lehman Brothers

Great. Thanks.

Operator

Thank you very much, sir. And your next question, ladies andgentlemen, comes from the line of Andy McCulloch from Green Street Advisors.Please proceed.

Andy McCulloch - Green StreetAdvisors

Hey, guys. Just one quick question for you. On historicalbasis what percent of your MH buyers are all cash buyers?

Michael Berman

Approximately 50%.

Andrew McCulloch - Green StreetAdvisors

Okay. Great, thanks.

Operator

Thank you very much, sir (Operator Instruction). This timegentlemen, we have no further questions in queue.

Tom Heneghan

All right, thank you everyone for joining us on our calltoday. As always, Michael Berman, our CFO, is available for anybody who hasfollow-up questions after the call. Look forward to updating you in our nextquarter. Take care.

Operator

Thank you very much, sir. And thank you ladies and gentlemenfor your participation in today's conference call. This concludes yourpresentation for today. You may now disconnect. Have a good day.

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