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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

Equity Lifestyles Properties Inc. (ELS) Q3 2007 Earnings Call October 16, 2007 11:00 AM ET

Operator

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

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

Certain matters discussed during this conference call may contain forward-looking statements in the meanings of the Federal Securities Laws. Our forward-looking statements are subject to certain economic risk and uncertainty. The company assumes no obligation to update or supplement any statements that become untrue because of subsequent events.

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

Tom Heneghan

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

Before we open it up for your questions, I would like to take a moment to discuss current stick-built housing issues. This is a little bit of a departure from our normal discussion, but I think it is helpful in understanding our business today and our future prospects. There is a spectrum of property types in our industry ranging from affordable housing through lifestyle oriented housing. My comments have a particular focus on affordable housing. However, we believe there are spillover effects in the housing in general.

Although, we have some exposure to affordable housing, our primary focus has been and continues to be on properties that attract customers seeking an active adult lifestyle. We think the current disruption in stick-built housing will be a net long-term positive for our company.

I think a little history will help explain why. From 1990 through about 1996 inflation adjusted stick-built home prices were relatively flat in most markets. Some markets, including California, actually experienced nominal price declines during the 1990 to 1996 period.

Loan underwriting requirements included significant down payments, good credit, income documentation and tight housing expense ratios. All of this created a backdrop in which the home buyer was at risk with respect to his investment and the lender at risk with respect to repayment. In addition, the underwriting standards acted as a barrier to entry for less qualified buyers.

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

Securitization of manufactured home loans, or chattel financing as it is called, began in the mid 1980’s. During the 1990’s, the process of securitizing chattel loans became so popular that one company, Green Tree Financial, became an industry darling, capturing over 40% of the market. Its CEO was the highest paid executive in the country in 1996, earning over $100 million.

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

In the process, any semblance to rational underwriting went out the window. No money down, variable interest loans, interest rate buy downs, teaser rates, longer amortization periods, no documentation, aggressive appraisals, loan fraud, etc. became the norm -- and so eventually did loan defaults, repossession, lender and manufacture bankruptcies and related investigations and losses.

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

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

The corollaries are striking, although the numbers are quite a bit higher. Existing stick-built homes were less than 3.5 million units sold in each year from 1989 to 1992 and they reached their peak at 7.1 million units in 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 almost doubled.

In addition, new home sales volumes went from approximately 500,000 homes to over 1 million homes a year in the period 2003 to 2006. In total, that's over $1 trillion a year of additional transactional activity. New single-family home sales alone exceeded $300 billion a year. Sub-prime lending which averaged over $600 billion a year in 2005, 2006, was a major factor driving this activity.

All this new leverage was achieved with household incomes adjusted for inflation, essentially, unchanged since 1990 and rising less than 50% in nominal terms.

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

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

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

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

In addition, factory-built homes can be moved to locations where there is demand, helping to liquidate excess supply. Moreover, many of the factory-built homes are replacing exciting older housing stock. There was no significant development in most states. In many respects the issues the factory-built industry dealt with were degrees lesser in severity, although it didn't feel that way for those experiencing the decline.

As I indicated earlier, most of this turmoil has not impacted our business. Over the years, ELS has been successful selling new homes in our lifestyle-oriented communities despite a backdrop where investing in residential land was seen as a no-lose proposition combined with the negativity of chattel lending's securitization problems.

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

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

In the near-term, we are being impacted by the inability of our potential customers to sell their existing stick-built residents, as well as heightened price sensitivity for seasonal and second homebuyers. We do not know how the current stick-built oversupply problem gets resolved, but we do expect the overhang to impact our new home sales operation into 2008.

We also believe that as the oversupply issue is resolved and psychology shifts, even more people will be attracted to the housing choice we offer; an active, vibrant community that allows owners to limit their exposure to residential real estate, while still enjoying the detached single-family home 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 with Joe McAdams and Thousand Trails operating core. We have made significant progress over the last few months and we believe we are on track to make an announcement by year-end.

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

Question-and-Answer Session

Operator

Thank you very much, sir. (Operator Instructions). And our first question comes from the line David Bragg of Merrill Lynch. Please proceed.

David Bragg - Merrill Lynch

Thanks, good morning. Just looking for a breakout between the MH segment and the RV segment for this quarter, but also as we get closer to '08, given that your guidance is still intact, if you could just provide some 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 gains came from Arizona. In our resort business, we were up a little over 5%, and there we have seen a continuation of the trends we have had all year long with our annuals up over 8%, roughly 6% from rate and about 2% from occupancy, in rough numbers. And the other thing that we have seen is our utility and other income programs continuing to show results. They were up almost 20% in the quarter.

With respect to the fourth quarter, we see similar trends going on. Really not much different than what you would see in the third quarter. In 2008, we would expect some of the revenue numbers to moderate. We mentioned on the last call, we see CPI going down for us. In 2008, our expectation is we would have core revenues on the MH side growing approximately 3.8%, that's kind of the midpoint of a range assuming zero increase in occupancy, and about 65% of our notices have gone out at that rate.

On the RV side, a little bit harder to predict in the future given the seasonal and transient component that we have. But, assuming if it's our expectations, we would expect order magnitude 4.5% to 5.5%, again driven by our annuals. And, again, on the utility and other income, we see that slowing fairly dramatically as we have no new plans right now to implement any of these programs 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 - Merrill Lynch

Great, thanks. And then, next on the rent control, do you have an outlook there for costs expected in 2008? And could you provide us with any updates on this year, any progress that you have made? I understand that you 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. With respect to 2008, given that we are waiting for Judge Walker, I would say that we have fairly modest expectations of cost now. However, if we get a positive result, which we hope to happen, then we might invest more in that activity.

David Bragg - Merrill Lynch

Okay. Thank you.

Operator

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

John Stewart - Credit Suisse

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

Tom Heneghan

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

John Stewart - Credit Suisse

$16.5 million?

Tom Heneghan

Yeah.

John Stewart - Credit Suisse

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

Tom Heneghan

No, I don't think so, but I'll let Roger comment on. I think at 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, our annuals are up about 8%, our seasonals are up about 8%, our transients are flat. And what we're seeing, we had a business plan on our RV side to take our existing customer base and extend the length of stay. I think the deal is executed on that magnificently. We've created more annuals, we've created more seasonals, and we like the opportunities we have in the RV business and they are performing well.

John Stewart – Credit Suisse

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

Roger Maynard

They were three RV communities, we like what we did in the quarter. The one outside Boston is 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 pretty good quarter in terms of acquisition.

John Stewart - Credit Suisse

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

Roger Maynard

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

John Stewart - Credit Suisse

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

Michael Berman

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

John Stewart - Credit Suisse

Okay. Sorry go ahead.

Michael Berman

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

John Stewart - Credit Suisse

Right. Okay. And then lastly, Tom, you touched on your expectation of an announcement by year-end for Privileged Access. Can you give us 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 cause us to be in a position to announce something, it's potentially what we've been working on for the last 90 days that involves negotiation with Mr. McAdams. It also involves legal council and accounting review. So, I think what we are going to announce is going to be a positive event for the company and we are looking forward to announcing some by the end of the year.

John Stewart - Credit Suisse

Okay, thank you.

Operator

Thank you very much, sir. Ladies and gentleman, your next question 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 the connection between the home sales piece, as really it's the occupancy levels and with home sales coming down and how is that you expect that to translate in the occupancy in your communities?

Roger Maynard

Well, at the pace we are at right now. We are up in the quarter about 80 plus sites about a 160 year-to-date based on our home sales that we're projecting now that Michael just spoke about, 450 or so for the year. 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 Rey assets?

Roger Maynard

Stick-built home builder.

Craig Melcher - Citigroup

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

Michael Berman

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

Craig Melcher - Citigroup

Thank you.

Operator

Thank you very much, sir. Ladies and gentleman, your next question comes from the line of Paul Adornato of BMO Capital Markets. Please proceed.

Paul Adornato - BMO Capital Markets

Hi, thanks. I was wondering if you could comment on the transient business in the third quarter. I realized that a lot of the communities are out of season. But, are you thinking of ways to perhaps try to get 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 seasonal and annuals. We are trying to do some rallies and some other things in our business trying to create some off season business, but we still saw very strong demand on the weekends and holidays during the season. And we've got some work to do on the shoulder and the off-season just to pick some transient revenue there.

Paul Adornato - BMO Capital 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 your comments might indicate that there could be some stabilization on the low-end as well. Do you share that view?

Tom Heneghan

Like said it's question of timing and how does the stick-built housing issue get resolved. You've seen a lot of commentary with respect to either monetary or fiscal policy being involved and how the stick-built housing issue does get resolved. So, it's a little difficult to say how it unwinds or how it does get resolved, but to the extent that capital that was once available to borrowers in the sub-prime lending environment is no longer available. Certainly, the affordable housing factory-built community owner should be net beneficiaries of that. A couple of cautions with respect to that, location and population and job growth are everything to, one, resolving the stick-built housing issue and its oversupply. And two, the demand for any factory-built affordable housing community.

Paul Adornato - BMO Capital Markets

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

Tom Heneghan

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

Paul Adornato - BMO Capital Markets

Okay. Thank you.

Operator

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Richard Haley of ABP Investments. Please proceed.

Richard Haley - ABP Investments

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

What's happening with pricing there and how compelling is that becoming compared to the manufactured housing alternative with a similar nice club house, a swimming pool and all the activities and stuff that goes with it, 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 their place with whatever they can, that's going to stem the bleeding from their personal cash flow perspective. So, is renting a villa in an age-restricted community becoming more of a competitive option for them?

Tom Heneghan

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

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

Richard Haley - ABP Investments

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

Tom Heneghan

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

Richard Haley - ABP Investments

And how about, and then I don't want to dominate, but just also sort of Phoenix and I guess California which are the other two areas that you guys have tended to have nice assets as well as, I guess, the competition from housing now?

Tom Heneghan

Again, we believe population growth is going to continue apace in Arizona. Arizona's issues were more of an overall housing supply than some of the pricing issues that happened in certain locations in Florida. So, the question is how does this oversupply issue get resolved with respect to adsorption and I think that's going to be an overhang not on just factory built, but also on the apartments and any other housing choice that exists in those marketplaces.

Richard Haley - ABP Investments

Indeed. Thank you.

Operator

Thank you very much, sir. (Operator Instructions). Our next question comes from the line of Steve Rodriguez of Lehman Brothers. Please proceed.

Steve Rodriguez - Lehman Brothers

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

Tom Heneghan

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

Steve Rodriguez - Lehman Brothers

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

Tom Heneghan

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

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 magnitude points recorded is the 5.25. We've seen a little bit of moderation this quarter in utilities and real estate taxes. We are keeping our fingers crossed that that continues in '08.

Steve Rodriguez - Lehman Brothers

Great. Thanks.

Operator

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

Andy McCulloch - Green Street Advisors

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

Michael Berman

Approximately 50%.

Andrew McCulloch - Green Street Advisors

Okay. Great, thanks.

Operator

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

Tom Heneghan

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

Operator

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

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