This is an abridged version of the full report published on Hoya Capital Income Builder Marketplace on June 27th.
Manufactured Housing REITs ("MH REITs") - one of the most "recession-resistant" REIT sectors given their countercyclical demand profile- have rebounded over the past month following uncharacteristic underperformance in early 2022. Within the Hoya Capital Manufactured Housing Index, we track the three U.S.-listed MH REITs, which account for roughly $35B in market value: Equity LifeStyle (NYSE:ELS), Sun Communities (NYSE:SUI), UMH Properties (UMH). We also track small-cap Flagship Communities (OTCPK:FLGMF), which trades on the Toronto Stock exchange.
MH demand tends to exhibit counter-cyclical demand patterns, while also having lease characteristics that provide decent – and certainly underappreciated - inflation protection. SUI and ELS have both made a push into more pro-cyclical analogous asset classes – RVs and marinas – that have offset some of these effects, but all of these sub-sectors benefit from a similar fundamental backdrop of limited supply and relatively high barriers to entry. RV parks now comprise roughly a third of assets for ELS and SUI, while marinas comprise 5% and 19%, respectively. UMH and newly-listed FLGMF focus exclusively on traditional manufactured housing communities.
Beneficiaries of the intensifying affordable housing shortage across the United States resulting from a decade of underbuilding, manufactured housing REITs have been the single-best performing REIT sector since the start of 2010 with average annual total returns of nearly 25%, but had uncharacteristically lagged in early 2022. Counterintuitively, despite these double-digit annual returns, MH REITs are among the most interest-rate-sensitive property sectors, resulting primarily from the remarkable consistency in delivering mid-single-digit rent growth regardless of the macroeconomic environment, but we believe that MH REIT rent growth will surprise to the upside given its more direct linkage with the CPI Index than other residential REIT sector.
This CPI-linkage comes in two forms - indirectly through the wage effects driven by Social Security Cost of Living Adjustments ("COLA") and directly through the explicit CPI-linkage on longer-term MH ground leases. As the most affordable housing option in most regions and with a generally older resident base, a significant share of renters is in retirement age and receiving social security income or other inflation-linked transfers. Social Security benefits received a 5.9% cost-of-living adjustment for 2022 - the highest increase in about 40 years - and could increase further in 2023 as the measure used for the COLA is currently higher by nearly 10% through the first half of 2022.
While the majority of leases are determined by market-rate adjustments on an annual basis, a direct CPI linkage affects approximately 10% of MH sites owned by ELS and SUI - primarily those in Florida and California due to state rent control statutes. The multi-decade highs on the CPI Index can effectively "unlock" embedded rent growth on below-market leases that were capped under the previous economic regime of low inflation and begin to "catch-up" with market rents which continue to rise by double-digit annual rates across the nation per the latest Zillow (Z) report. While MH renters are unlikely to see double-digit rent hikes in the foreseeable future, we do expect rent growth to meaningfully accelerate and significantly exceed analyst forecasts.
Growth in funds from operations (“FFO”) – the earnings per share “equivalent” for REITs – is driven by the combination of same-store “organic” growth and by external growth through acquisitions and new development. Manufactured housing REITs delivered incredible FFO growth of 22% in 2021, which was significantly above their earlier estimates and was the strongest year of FFO growth on record for all three of these REITs. As discussed in our REIT Earnings Recap, the outlook for 2022 - which was already meaningfully raised in Q1 by ELS and SUI - now calls for average FFO growth of nearly 10%, but we expect that accelerating rent growth resulting from the CPI effects will drive another year of at least 12-15% FFO growth.
Earlier this year, Harvard University’s JCHS published its annual "State of the Nation's Housing." Researchers noted that "the supply of existing homes for sale has never been tighter," as soaring home prices and rents have been fueled by "the combination of robust demand and limited supply." JCHS concluded that "the pandemic is partially to blame for such tight conditions, but the biggest reason behind the constraints on supply is the underproduction of new homes since the mid-2000s." The report noted that "supply constraints are nearly universal," but particularly in the affordable housing segments. A separate report by the NAR estimated that the underproduction of new housing units relative to household formation totals 6.8 million units.
MH REITs have been the "canary in the coal mine" of the intensifying housing shortage for the past decade, continuing to produce sector-leading NOI and FFO growth and, as a result, have outperformed the Equity REIT Index in each of the past nine years - the longest streak of consecutive outperformance ever within the REIT sector. Driven by strong performance in their RV segment and occupancy increase in their core manufactured housing parks, the three major MH REITs – ELS, SUI, and UMH - delivered same-store NOI growth of 10% for full-year 2021 and these REITs are expecting NOI growth of roughly 7% at 2022 at the midpoint of their updated financial outlook.
As noted, MH REITs have historically been one of the most interest-rate-sensitive REIT sectors - a function of their historically counter-cyclical fundamentals and the remarkable consistency in delivering mid-single-digit rent growth regardless of the macroeconomic environment. The diversification into RV parks and boat marinas - which have a more economically sensitive demand and cash flow profile - have provided a pro-cyclical counterbalance that should neutralize some of the potential headwinds from rising rates and inflation. The RV Industry Association reported that RV sales set record-highs in 2021 despite facing similar supply chain issues as traditional homebuilders, demand that helped power a 6% rise in "same-community" RV rents in 2021.
Recreational boat sales have also accelerated significantly during the pandemic despite ultra-lean inventory levels. The recreational boating industry includes several public companies including MarineMax (HZO), Malibu Boats (MBUU), MasterCraft Boat (MCFT), and Brunswick Corporation (BC). With SUI's major investment in Safe Harbor Marinas, these MH REITs are now the two largest owners of marinas in the country. Institutional-quality marinas - of which there are roughly 500 across the U.S. - offer substantial operating parallels to the company's RV business. ELS now owns 23 marinas comprising 6,800 slips while SUI owns nearly 50,000 slips across 128 marinas.
Sales of new manufactured housing units have also exhibited a strong acceleration over the last year, eclipsing 100k units in a twelve-month period for the first time in 14 years, driven largely by site expansions of existing MH REIT parks. MH sales peaked in the late 1990s when zoning and credit standards were loose but declined sharply beginning in the early 2000s during the pre-GFC housing boom as demand shifted to site-built homes. MH units are typically the most affordable non-subsidized housing option in most markets and 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.
Utilizing a strong cost of equity capital, these REITs have continued to grow externally by adding units to existing sites and by growing via acquisitions and site expansions. MH REITs acquired nearly $2 billion in assets over the last year. On its earnings call last quarter, SUI CEO Gary Shiffman did note that while the acquisition pipeline remains robust, that it's "currently seeing continued cap rate compression in MH and RV. Certainly, everything is trading in the low-4s and much of it is trading sub-4 and the 3s. That pressure and the shortage of assets has continued with cap rate compression."
Pressured by rising interest rates and the growth-to-value rotation within the REIT sector, MH REITs had uncharacteristically underperformed for much of 2022, but have been among the best-performing REIT sectors over the past month amid a rotation back into "essential" and defensive property sectors. The Hoya Capital Manufactured Housing REIT Index is lower by 20.4% this year, slightly lagging the 19.7% decline from the Vanguard Real Estate ETF (VNQ) and the 17.9% decline from the S&P 500 (SPY).
MH REITs edged out the Equity REIT Index in 2021 with total returns of 42% to push their incredible streak of nine straight years of outperformance. ELS has held up better than its peers this year with its 16% pull-back while SUI has declined by 22% and UMH has dipped more than 30%. Still a relative unknown to many generalist investors, SUI - our largest position - is by many measures the GOAT ("Greatest of All Time") of the REIT sector, delivering the strongest total returns of any REIT since 2005 while its peer ELS is not far behind. Over the past five years, MH REITs have delivered average annual returns of 13.2% - nearly triple the broader REIT average during that period.
The non-REIT players in the manufactured housing and RV industry have also been under pressure this year following a robust 2021. After leading the gains last year, MH builders Skyline Champion (SKY) and Cavco Industries (CVCO) are each off by roughly 40% while RV retailer Camping World (CWH) is also lower by more than 40%. RV manufacturers including Thor Industries (THO) and Winnebago Industries (WGO) have seen similar declines of 30-35% so far in 2022, as have RV and marine parts dealers Patrick Industries (PATK) and LCI Industries (NYSE:LCII).
Roughly one-in-twelve Americans live in a factory-built manufactured home, and shipments of these units represent roughly 10% of housing starts in a typical year. MH REITs comprise 2% of the "Core" REIT ETFs and also represent 4% of the Hoya Capital US Housing Index, the benchmark that tracks the performance of the US housing industry. These REITs generally own communities in the higher tiers of the quality spectrum and are more "retiree-oriented" than the average MH community.
The quality and appearance of MH parks can vary significantly from communities that are nearly indistinguishable from a typical single-family master-planned community to the stereotypical "trailer parks." Often misunderstood by investors, manufactured homes are generally not "mobile" (except for recreational vehicles "RVs") as about 80% of MH units remain where they were initially installed, and while units are generally built to higher-quality standards than commonly believed, the JCHS report noted the MH homes were among those most "in need of repair."
For residents, the economics of MH 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.
Manufactured Housing REITs pay an average dividend yield of 2.3%, ranking towards the bottom of the REIT sector and below the market-cap-weighted average of 2.9%. MH REITs, however, have delivered one of the strongest rates of dividend growth over the last five years. ELS and SUI are two of only a dozen REITs that raised their dividends in 2020, 2021, and again in 2022. MH REITs pay out just 55% of their available cash flow, implying strong potential for future dividend growth and more free cash flow to fund external growth.
Among the three larger MH REITs, UMH pays the highest dividend yield in the sector at 4.58% but went nearly two decades with zero dividend growth before finally raising its distribution for the first time since 2008 last year. Equity LifeStyle pays a dividend yield of 2.26%, while Sun Communities pays a dividend yield of 2.15%. ELS has delivered average annual dividend growth of 8.3% over the last five years, among the best in the REIT sector, while SUI has taken a more growth-oriented approach with a lower payout ratio and a dividend yield of 2.15%.
MH REITs have remarkably delivered nine consecutive years of outperformance compared to the broader REIT Index, benefiting from strong operational execution, significant supply constraints, demographic tailwinds, and high barriers to entry. While MH REITs have historically been among the most rate-sensitive sectors due to their remarkable consistency in delivering steady 3-4% rent growth, we believe their inflation-hedging potential is underappreciated. We expect rent growth to surprise to the upside and anticipate that these "recession-resistant" REITs will ultimately extend their streak to a tenth-straight year of outperformance.
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Disclosure: I/we have a beneficial long position in the shares of RIET, HOMZ, SUI, ELS, UMH either through stock ownership, options, or other derivatives. 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.
Additional disclosure: Hoya Capital Real Estate ("Hoya Capital") is a research-focused Registered Investment Advisor headquartered in Rowayton, Connecticut. Founded with a mission to make real estate more accessible to all investors, Hoya Capital specializes in managing institutional and individual portfolios of publicly traded real estate securities, focused on delivering sustainable income, diversification, and attractive total returns.
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