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UMH Properties: Secure 5% Dividend And A 62% P/FFO Discount To Its Peers

About: UMH Properties, Inc. (UMH)
by: Roberts Berzins
Roberts Berzins
Long only, value, Growth, long-term horizon

UMH benefits from favorable U.S. housing trends and a recently initiated program by Freddie Mac that allows homebuyers to access conventional financing for manufactured homes.

UMH has a strong growth pipeline driven by improved occupancy/rent levels, value-add expansions, and accretive acquisitions.

The balance sheet is very conservative and gives UMH the right flexibility to go through capital-intensive future periods.

UMH trades at a 62% P/FFO discount relative to its peers. This is totally unreasonable as the fundamentals would rather support the case for a premium.

UMH Properties (UMH) is a small-cap equity REIT that owns and operates a portfolio of 122 manufactured home communities with approximately 23,000 developed homesites. These communities are located in eight states throughout the Northeast: New Jersey, New York, Ohio, Pennsylvania, Tennessee, Indiana, Michigan and Maryland. The company is a great investment for dividend-oriented investors whose goal is to receive a yield in the 4-6% range backed by strong underlying fundamentals that, in the meantime, provide opportunity for notable capital gains.

Favorable U.S. Housing Trends

For a company to achieve above-average growth in the long run, the existence of secular tailwinds is vital. Otherwise, if the opposite is the case then it might get really hard to increase or even sustain the top-line figure. Retail, paper industry, DVD rentals, and oil and gas industries are all good examples of what happens to companies' share prices if the industry is in decline.

Source: UMH

UMH is well-positioned to enjoy a significant boost to its future growth. As you can see in the graph above, housing has not yet recovered from the financial crisis 2008. Single-family housing starts have been gradually coming back to previous levels, but there is still a long way to go. Manufactured housing shipments, which are super relevant for UMH, show the same pattern - slowly but steadily regaining the pre-crisis level.

Here is a great excerpt from the recent Wells Fargo special commentary on the outlook for manufactured housing in 2019:

Given the affordability issues hampering the single-family market, manufactured housing should gain favor with homebuyers. An aging demographic will also produce a steady stream of homebuyers in the form of retirees looking to downsize and/or relocate to parts of the country where manufactured housing communities are more popular. Moreover, manufactured housing demand will benefit from the coming wave of young Millennial buyers, many of which have smaller families and prefer a minimalist lifestyle and a smaller footprint.

Basically, rising labor and material costs as well as severe weather conditions were a substantial headwind for homebuilding in 2018. UMH, as a manufactured home producer, is less exposed to these risks given that homes are built in plants with a more streamlined production process.

Moreover, manufactured housing companies will definitely benefit from the recent moves made by policymakers. Manufactured home sales boomed in the 90s, mostly the result of loose lending standards that have since been heavily restricted. However, Freddie Mac recently initiated a program that will enable homebuyers to receive conventional financing for some manufactured homes, such as those with permanent foundations and pitched roofs. Fannie Mae and HUD have also indicated that they are working on similar programs.

Three Ways UMH Will Grow its Cash Flows

We now have a clear picture that UMH is in the right place to experience some help from the industry, or that it will definitely not have to deal with the consequences from a declining industry. Let's look at three company-specific channels from which the future growth should come.

No. 1 - Increased Rents and Occupancy

UMH's portfolio has two problems that, if dealt with appropriately, could result in an immense jump in NOI figures.

Source: UMH

The table above depicts UMH's current portfolio allocation and some informative statistics. Immediately you can see that both occupancy and average monthly rents vary among the communities. This is totally reasonable as there are different levels of disposable income among states. However, the total figures indicate that there is definitely room for improvement.

The total occupancy number of 82% indicates that almost 20 houses from 100 are empty. Compared to the company's closest two competitors (there are only two other publicly traded equity REITs that are classified as manufactured housing), UMH's occupancy looks very bad. Equity Lifestyle Properties (ELS) and Sun Communities (SUI) have their total occupancy rates at 95.3% and 95.7%, respectively. If UMH managed to get its overall occupancy rate to, let's say, 90% (an increase of 8%), the effects on the cash flows would be tremendous.

Source: UMH

And the great thing is that, since the beginning of 2018, UMH has improved the same-store occupancy rate level almost uninterruptedly. This just proves that management has noticed this huge gap between the competitors, and that it's actively seeking ways to attract more tenants.

In addition to somewhat lagging occupancy numbers, UMH has experienced the same problem with the current rent levels. Each community in which UMH operates has, on average, much larger rent levels than UMH is currently charging.

Source: UMH

As you can see, the differences are huge. In the two biggest communities for UMH, which comprise almost 70% of the total portfolio, UMH charges ~72% below the market average. Even compared to SUI and ELS, the average rent of $441 charged by UMH is way below the norm. For instance, SUI charges on average $995 per one manufactured home unit, implying a 44% premium relative to UMH's rent level.

As with the occupancy issue, management has started to actively work on closing this enormous gap. To put this in specific numbers, in the past 12 months UMH has successfully increased rents by 6%. Again, compared to SUI and ELS, which in their 2019 guidance estimated a 2%-4% rent increase, it's clear that the convergence process has already started.

No. 2 - Value-Add Expansions

In general, rapidly appreciating land values have made manufactured housing communities an attractive target for redevelopment. However, redevelopment activities usually do not lead to abnormally high IRRs. The reason lies in the whole affordability idea of manufactured housing. Manufactured housing sets a cap on how high rents can be lifted in order to not suffer a drastic fall in occupancy rates, irrespective of how luxurious the manufactured house is. Hence, for real estate companies that operate in manufactured housing business it's extremely important to own vacant land in order to achieve good long-term growth.

Source: UMH

UMH has approximately 1,697 acres available for future development. The vacant land accounts for 36% of the total acres in the UMH's portfolio. UMH has already planned out how it will set aside part of the vacant land to use. Until 2024, UMH will build additional 2,618 sites. That indicates a 10% increase in the number of current site units.

Source: UMH

An expansion of Fairview Manor is a perfect example of how fruitful putting new units on the adjacent/vacant land can be. Overall occupancy tends to rise, the company is able to charge much higher rents, and the NOI metric surges.

I expect that UMH will rely a lot on value-add expansions in the future. This way, the company will also be able to deliver on the first point regarding increased occupancy and current level of rents more easily. While the already communicated plan of expanding the site count by 10% is impressive, UMH has a much bigger potential for performing profitable expansions. The vacant land comprising 36% of the total used land is a remarkable asset to own that will play an increasingly important role in its future growth.

No. 3 - Accretive Acquisitions

The third major source contributing to the long-term cash flow growth is acquisitions. Since 2015, UMH has been actively involved in buying new sites, which have helped it to achieve double-digit FFO growth in the past few years.

Source: UMH

The acquired sites since 2015 account for 35% of the total current sites. This is a truly impressive fact, indicating that management is very aggressive when it comes to buying new properties.

The most important thing, however, is that the aggressive acquisition strategy has resulted in improved financial results. To buy new units consisting of more than one-third of the total portfolio in such a short period of time is a risky thing to do. Usually, the integration and ensuing management processes of such large scale maneuvers are difficult to implement in the organization without suffering some negative financial impacts. UMH has delivered perfectly here. All of the acquired sites have increased occupancy rates compared to the levels prior to the acquisitions. The rents charged for the recently bought sites (2018 and 2019) are now way above the current average rent of $ 441.

Below you can see an example of how Boardwalk and Parke Place's acquisition in 2017 looked in 2019. It just proves that non-organic growth for UMH is highly welcomed.

Source: UMH

Healthy Balance Sheet

The key thing here is to assess whether UMH has a balance sheet that is flexible enough to allow management to dedicate funds to the three aforementioned growth pillars without exposing shareholders to an elevated financial risk. The answer is "yes."

Source: UMH

Net debt to total market cap of 29% is considered a very prudent level. Compared to SUI and ELS, UMH's indebtedness is relatively safe. While the net debt/total market cap ratio is the highest, the debt/EBITDA ratio is the lowest for UMH relative to its sector peers. The company has even shown that despite the intensive acquisitions and expansion activities, the gearing has improved significantly.

Source: UMH

Check out the graph above, which illustrates the site expansion schedule. The debt maturity timetable is very much aligned to that. There are no notable amounts of debt coming due in the next few years during which UMH plans to go through a capital-intensive investment program.

Another important metric to consider is the FFO payout. The lower the payout level, the more funds the company retains for covering planned investments. This, in turn, means that required amount of additional borrowing is lower as the company is able to use its internal cash flows to fund the growth strategy. The TTM FFO payout for UMH is 46%, which is a very prudent level. Basically, half of the FFOs are left for investments.

Risks to Consider

We are definitely in the late stages of the business cycle, where the probability of suffering a crisis or negative GDP growth in the near term is high. The slowdown might affect the pace at which UMH will be able to carry out rent hikes and increase the occupancy rate closer to its peers' level. However, the huge gap with regard to SUI and ELS definitely serves as a floor for how far rents and occupancy might fall in case of a slowdown. Namely, the chances are much higher that SUI and ELS will be impacted more severely because of their already sky-high occupancy and rent levels. Plus, UMH has a healthy balance sheet and very low FFO payout that would allow management to be more opportunistic by buying new properties when the overall cap-rates become more appealing. Finally, let's not forget that UMH operates in a defensive sector, which is less sensitive to economic shocks.

Since UMH is a small-cap REIT, there might be a structural obstacle hindering UMH's multiples from going up. Currently, small-cap REITs trade at 10-year historical discount relative to large caps. However, as long you have the patience to wait until the convergence takes place, this is not a problem. The most important thing is that the underlying business operations are stable and offer meaningful growth potential - as is the case with UMH.

Return Expectations

According to NAREIT, UMH has only two competitors operating in the same sector. The table below shows that UMH trades at a significant discount to its peers, even though the consensus forecasts for 2020 FFO growth are way above the peer average.

Source: NAREIT

Given the analysis above, all of the growth opportunities - which are fully backed by a fortress-like balance sheet and UMH's already proven track record - render the discount unjustifiable. It's extremely hard to find some reasonable basis for the 62% gap. It seems that even UMH's management thinks that the discount has gone too far - currently, it owns 11% of the shares and has continued to buy them.

A long-term investor should be able to get a 62% return from capital appreciation. It will take time for UMH to execute all its growth plans, but in the meantime one can easily expect a dividend of ~5% that has a very small chance of being reduced.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.