Ground Zero Of The Affordable Housing Shortage

Oct. 30, 2019 8:47 AM ETCVCO, CWH, ELS, IYR, SKY, SUI, THO, UMH, VNQ, WGO, ROOF, REET, RWR, BBRE, FREL, FRI, REIT.IND, SRET, KBWY, PSR, PPTY, REZ, NURE, XHB, ITB, PKB, SCHH, XLRE, VRAI, RWO, RDOG, LRET, URE48 Comments31 Likes

Summary

  • Beat, Raise, Repeat. The manufactured housing REIT sector delivered another stellar quarter in 3Q19 and is on track to outperform the broader REIT index for a remarkable seventh straight year.
  • 2019 was poised to be the year where cracks in the story began to emerge as manufactured housing and RV home sales showed notable slowing early in the year.
  • Instead, the tailwinds of accelerating blue-collar wage growth and the lingering and mounting affordable housing shortage continue to support robust rent growth and occupancy levels.
  • 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.
  • The secret is out, however, and manufactured housing REITs command the highest relative valuations across the REIT sector. Investors will continue to demand perfection but haven't been let down in quite some time.
  • This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

REIT Rankings: Manufactured Housing

In our REIT Rankings series, we introduce and update readers on each of the residential and commercial real estate sectors. We analyze REITs within the sectors based on both common and unique valuation metrics, presenting investors with numerous options that fit their own investing style and risk/return objectives. We update these rankings every quarter with new developments and an analysis of the most recent earnings reports.

manufactured housing reits

This article was co-produced with Brad Thomas through iREIT on Alpha.

Manufactured Housing Sector Overview

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).

mobile home REITs

In addition to traditional manufactured housing communities, these REITs also manage resort-style RV parks, which account for roughly 25% of these REITs' portfolio. 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 while Winnebago (WGO), Thor Industries (THO) and Camping World (CWH) are all closely linked to the performance of the recreation vehicle sector. Manufactured Housing represents roughly 4% of the Hoya Capital US Housing Index, the benchmark that tracks the GDP-weighted performance of the US Housing Industry. housing 100 index

Manufactured housing is typically the most affordable non-subsidized housing option in most markets, and roughly 7% of the US population lives factory-built manufactured homes and shipments of these units represent roughly 10% of housing starts in a typical year (although they are not included in the official US Census Bureau estimates). 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.

manufactured housing

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. The quality and appearance of these sites can vary significantly from communities that are almost indistinguishable from a high-end single-family master-planned community to the stereotypical low-end "trailer parks" and plenty in between. These REITs generally own communities in the higher-tiers of the quality spectrum.

By comparison, a new site-built single-family home of the same size would cost roughly $150k including land. By foregoing the investment in the land, however, property appreciation generally accrues to the manufactured housing community owner rather than the homeowner and the home itself generally sees minimal to negative price appreciation. 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.

mobile home reits

Unlike site-built homes, MH homeowners 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 at a higher interest rate. Last year, Fannie Mae developed a program that allows certain high-end manufactured housing units to qualify for traditional mortgages. Given the limited appreciation potential for the physical MH unit itself (without the land), we think financing options will likely remain limited for MH buyers.

Often misunderstood by investors, manufactured homes are generally not "mobile" as roughly 80% of MH units remain where they were initially installed. The manufactured housing resident-base is incredibly "sticky" as the average MH owner stays in a community for 14 years, far higher than the 1-3 year average for other rental units. Manufactured housing REITs are among the most "efficient" real estate sectors, commanding a relatively low operating and overhead expense profile and requiring minimal ongoing capital expenditures.

manufactured housing reits operating

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. "Ground zero" of the affordable housing shortage, 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.

housing shortage

There are roughly five million land-lease manufactured housing sites in the US, and these three REITs own roughly 5% of all sites. 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.

manufactured housing reitRecent Stock Performance

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.

real estate sectors

The remarkable run of outperformance has actually intensified in 2019 as the combination of robust earnings growth and a favorable macroeconomic backdrop of lower interest rates and slow-but-steady economic growth has lifted the MH REIT sector by nearly 50% on the year. ELS and SUI have been the top-performing residential REITs in Hoya Capital US Housing Index, which has climbed roughly 31% 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. 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.

REITs

Sun Communities and Equity Lifestyle had been moving in near-lockstep over the last three years, but SUI has significantly outperformed on its "rival" this year, due in large part to the strong 3Q19 results posted on SUI last week. Small-cap UMH Communities, a favorite with some yield-focused investors despite it's lower total-return outlook, continues to lag the other sector stalwarts. 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.

equity lifestyle

Manufactured Housing REIT Fundamental Performance

"Beat and raise" has become the standard for the manufactured housing REIT sector over the past half-decade as these REITs delivered another stellar quarter in 3Q19. Same-store revenues averaged 5.5%, a slight deceleration from last quarter's 5.7% growth, but a moderation in expense growth allowed the sector to match the 6.2% rate of same-store NOI growth achieved last quarter. As noted above, however, SUI was the clear standout this quarter, raising same-store NOI guidance to a stellar 7.0%. ELS, interestingly, lowered its full-year target on an uptick in expense growth, but provided initial 2020 guidance that suggested an acceleration in revenue and NOI growth next year.

sun communities

Driving the 5.5% rise in same-store revenue growth in 3Q19 was a 4.6% average rise in MH rents and an impressive 125 basis point uptick in same-store occupancy. ELS reported a 4.8% rise in MH rents while SUI reported a 4.2% rise in rents, each near or exceeding the highest rates of rent growth on record. Occupancy levels continue to breach new record-highs, raising some concern over how much occupancy-driven revenue growth there may be left.

ELS

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. As we analyzed extensively in other reports, the relative rate-driven slowdown in the single-family ownership markets was more-than-offset by renewed strength in the rental markets across the apartment, single-family rental, and manufactured housing sectors. 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.

rent is too dam high

On that point, the direct effects of the mounting affordable housing shortage has 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. As a result of these macroeconomic trends, rent growth has steadily accelerated since rising about 3% in 2014 and may end 2019 with a 5-handle when all is said and done.

State of the Manufactured Housing & RV Industry

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, roughly matching the weakness in new and existing home sales that we cover frequently in our research.

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. After several strong years, manufactured housing sales are lower by 6.8% over the last twelve months, the worst rate of growth since 2012, but have shown a notable pick-up this summer as interest rates again flirt with post-recession lows.

manufactured housing sales

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. While the slowdown in MH sales does raise an eyebrow, the magnitude of the dip in RV sales was has been more significant and has raised caution among many investors in RV-focused names like Winnebago (WGO) which had a brutal 2018 with the stock diving more than 50%. In 2018, however, RV sales dipped about 5% and are expected to lower by 17% in 2019.

rv sales 2019The combination of rising manufacturing costs - driven largely by tariff pressures - and higher financing costs had significantly impaired affordability, but the sharp pull-back in interest rates over the last two quarters has reversed much of the negative momentum. According to the RV Industry Association, RV shipments in September were higher on a year-over-year basis for the first time in 14 months and we expect to see decent strength into year-end given the favorable financing environment and still-solid economic growth. Winnebago's stock has more than doubled in 2019 as optimism has returned to the RV sector.

rv sales

Manufactured Housing REIT External Growth

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 $680 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.

manufactured housing reits acquisitions

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 its total revenue-producing sites by roughly 1.5% over the past year while SUI has expanded by more than 5%. Home sales were relatively light in the past quarter, as these REITs are still seeing the effects of the broader slowdown in MH sales discussed above. SUI's new home sales for the quarter, however, were a bright spot with a 14% gain over the same quarter last year.

equity lifestyle sun communities

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. Both ELS and SUI boosted Core FFO guidance yet again in 3Q19 as the sector is on pace for 7.3% growth this year.

growth mobile homes

Bull And Bear Thesis For Manufactured Housing REITs

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 direct effects of this housing shortage, we believe, is the continued rise in rents and a growing share of spending towards housing services.

housing shortage

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.

bullish mobile homes

Aside from slowing home sales in the MH and RV categories, investors do 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.

bearish manufactured housing

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

Manufactured Housing REITs pay an average dividend yield of 2.3%, ranking towards the bottom of the REIT sector average of around 3.3%. MH REITs pay out just 65% 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.

dividends manufactured housing

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 the company has 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.

manufactured housing dividend yield

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 third most sensitive to interest rates and shows quite a low correlation to the broader equity market.

interest rates reits

Bottom Line: Ground Zero Of The Housing Shortage

Beat, Raise, Repeat. The manufactured housing REIT sector delivered another stellar quarter in 3Q19 and is on track to outperform the broader 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, but we've noted a solid recovery in recent months, in-line with the trends in the broader housing sector. The sector made it through the hurricane-prone third-quarter with no major damage, the final obstacle standing in the way of another stellar year.

"Ground zero" of the affordable housing shortage, the continued strength of the manufactured housing REIT sector is a testament to the lingering and intensifying undersupply of housing across large swaths of the United States ahead of a robust demographic twin-tailwind of maturing millennials and retiring boomers. Trading at the loftiest valuations in the REIT sector, investors will continue to demand perfection but haven't been let down in quite some time.

If you enjoyed this report, be sure to "Follow" our page to stay up-to-date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Student Housing, Single-Family Rentals, Manufactured Housing, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Hotels, Office, Storage, Timber, and Real Estate Crowdfunding.

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