Equity LifeStyle Properties: On My Watchlist But Not A 'Buy' Today

Summary

• ELS is a blue-chip REIT in the manufactured housing and RV park space, boasting 17 consecutive years of strong dividend growth.
• Investors have continuously shown a willingness to bid up the valuation multiples of ELS further and further into the stratosphere.
• ELS exhibits impressive growth both organically and (more recently) externally through portfolio expansion.
• Astonishingly, the REIT's share count has barely risen at all in the last decade.
• Despite being a solid business, it's hard to pull the trigger on a 35x FFO multiple.
• Looking for a helping hand in the market? Members of High Yield Landlord get exclusive ideas and guidance to navigate any climate. Learn More »

Larry Crain/iStock via Getty Images

Thesis: Missed The Boat (And The RV) On This One

Equity LifeStyle Properties (NYSE:ELS) is a real estate investment trust that owns manufactured housing / mobile home communities, recreational vehicle ("RV") parks, and marinas primarily in coastal regions of the United States. The "trailer park" reputation of many mobile home communities being run-down and poorly maintained is not true of ELS's communities, which are some of the highest quality and most amenitized (e.g. clubhouses, swimming pools, tennis courts) in the nation.

One nice element of this business model is that the tenant almost always owns the home or mobile vehicle, whether it's a manufactured home, RV, or boat. As such, the tenant is responsible for the upkeep of their property and simply rents a plot of land (or slip of water) from ELS in something akin to a short-term ground lease.

What's more, ELS has specifically chosen to focus on locations in retirement and vacation destinations, especially those near rivers or bodies of water. Over 70% of ELS's MH communities have age restrictions or an average resident age over 55. This makes ELS something of a play on both a post-pandemic return to travel and vacationing as well as affordable housing for a growing number of retirees.

ELS also enjoys one of the most prudent management teams and conservative balance sheets in the REIT sector. These elements have resulted in strong growth over the years.

From Q3 1998 to Q3 2020, ELS's same-store NOI growth has averaged 4.1% annually, compared to 2.8% for the overall REIT industry. In October 2021 quarter-to-date, MH base rent rates increased 4.2% while RV annual base rents grew 4.3% YoY.

And as my High Yield Landlord colleague R. Paul Drake points out in an article published in July 2021, ELS has also managed to grow AFFO per share at an annual rate of 7.5% over the last seven years.

On the back of this solid track record, ELS has also established itself as a consistent dividend grower. The REIT has boosted its dividend for 17 consecutive years, and these have been no mere token increases. In the last decade, the average annual dividend growth has been around 15%. In the last 7 years, according to Paul, it has come in at 16% annually.

That said, investors seem to be well aware of ELS's strong track record and have bid the stock up accordingly. Over the last decade, ELS's enterprise value to EBITDA has risen further and further, from the single-digits to over 30x.

Data by YCharts

Moreover, looking at price to operating cash flow, we find again that ELS has rarely been this richly priced anytime in the post-Great Recession period.

Data by YCharts

With a paltry dividend yield of 1.65%, even 10 more years of 15% annual dividend growth would only deliver a yield-on-cost of 6.7%.

And a price to 2021 FFO of 35x strikes me as just far too much to pay for almost any REIT. I would have to feel a high degree of confidence that the REIT has a long runway of rapid growth to pay that much. Though I like ELS's growth profile, I do not have that degree of confidence. As such, ELS is going on my watchlist as a potential "buy" in the future.

Brief Overview of ELS

The portfolio is primarily concentrated along the coasts with clusters of properties in the Midwest, Arizona, and Texas as well.

Source: ELS November Presentation

As of the end of 2020, here were ELS's top five markets by operating revenue:

1. Florida (44.3%)
2. California (12.9%)
3. Northeast (11.0%)
4. Arizona (9.5%)
5. Midwest (5.5%)

Occupancy in ELS's core MH segment sat at 95.2% in Q3 2021, roughly flat against 2020 occupancy levels. But, given that this is the most affordable housing available in many areas, occupancy tends not to drop significantly during recessions.

Source: ELS November Presentation

Tellingly, during the pandemic year of 2020, base rent in ELS's MH communities rose 4.8%, well above its long-term average annual growth of 4.1%.

The portfolio makeup consists as follows:

• 205 manufactured housing communities (47%)
• 208 RV resorts (48%)
• 23 marinas (5%)

As Paul points out in his article mentioned above, ELS has managed to grow AFFO/share at a similar pace as close peer Sun Communities (SUI) over the last seven years — 7.5% annually for ELS compared to 7.8% for SUI. But the nifty thing about ELS is that it has accomplished this while growing its total share count at a tiny fraction of SUI:

Data by YCharts

This is very unique among REITs, which typically issue lots of equity to fund portfolio expansion. Indeed, SUI's equity issuance has been to do just that: expand its property portfolio.

Data by YCharts

Much more of ELS's growth has come organically than for SUI, which means that it is less reliant on external growth for consistent AFFO/share growth.

This situation may be changing, however, as ELS has kicked its acquisition engine into high gear this year:

Source: ELS November Presentation

As you can see, acquisitions completed in 2021 are more than double the average amount from recent years. This could meaningfully boost AFFO/share growth going forward if continued into future years.

As for recent performance, there's no mistaking that ELS enjoyed a great year in 2021. Third quarter YTD revenue increased 15.5% YoY.

Meanwhile, Q3 YTD FFO per share of $1.88 increased a phenomenal 21.3% YoY. Compare that to a YTD dividend of $1.0875 and we arrive at an FFO payout ratio of 57.8% for the first three quarters of the year.

For the full year, ELS expects core income from property operations to rise 8.1% to 8.7% YoY. And the midpoint of 2021 FFO/share guidance is $2.50. Considering the annual dividend of $1.45, ELS's FFO payout ratio for 2021 should be around 58%.

Now, FFO is not the most accurate metric to measure a true free cash flow payout ratio. It would be better to use adjusted FFO or funds available for distribution ("FAD"), but ELS does not report these metrics. In any case, however, investors can rest easy, knowing that ELS's payout ratio is quite low, making its dividend safely covered by recurring cash flows.

Bottom Line

ELS is a solid business, and I would love to own it. But I can't bring myself to pay 35x FFO for it. Even using analysts' consensus estimate for 2022 FFO/share of $2.69, ELS is still pricey at a 32.6x FFO multiple. The business is good, but is it that good?

Then again, remember that investors have exhibited a willingness to pay ever higher valuation multiples for ELS over the past decade as the REIT has proven itself a blue-chip performer. How much higher can those valuation multiples go?

Candidly, I have no idea. But I don't care to be the one helping to push them up.

As such, though I consider ELS a blue-chip dividend growth REIT, it's a hold for me.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[Long_investing_horizon]

@Austin Rogers Your time to pick up some ELS is hopefully coming... I'm going to join. I share your struggle in terms of valuation here. I think one major question to answer is what you see as a dominant reason that the multiple has been going up over the last decade:
1) interest rates decline
2) supply/demand imbalance worsening

If you think it is rather the later and the trend will continue due to demographic trends, you can justify much higher multiple than 5 years ago as the alternatives are even less affordable.
If you find the interest rates argument more relevant, I think you should not pay more than between 2016-2018.

What are your thoughts?

[Austin Rogers]

@Long_investing_horizon Good points. I would think it would have to be a combination of the two - lower interest rates and less affordable housing. I've taken advantage of zero commissions and purchased a few shares under $80. I'm keeping a close eye on it.

[Long_investing_horizon]

@Austin Rogers That is what probably most investors who know it a bit will agree on - that it is the combination of the two:) I was curious which one you deem to be the prevailing one. I'm exercising patience and waiting for a better price. I would like to get 26x FFO 2022 as it is 5y average multiple = ~$70 (or 2-3$ higher as I find consensus 2022 FFO a bit too low).

[Austin Rogers]

@Long_investing_horizon Difficult to say. In the longer term, I'd say its housing affordability, but interest rates have a bigger effect on short term price swings. I think fear of rapidly rising interest rates brought on by the Fed is spurring most of the selloff right now. I like your target buy price.

[Tim Plaehn]

Look at the long term price chart and ask yourself if that is the type of stock you want to own.

[Austin Rogers]

@Tim Plaehn My answer is yes. But what is a fair value for this company? The valuation keeps going up and up and up, and has done so over the last roughly 15 years. I guess the solution is just to buy on dips? But how high can the valuation go?

[Scarlo]

I bought in a little while back and am content to hold, even at these loftier valuations.

With MHC the land owner usually pays relatively little in capex (compared to other REITs), just maintaining the common areas, roads, signage. Infrastructure is often maintained by the the municipality and tenants maintain their own structures (or lose them to the landlord, if they don't pay rent).

Because of this attribute any increases in revenue, be it from rising rents, decreasing expenses, or increasing tenancy flows heavily to the bottom line. I suggest this is an exceptional trait to have during a period of rising prices & a shortage in affordable housing.

Other favorable attributes include low supply & hard to replicate (not in my back yard!), positive demographics (many are 55+), and very high rent collections in higher quality parks (where structures are real assets; often having granite counters, stainless appliances & tenants with little debt).

ELS also focuses less on marinas & RV parks and more on higher quality MHC parks.

It's true that ELS is not cheap, but you get what you pay for. Just look at the price history to see a long, consistently increasing price & dividend.

[Austin Rogers]

@Scarlo Well said. I suppose my plan then is basically just to buy on dips.

[Scarlo]

@Austin Rogers If you have some cash getting low returns you could sell puts too, of course.

[Arimnestos]

A great business but extremely rich at this point. In addition, RV facilities are a completely different animal than MH parks. In a recession, the RV parks will perform much worse than MH parks, but will perform better in boom times. Though I would prefer that ELS stick to MH parks and the occasional marina, I would still be interested in the name in a significant pullback. I'll wait.

[Austin Rogers]

@Arimnestos That is true about RV parks generally, but even the ones ELS owns tend to favor long-term (annual) leases rather than day passes. They are more for living than vacationing, from what I can tell.

[R. Paul Drake]

@Austin Rogers I really like this article as a compliment to the one of mine that you linked and quoted. Thanks. I'm glad I went long when I did, and happy to keep holding. I also think that ELS it even now not a terrible addition to a collection of quality, REITs that will steadily grow income. As you rightly point out, if they ramp up their acquisitions on a sustained basis, this could kick the growth up to really interesting levels.
Paul

[Austin Rogers]

@R. Paul Drake I really would like to buy a position, but it's hard to figure out what exactly a fair value (or even a remotely fair value) would be for ELS since the multiple has continued to rise and rise over the last 15 years.

[R. Paul Drake]

@Austin Rogers My math says ELS is fairly valued today to produce a total return near 10%, if they continue their recent 8% rate of growth of AFFO/share and increase the dividend proportionally. But if they are really going to up their rate of acquisitions, this will mean that add external growth with equity issuance to their business model. It could push the valuation up quite a bit. But if that is the plan, they were not talking about it in the Q3 earnings call.

I guess other than buying on dips, watch for share issuance. If they ramp that up, just buy anyway at anything near the present price.

[Austin Rogers]

@R. Paul Drake Thanks. Do you think the big spike in acquisitions in 2021 could have been a one-time or opportunistic thing that won't continue into future years?