UMH Properties Crushes Sun Communities Through Smarter G&A
- Compensation expense, when handled well, can attract talent to a REIT.
- When done poorly, it leads to shareholder capital going disproportionately to a few executives.
- UMH has a much healthier balance than SUI and it shows up in community-level performance.
- This idea was discussed in more depth with members of my private investing community, Portfolio Income Solutions. Learn More »
In 2020 median employee-pay at Sun Communities (NYSE:SUI) dropped to $29,100 while Gary Shiffman's paycheck increased to $11.14 million. That brings CEO pay to a whopping 382X that of the average employee at the company.
While this sort of ratio may raise social concerns, I am viewing it from the lens of an investor. At Portfolio Income Solutions, part of my due diligence is making sure we invest with strong management teams and part of that is making sure the management teams do not pilfer shareholder value into their own coffers.
That is why we own UMH Properties (NYSE:UMH) and not SUI.
Why UMH is better than SUI going forward
The manufactured housing REITs trade at high multiples because the underlying fundamentals of the sector are fantastic. Sun Communities, however, is likely to underperform its peers because capital that should be either going to reinvest in the business or get paid to shareholders as dividends is going to executives. UMH is consistently outperforming SUI in terms of organic growth and its valuation is much more attractive.
Let us begin with a look at the magnitude of G&A expense at SUI.
It has been ramping up consistently for over a decade and seems to have accelerated recently.
G&A expense will naturally go up when a company is growing in size, but $126 million is well above normal levels. As a comparison, we can look at its manufactured housing peers Equity Lifestyle (ELS) and UMH Properties.
ELS's G&A also went up as it grew, but it has capped out at around $35mm.
As a smaller company, UMH's G&A is significantly lower at about $11mm.
Generally speaking, as a company grows, G&A will go up in absolute dollars but down as a percentage of revenues.
Micro-cap and small-cap REIT might have G&A as a percentage of revenue in the ballpark of 5%-10% whereas large-cap REITs will tend to have G&A about 3%-5% of revenue.
Sun Communities is a very large REIT, but it still has G&A at 9.4% of revenue.
G&A as a % of revenue
Data from SNL Financial
The G&A of UMH and ELS is quite normal for their respective market caps.
If SUI were to operate at the expensive end of normal efficiency for a large cap (5% of revenues) that would be $66mm of G&A. SUI's current expense is fully $60mm higher than it should be.
That is $0.52 per share in extra compensation beyond a normal payment schedule. FFO/share would be about 10% higher without the extremity of executive comp.
Generally speaking, higher G&A is not strictly a bad thing. Its purpose is to attract and retain talent. So to the extent that it is attracting talent, this might be acceptable.
Thus, I intend to look at it from 2 perspectives:
- Should the extra compensation in theory be attracting talent?
- Is the extra compensation in practice attracting talent?
Theory behind compensation as an incentive
These companies operate in a capitalist country and the basic tenet of capitalism is that better work leads to higher pay. By incentivizing hard work, it causes people to work harder.
Offering a higher wage job attracts a more skilled worker to fill that position.
In general, this works, but there are individual instances in which it breaks down and I think SUI is not properly compensating with regard to incentivization.
Salary hits a point of diminishing returns. If a position is offering a $40,000 salary as opposed to a $30,000 salary, it can probably attract higher education/experience applicants. I am not convinced that paying $11 million truly attracts a higher level of talent than $10 million. Thus, I don't see SUI's top heavy compensation structure as attracting better overall talent to the company.
Here is the breakdown:
Shiffman gets $11.1 million as broken down below.
The COO, McLaren got $6.7mm in 2020 and the CFO got $5.8mm (data from SNL Financial). Note that the $126mm of G&A doesn't even include the $52mm golden parachute that Shiffman has set up.
At the same time, the average SUI employee only gets $29.1K.
From the perspective of an investor, $126mm is far too much G&A and to make matters worse, the allocation of that $126mm is not optimal for attracting talent.
If a company is to spend X dollars on G&A, a more even distribution is going to attract more talent because of the diminishing returns at the high end.
Thus, from a theoretical perspective, SUI's G&A is suboptimal. How does it look in practice?
Fundamental company performance
SUI has been growing nicely, but to separate whether that is strong management or just the strong fundamentals of the sector, we should look at their growth as compared to peers.
Data from SNL Financial, chart in Excel
SUI and ELS are doing fairly well with 6-year average organic growth rates of 6.8% and 4.8%, respectively, but UMH is the stand out here with a 6-year average of 12.0%.
Manufactured housing, as compared to other REIT sectors, is a management-intensive property type. Beyond the macro considerations of which communities to buy in which regions of the country, each individual community must be managed well in order to be successful.
For something like triple net retail, a regional manager can handle a large number of properties, but in manufactured housing each community must be handled with individual attention. The manager must know which community amenities will get their particular tenants the most bang for the buck.
- Should there be a swimming pool or a tennis court?
- Should the community be workforce housing or an age-restricted retirement-focused community?
- What are the criteria for evicting?
I'm not going to sit here and pretend I know the answers to any of these, but I do know that they need to be answered and that skill with which they are addressed has huge impacts on the welfare of the tenants and ultimately the net operating income growth of the property.
Part of the reason UMH has crushed SUI and ELS in terms of growth is its value-add strategy in which it buys run-down communities for very cheap and manages them up to flourishing communities.
Another big part of it is that UMH is able to hire stronger local community level managers by actually giving them a decent wage.
Median employee-pay at UMH in 2020 was $39.5K compared to $29.1K at SUI and $23.4K at ELS.
The less top-heavy compensation structure of UMH attracts more talent while still keeping overall G&A at normal levels.
G&A is just one of many fundamentals to look at and the reason I went so deep into it here is that it is so often overlooked in analysis. The magnitude and allocation of G&A directly affect growth and shareholder returns.
The accelerating economy is creating strong demand for housing of all types and manufactured housing is one of the big beneficiaries. As a result, the manufactured housing REITs trade at a high multiple in the mid 20s and at a sector level I think the high valuation is well deserved.
The breakdown of FFO multiples can be seen below.Source: SNL Financial
Note that UMH trades about 4-5 turns cheaper than SUI and ELS.
This cheaper valuation already makes it more attractive to me, but it becomes the clear going forward winner of the sector once we factor in growth.
We already discussed its superior organic growth, but let us take a look at how that translates into FFO/share growth. Shown below are the consensus sell-side estimates as aggregated by S&P Capital IQ.
2021 FFO estimate
2022 FFO estimate
2023 FFO estimate
Total FFO growth over period
Data from SNL Financial
With 43.8% FFO/share growth projected over the next 3 years, UMH is outgrowing its peers by a mile.
This growth comes from 3 sources:
- The organic NOI growth from 3-4% annual rent bumps and significant occupancy lease up
- Refinancing of expensive preferreds with cheap capital saving about 400 basis points
- A massive land bank available for expansion allowing 400 to 1000 new rental units annually for the foreseeable future.
In Portfolio Income Solutions, we have owned UMH for a long time and continue to believe it will outperform. ELS looks fine fundamentally but has an expensive valuation and SUI is just out of consideration until it can get that compensation under control.
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