Manufactured Housing REITs: Beat, Raise, Repeat
Summary
- Perhaps, the biggest beneficiaries of the mounting housing shortage, the Manufactured Housing REIT sector, has continued their stellar run into 2019. The already sector-leading fundamentals have improved further this year.
- Surging nearly 30% so far this year, the manufactured housing REIT sector is on pace to outperform the REIT index for a remarkable seventh straight year.
- As the most affordable non-subsidized housing option in most markets manufactured housing demand has benefited from the long-awaited acceleration in wage growth among blue-collar workers.
- Beyond the sector-leading internal growth, external growth through acquisitions and site expansions provide an added boost. While competition has heated up, these REITs command a superior cost of capital.
- Home sales of manufactured housing and RV units, however, were not immune to the broader housing market slowdown last year. The magnitude of the dip in sales raises some concern.
REIT Rankings: Manufactured Housing
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Manufactured Housing Sector Overview
Manufactured Housing represents roughly 4% of the Hoya Capital US Housing Index, which tracks the GDP-weighted performance of the US Housing Industry. Within the Hoya Capital Manufactured Housing REIT Index, we track the three manufactured housing REITs, which account for roughly $25 billion in market value: Equity Lifestyle Properties (ELS), Sun Communities (SUI), and UMH Properties (UMH). Manufactured Housing REITs comprise roughly 2% of the broad-based REIT Indexes (VNQ and IYR).
Generally, the most affordable non-subsidized housing option in most markets, roughly 7% of the US population lives a factory-built manufactured home. Due to local zoning ordinances, the placement of manufactured homes ("MH") and recreational vehicles ("RV") is generally limited by municipalities to designated "land lease" communities, of which there are roughly 38,000 across the country. Residents generally own their home but lease the land underneath it, paying an average of $70k for a new 1,500 square foot prefabricated home.
By comparison, a new site-built single-family home of the same size would cost roughly $150k including land. The average monthly lease to set their home on a site and hook-up to utilities in MH or RV community can range from $300-1,000 per month. Unlike site-built homes, MH homes in land lease communities generally cannot finance MH or RV purchases with traditional mortgages, and as with RVs, owners must finance the acquisition with a personal property (chattel) loan. While not included in the REIT indexes, it should be noted that Cavco Industries (CVCO) and Skyline Champion (SKY) are the largest publicly-traded builders of manufactured homes.
Often misunderstood for investors, manufactured homes are generally not "mobile" as roughly 80% of MH units remain where they were initially installed. In addition to traditional manufactured housing communities, these REITs also manage resort-style RV parks, which account for roughly 25% of these REITs' portfolio. The past half-decade has seen substantial growth in RV sales, which has provided an added tailwind for these REITs.
Viewed as a defensive, countercyclical sector, manufactured housing has historically been among the most yield-sensitive REIT sectors despite its recent track record of stellar growth. Building new manufactured housing communities in moderately high-value areas is notoriously difficult, a function of local politics and restrictive zoning regulations. The total supply of manufactured housing sites is estimated to have grown at a rate of 0-1% per year over the past decade, compared to 1-2% per year supply growth in the major real estate sectors. Low supply and strong demand have driven stellar fundamental performance for the sector over the past half-decade.
Manufactured housing accounts for as much as a quarter of the total housing stock in some southern states, and as we discuss below, about half of MH REIT communities held by these REITs are in "at-risk" areas to potential hurricane damage, a potential source of concern particularly in the upcoming third quarter. While all three MH REITs are fairly diversified across the country, we note that ELS has a higher concentration in Florida while SUI has a large portfolio in Michigan. UMH's portfolio is highly concentrated in the northern Appalachian shale region. There are roughly five million land-lease manufactured housing sites in the US, and these three REITs own roughly 5% of all sites.
Bull And Bear Thesis For Manufactured Housing REITs
On pace to outperform the REIT index for a remarkable seventh straight year, the manufactured housing REIT sector has slowly but surely gathered its fair share of fans over the past half-decade. Manufactured housing REITs have been among the biggest beneficiaries of the mounting housing shortage, which has been most acute in the lower-cost segments of the housing market. As we analyzed in The Housing Shortage is Getting Worse, by nearly every metric, housing markets remain significantly undersupplied due to a historic level of underinvestment in new and existing homes over the past decade.
A combination of factors, including rising construction costs, a restrictive regulatory environment, and the lingering fallout from the housing crisis, has stymied residential fixed investment ahead of the largest demographic wave of millennials which will enter the housing markets in full force during the 2020s. Total household formations rose by nearly 2% in 2018, the strongest year for formations since 1985. Meanwhile, on a rolling 10-year average, residential fixed investment as a share of GDP is the lowest since the end of WWII even as growth in household formations reached the highest level since 1984 last year.
The effects of these trends have been a persistent rise in overall housing costs, manifesting in rising rents and higher home values. Housing inflation has outpaced the broader inflation rate on a year-over-year basis in 90% of months since 1995 and does not show signs of receding anytime soon as rent growth metrics have actually re-accelerated over the past year to the strongest rate of growth since early 2016. Using same-store rent growth metrics reported by ELS and SUI, we chart manufactured housing rent growth compared to the alternatives according to the Zillow ZRI Index, highlighting the relative stability of MH rents. Rents have accelerated across the board in 2019, a function of continued job growth, rising real wages, and further moderating supply growth across both the multifamily and single-family housing sectors.
Even as the sector trades at lofty valuations - as it has for most of its phenomenal run of performance - investors have other reasons to remain bullish on the sector in addition to the macroeconomic tailwinds associated with the housing shortage. As the cheapest non-subsidized housing option, the resident base tends to be 'stickier' than in apartments or single-family housing. Acquisition-fueled external growth also continues to add value, aided by a wide premium to private market implied Net Asset Value. Finally, while other rental REIT sectors have been dealing with elevated supply growth in recent years, zoning regulations continue to make adding new supply all but impossible. Below, we outline five reasons that investors remain bullish on the manufactured housing REIT sector.
While there hasn't been much to complain about over the past half-decade, investors do have reasons to be cautious. Home sales of manufactured housing and RV units were not immune to the broader housing market slowdown last year as higher financing costs led to a significant slowdown in new sales across both categories. Manufactured housing sales - which are excluded in the Census Bureau housing starts data - accounted for as much as 15% of total new housing supply during the mid-1990s. Interestingly, MH sales plunged during the early-2000s housing boom as demand shifted to site-built homes amid a period of incredibly easy credit conditions and seemingly relentless home price appreciation. While MH home sales have bounced back in the post-recession period, the recovery has been slow and stalling in recent months. After several strong years, manufactured housing sales are lower by 4.1% over the last twelve months, the worst rate of growth since 2012.
While the slowdown in MH sales does raise an eyebrow, the magnitude of the dip in RV sales is beginning to become a bit more worrisome. The past half-decade has seen substantial growth in RV sales, which have more than doubled since 2009. Strong RV resort performance has provided an added tailwind for these REITs, particularly ELS and SUI where RV rents account for roughly one-fourth of total revenue. In 2018, however, RV sales dipped about 5% and are expected to lower by 14% in 2019.
The combination of rising manufacturing costs - driven largely by tariff pressures - and higher financing costs have impaired affordability. That said, interest rates have pulled back sharply over the last six months, so at least one headwind on sales should be allayed for the back half of this year. While manufactured housing REITs have not seen any material impact from these trends yet, these data sets certainly bear watching over the coming quarters and certainly have an impact on related companies including Winnebago (WGO), Thor Industries (THO), and Camping World (CWH).
Aside from slowing home sales in the MH and RV categories, investors have other reasons to be bearish on the high-flying sector. A sizable percentage of these REITs' assets are in regions most exposed to Atlantic hurricanes, and if we are indeed seeing more extreme weather due to climate change, these REITs may be negatively impacted. Compared to the broader population, a significantly higher percentage of residents are out of the workforce, and many are on some form of government assistance. A tighter labor market and the potential for entitlement reform present risks to the long-term demand outlook if residents seek job opportunities and relocate closer to employment centers. Below, we outline five reasons that investors are bearish on the manufactured housing REIT sector.
Manufactured Housing REIT Fundamental Performance
"Beat and raise" has become the default for the manufactured housing REIT sector over the past half-decade as these REITs delivered another stellar quarter in 2Q19. Same-store revenues averaged 5.7%, accelerating from last quarter's 5.0% growth, driving a 6.2% average rise in same-store NOI growth despite an uptick in same-store expense growth due primarily to higher property taxes. Both ELS and SUI raised full-year 2019 guidance for same-store revenue and NOI growth as well as core FFO. RV revenue guidance at ELS, however, was revised lower for the third straight quarter in a sign that the discussed slowdown in the RV category may be having some marginal impacts on these REITs.
Driving the nearly 6% rise in same-store revenue growth in 2Q19 was a 4.4% average rise in MH rents and a 55 basis point uptick in occupancy. Occupancy levels continue to breach new record-highs, raising some concern over how much occupancy-driven revenue growth there may be left.
A result of the macroeconomic trends discussed above associated with the mounting housing shortage, rent growth has steadily accelerated since rising about 3% in 2014 and may flirt with a 5-handle for full-year 2019.
Strong organic revenue growth is only half the story for manufactured housing REITs. Utilizing a strong cost of equity capital, these REITs continue to grow externally by adding units to existing sites and by growing via acquisitions and site expansions. Even without any major portfolio acquisition, the sector acquired $960 million worth of properties over the last year, largely in one-off acquisitions while disposing of around $90 million in assets. We expect to see another strong year of M&A given the 20-30% premium to NAV enjoyed by the sector, among the best in the REIT industry.
Site expansions continue to be a positive catalyst as both REITs control a land-bank large enough to grow total sites by roughly 2% per year for the next five years through site expansions alone. ELS expanded their total revenue-producing sites by roughly 2% over the past year while SUI has expanded by more than 5%. Home sales were relatively light in the past quarter, as these REITs do appear to be experiencing the effects of the broader slowdown in MH sales discussed above.
Strong internal and external growth resulted in core FFO growth averaging 8.5% in 2018, the third straight year of over 8% growth. ELS and SUI tend to provide conservative guidance early in the year and have consistently "beaten-and-boosted" guidance throughout the year. While guidance still calls for an average core FFO growth of 7.0%, trends during 1H19 suggest that results in 2019 may look as strong, if not stronger, than 2018.
Recent And Long-Term Stock Performance
Manufactured Housing REITs are on pace to push their outperformance to seven straight years, having jumped nearly 30% so far in 2018. ELS and SUI have been among the top-five performing residential REITs in Hoya Capital US Housing Index, which has climbed roughly 23% so far this year as receding mortgage rates and continued solid economic growth have lifted optimism across the sector after the "mini-housing-recession" of 2018.
Sun Communities and Equity Lifestyle have moved in near-lockstep over the last two years while small-cap UMH has underperformed. As the most affordable housing option, the continued rise in housing costs in the single-family and apartment sectors has supported fundamentals and valuations for the manufactured housing REIT sector.
As discussed, Manufactured Housing REITs have outperformed the broader REIT index for six straight years and are on pace to push it to seven. The remarkable stretch of outperformance is matched only by the self-storage REIT sector, which outperformed the REIT average for six straight years between 2010 and 2015. On the flip side, the mall and shopping center REIT sectors are on pace to underperform the REIT index average for the fourth straight year, one of the worst stretches of performance of the Modern REIT era.
Valuation Of Manufactured Housing REITs
Relative to other REIT sectors, manufactured housing REITs trade at a sizable premium based on consensus Free Cash Flow (aka AFFO, FAD, CAD) metrics, as they have for most of the past five years in which the sector has produced sizable outperformance. When we take into account the sector-leading growth rate, however, MH REITs appear more attractively valued. MH REITs trade at a 20-30% premium to NAV, one of the few REIT sectors that have consistently enjoyed an NAV premium through the past three years. A healthy NAV premium can have positive effects on fundamentals, particularly for REITs focused on external growth, as these REITs can fund this growth with "cheap" equity.
Manufactured Housing REIT Dividend Yield
Paying an average dividend yield below 2%, manufactured housing REITs rank towards the bottom of the REIT sector. MH REITs pay out just 50% of their available cash flow, however, so these firms have greater potential for future dividend growth than other sectors and have more capital to fund external growth.
A common theme we observe in the REIT sector, "yield chasing" is rarely a fruitful endeavor. UMH Properties pays the highest dividend yield in the sector, but investors have woefully underperformed the sector on a total return basis over every recent measurement period. According to our research, over the past decade, investors with the investment strategy of picking a basket of the lowest yielding REITs (and generally the highest-valued on an FFO basis) have produced far-superior total returns on a magnitude of several hundred basis points per year. Like the Sirens of Greek mythology, many of the juicy dividend yielding REITs are hard to pass up.
Manufactured Housing REITs And Interest Rates
Viewed as a defensive, countercyclical sector, manufactured housing has historically been among the most yield-sensitive REIT sectors despite its recent track record of stellar growth. Despite their robust, sector-leading growth rates, manufactured housing REITs tend to be more "bond-like" than expected. The sector is the second most sensitive to interest rates and shows quite a low correlation to the broader equity market.
Bottom Line: Housing Shortage Fuels Fundamentals
Perhaps the biggest beneficiaries of the mounting housing shortage, the Manufactured Housing REIT sector has continued their stellar run into 2019. The already stellar fundamentals have improved further this year and the second quarter was yet another "beat and raise." Surging nearly 30% so far this year, the manufactured housing REIT sector is on pace to outperform the REIT index for a remarkable seventh straight year.
As the most affordable non-subsidized housing option in most markets, manufactured housing demand has benefited from the long-awaited acceleration in wage growth among blue-collar workers. Beyond the sector-leading internal growth, external growth through acquisitions and site expansions provides an added boost. While competition has heated up, these REITs command a superior cost of capital.
Home sales of manufactured housing and RV units, however, were not immune to the broader housing market slowdown last year. The magnitude of the dip in sales raises some concern, but primarily for RV manufacturers at this point. As always, MH REIT investors will have to hold their collective breaths over the hurricane-prone third quarter. If climate conditions cooperate, it's set to be another stellar year for the high-flying manufactured housing REIT sector.
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This article was written by
Alex Pettee is President and Director of Research and ETFs at Hoya Capital. Hoya manages institutional and individual portfolios of publicly traded real estate securities.
Alex leads the investing group Learn more.Analyst’s Disclosure: I am/we are long ELS, SUI, CVCO, VNQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
It is not possible to invest directly in an index. Index performance cited in this commentary does not reflect the performance of any fund or other account managed or serviced by Hoya Capital Real Estate. All commentary published by Hoya Capital Real Estate is available free of charge and is for informational purposes only and is not intended as investment advice. Data quoted represents past performance, which is no guarantee of future results. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy.
Hoya Capital Real Estate advises an ETF. Real Estate and Housing Index definitions are available at HoyaCapital.com.
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