In our REIT Rankings series, we introduce and update readers to each of the residential and commercial real estate sectors. We focus on sector-level fundamentals, analyzing supply and demand conditions and macroeconomic factors driving underlying performance. We update these reports quarterly with a breakdown and analysis of the most recent earnings results.
(Hoya Capital, Co-produced with Brad Thomas through iREIT on Alpha)
Within the Hoya Capital Manufactured Housing REIT Index, we track the three manufactured housing REITs, which account for roughly $30 billion in market value: Equity LifeStyle Properties (ELS), Sun Communities (SUI), and UMH Properties (UMH). 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 RV sector.
Manufactured housing units, colloquially known as "mobile homes," are typically the most affordable non-subsidized housing option in most markets. MH REITs own roughly 5% of the five million manufactured housing sites in the US. Manufactured Housing (MH) REITs comprise 2% of the "Core" REIT ETFs. MH REITs also represent 4% of the Hoya Capital US Housing Index, the benchmark that tracks the GDP-weighted performance of the US Housing Industry. As we'll explain in this piece, manufactured housing REITs have been some of the most significant beneficiaries of the affordable housing shortage. Americans spend an estimated $1.3 trillion per year in direct and imputed rent and housing is the single-largest annual expenditure category for the average American at roughly 33% as measured by the U.S. Bureau of Labor Statistics.
The quality and appearance of MH sites can vary significantly from communities that are indistinguishable from a typical single-family master-planned community to the stereotypical low-end "trailer parks." These REITs generally own communities in the higher-tiers of the quality spectrum and are more "retiree-oriented" than the typical MH community. Roughly 7% of the US population lives in a factory-built manufactured home, 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). While all three MH REITs are 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.
For residents, the economics of manufactured housing takes on the qualities of both renter and homeowner. 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 average monthly lease to set their home on a site and hook up to utilities in MH or RV community can range from $300 to $1,000 per month. By foregoing the investment in the land, however, property appreciation is generally minimal, and as a result, 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.
Often misunderstood by investors, manufactured homes are generally not "mobile" as roughly 80% of MH units remain where they were initially installed, and units are generally built to higher quality standards than commonly believed. The manufactured housing resident-base is incredibly "sticky" as the average MH owner stays in a community for 14 years, far higher than the 3-5 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. That said, a sizable percentage of MH REIT portfolios are in regions potentially exposed to extreme weather, which can lead to year-to-year volatility in operating expenses.
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. A significant percentage of the total supply growth, interestingly, has come through site expansion of existing MH REIT communities. Low supply and strong demand have driven stellar fundamental performance for the sector over the past half-decade, which has averaged more than 6% over the last five years, more than double the REIT average.
External growth through site expansions and portfolio acquisitions has helped to boost total returns by another 1-2% per year over the last half-decade, and has shown few signs of cooling even as competition from private market competitors has heated up in recent years amid the sector's stellar run of performance. Viewed as a defensive, countercyclical sector, manufactured housing has historically been among the more yield-sensitive REIT sectors despite its recent track record of stellar growth. Despite the recovery in new home construction over the last several years, by nearly every metric, housing markets remain significantly undersupplied due to a historic level of underinvestment in new and existing homes over the preceding decade.
As discussed in our REIT Decade in Review, at the real estate sector-level, three themes dominated the 2010s: 1) The Housing Shortage, 2) The Retail Apocalypse, and 3) The Internet Revolution. Four of the five best-performing real estate sectors over the decade were on the residential side as the positive tailwinds of the affordable housing shortage continue to provide a favorable macroeconomic backdrop for rental operators and homebuilders, but none more so than the manufactured housing REIT sector, which produced incredible 23% annual compound total returns from 2010 through 2019. The sector produced cumulative returns that nearly doubled the next closest REIT sector. MH REITs outperformed the REIT average for a remarkable seventh straight year in 2019, surging nearly 50%.
The remarkable run of outperformance has continued in 2020 as the combination of robust earnings growth and a favorable 'Goldilocks' macroeconomic backdrop of lower interest rates and slow-but-steady domestic-led economic growth has lifted the MH REIT sector by another 12% since the start of the year. ELS and SUI are again among the top-performing residential REITs in the Hoya Capital US Housing Index, which has climbed roughly 7% so far this year, doubling up the 3.6% returns on the S&P 500.
All three MH REITs delivered total returns in excess of 40% last year, led by Sun Communities at 50%, compared to the 29% total returns from the broad-based REIT index. As they have for most of the past half-decade, Sun Communities and Equity Lifestyle moved in near-lockstep last year, but SUI has outperformed so far in the early-goings of 2020 after a very strong 4Q19 earnings report last week, which we'll analyze below. Small-cap UMH Communities, a favorite with some yield-focused investors despite its substantially inferior historical total-returns, continues to lag the other REITs.
Trading at the loftiest relative valuations in the REIT sector - as they have for the past five years - MH REITs are priced for perfection, but over the last half-decade, these REITs have delivered just that. "Beat and raise" has been the credo for these REITs and 4Q19 earnings season was no different as both ELS and SUI reported a strong final quarter of the decade and forecast another year of robust growth in 2020. ELS and SUI finished 2019 with same-store NOI growth of 5.0% and 7.3%, respectively, both above the initial guidance of 4.6% and 6.7%. Encouragingly, 2020 guidance calls for 6.0% average NOI growth compared to the 5.7% growth initial forecast for the prior year, implying expectations of an acceleration in fundamentals this year.
Driving the 5.5% rise in same-store revenue growth for 2019 was a 4.5% average rise in core manufactured housing rents, a 5.7% rise in RV rental rates, and another impressive 45 basis point uptick in same-store MH occupancy to fresh record-high levels. The strong RV rental performance was especially encouraging after a down-year for RV sales, which we discuss in more detail below. At 4.1%, same-store expense growth in 2019 was a tick higher than in 2018 when it averaged 3.9%, which was driven primarily by property taxes from higher assessed values.
Rent growth remained strong but steady in 2019, a function of continued job growth and rising real wages, coupled with another year of relatively modest supply growth in the affordable housing sectors. Diving deeper, we note the rent growth of MH REITs compared to the Zillow ZRI average for multifamily and single-family rentals. As we discussed last week in Renter Nation is Alive and Well, both apartments and single-family rental REITs reported reaccelerating rent growth and steady occupancy in 2019 as robust employment and wage gains powered another year of strong household formations. Since the start of 2018, more than 2.3 million net new households have been created, well above the overall housing unit supply 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. MH REITs acquired more than $700 million worth of properties over the last year through the end of the third quarter, 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 30-40% 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 its total revenue-producing sites by roughly 1% over the past year while SUI has expanded by more than 10%, including a 5% expansion over the last quarter alone driven by a $350 million acquisition of Jensen Communities, which included more than 5,000 units. Home sales, which represent a relatively minor, ancillary part of the MH REIT business, were relatively light over the last year, as these REITs are still seeing the effects of the broader slowdown in MH and RV sales discussed below, and as record-high occupancy puts a potential cap on incremental sales.
Strong internal and external growth resulted in core FFO growth averaging 8.0% in 2019, the fourth straight year of over 8% growth. ELS and SUI continually "beat and bumped" throughout the year, and each continued that trend in the fourth quarter with Core FFO coming in ahead of prior guidance. Initial 2020 guidance calls for a slight deceleration in 2020, although the 6.2% average is actually on-par with 2019's initial guidance, which ultimately ended the year at 8.0%. We forecast Core FFO growth between 7-8% in 2020.
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 "mini housing recession" that dragged into mid-2019 as the jump in interest rates in 2018 led to higher financing costs, pressuring sales across both the MH and RV category. Consistent with the trends observed across the broader housing sector, however, the pullback in interest rates since late 2018 has helped to power a significant reacceleration in housing activity. While 2019 ultimately ended with a 2.1% decline in total MH unit sales, the back half of the year saw growth averaging more than 6%, building momentum into the start of 2020.
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. Part of that effect, perhaps, is explained by an uptick in recreation sales as the past half-decade has seen substantial growth, as sales have more than doubled since 2009. Strong RV resort performance has provided an added tailwind for these REITs. Seeing very similar trends as MH sales, higher financing costs led to a sharp pullback in RV sales in 2018 and 2019, but the sharp pullback in interest rates over the last year has reversed much of the negative momentum, according to data and forecasts from the RVIA.
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. When we take into account the sector-leading growth rate, however, MH REITs appear more attractively valued. MH REITs trade at a 30-40% 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 REITs pay an average dividend yield of 2.0%, ranking towards the bottom of the REIT sector average of around 3.3%. MH REITs pay out just 70% 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. In our recent report, "The REIT Paradox: Cheap REITs Stay Cheap," we discussed our study that showed that lower-yielding REITs in faster-growing property sectors with lower leverage profiles have historically produced better total returns, on average, than their higher-yielding counterparts.
Diving deeper, we note that 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. Equity Lifestyle pays a dividend yield of 2.5% while Sun Communities pays a dividend yield of 1.6%. ELS has produced a 10-year Compound Annual Dividend Growth Rate (CADGR) of 16.11% compared to 1.76% for SUI and 0.0% for UMH Properties.
Even as the manufactured housing REIT sector trades at lofty valuations - as it has for most of its phenomenal run of performance - investors have reasons to remain bullish on the sector. In addition to the macroeconomic tailwinds associated with the affordable housing shortage, MH REITs have countercyclical properties as 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.
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.
Powered by the macroeconomic tailwinds associated with the affordable housing shortage, Manufactured Housing REITs were the best-performing real estate sector of the past decade, and it wasn't even particularly close. The sector produced cumulative returns that nearly doubled the next closest REIT sector. MH REITs outperformed the REIT average for a remarkable seventh straight year in 2019, surging nearly 50%.
The most affordable housing option in many markets, regulatory impediments to housing supply growth have supported sector-leading NOI growth for MH REITs, which has averaged more than 6% since 2015. 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.
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. While yields of around 2% may be understandably too low for many income-oriented investors, those with a more dividend-growth-oriented strategy would be wise to take a look at ELS and SUI as we believe that the combination of historically low housing supply and strong demographic-driven demand provides a compelling macroeconomic backdrop for companies involved across the US housing industry over the next decade.
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Real Estate • High Yield • Dividend Growth.
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