This article was co-produced with Williams Equity Research (“WER”).
I’m now writing a new book, The Intelligent REIT Investor, in which I’m utilizing content from a book written by the legendary Ralph Block called Investing In REITs. Mr. Block passed away in 2016 and he was not only a friend, but also a mentor, and I’m thrilled to be utilizing content he wrote in my new book.
“Over 50 years ago, an enterprising landowner brought a number of trailers, together with their owners, to a remote parcel of land, semi-affixed them to foundations, and called the project a ‘mobile home park.’
Many of today’s modern ‘manufactured home’ communities, however, bear little resemblance to yesterday’s mobile home parks. The homes, manufactured off-site, are rarely removed from the communities, and generally have the quality and appearance of site-built homes.
The homeowners enjoy amenities such as an attractive main entrance, clubhouse, pool, tennis courts, putting greens, exercise rooms, and laundry facilities.”
Since Block published his last book (the Fourth Edition) in 2011, the manufactured housing sector has grown to over $27.7 billion (market cap) in size, but still is peanuts compared with the dominant property sectors (more on the below). Also, “Manufactured housing” and “mobile home parks” tend to generate an emotional response, or at the very least, a strong bias.
Some look like the image above.
Others are less picturesque.
No matter one’s opinion or experience with manufactured home parks, they have a brand problem. As investors, a good or bad image isn’t key. What matters is value.
While working through this objective analysis of the pros and cons of investing in manufactured home parks, our suggestion is to keep an open mind.
This approach starts from a different perspective: the precursors of self-storage’s recent and dramatic success. This was another previously unloved and underappreciated segment of commercial real estate.
(Incidentally, W.P. Carey (WPC) also owns self-storage, net-leased of course).
Many of the drivers of self-storage’s incredible growth over the past 15 years apply directly to manufactured housing parks. In some ways, this segment has more powerful tailwinds than self-storage did before its ascent.
Source: Inland Investments
Did you know that manufactured housing parks were the top-performing real estate sector in 2019?
The segment’s return more than doubled that of apartments and quintupled student housing. There are more surprises on the way.
1. Lack of Institutional Investors
The first modern self-storage complex is said to have been built in Corpus Christi, Texas, in the 1960s. Just 15 years ago, institutional ownership in the self-storage was well under 10%. Based on industry data from 2019, 25% are now owned by institutions with 18% of that associated with publicly traded companies.
We can interchange institutional with professionally managed. The conversion from “mom & pop” to institutionally managed is agreed upon as one of if not the major driver of self-storage’s strong performance over the last economic cycle. There are six publicly traded self-storage REITs, and in aggregate, they generated $3.25 billion in funds from operations (“FFO”) in 2019 and managed to achieve a positive 0.50% increase in same-store net operating income (“SS NOI”) in Q1 of 2020.
Shifting gears, there are only three publicly-traded REITs focused on manufactured housing, and none are particularly large. These companies own only 2.5% of total manufactured housing community supply – that’s an order of magnitude lower than self-storage. Their cash flow generation is proportional though the sector has seen better SS NOI in 2020 growth (1.5-3%) than their resilient self-storage peers.
No other commercial real estate sector or sub-sector has fewer publicly traded REITs than manufactured homes. As of July 31, 2020, the market capitalization of these REITs is also among the smallest at $27.7 billion. For context, the categories of Industrial, Office, Self-Storage, and Retail are $135.7 billion, $78.8 billion, $60.7 billion, and $101.2 billion, respectively.
The manufactured home park sector consists of 45,000 to 49,000 individual properties. The total number of parks owned by the three publicly-traded REITs is approximately 1,100 based on data from Q1 2020 and historical growth rates.
It’s important to understand why the transition to institutional management matters. Just like what occurred in hotel and office properties many decades ago, and self-storage more recently, better capitalized and more sophisticated institutional investors generate a significant one-time gain when taking over a property from a “mom & pop” operation.
Financing costs drop, tenant management improves, scale grows, and rents are calculated based on potentially millions of real-time inputs instead of Mr. and Mrs. Jones’ best guess. Modern self-storage property rents are adjusted throughout the day using artificial intelligence.
Given what we know about capitalization rates, an institution’s ability to increase the property-level annual yield by 2-3% (e.g. 4% annual yield to 6-7%) equates to a potential 50% increase in value in today’s low interest rate environment.
2. Ideal Tenants
That header will cause many to do a double (wide) take. While many parks take advantage of RV customers as a side business, we are talking about manufactured home parks that resemble normal neighborhoods. This business is like charging rent on the tenant’s apartment or home. Let that sink in. The park owner charges each tenant $280 to $450 per lot. As a quick trip around any established mobile home park will confirm, the average tenant stays for approximately 14 years.
The National Association of Realtors states that the average length of time Americans stay in their traditional homes is about 13 years, up from 10 years in 2008. Owners of manufactured homes, surprisingly enough, stay in their homes longer than traditional homes.
This is also a measure of how long an individual or family stays in their manufactured home on the same property. Research by Tony Guerra indicates it costs $2,000 to $5,000 to relocate a manufactured home based on the size and distance involved. That’s just the physical move, however, and the total cost for relocation is upwards of $10,000. Given rent is a few hundred bucks a month, it takes serious motivation to cough up nearly five grand to make a move because of a modest rent increase.
Demographics is a trend we discuss often; it is the silent driving force behind many elements of the global economy. Per the Manufactured Housing Institute, 40% of the approximately 22,000,000 people living this dwelling type are age 50 or higher.
The rate rises for areas popular with retirees such as Arizona and Florida. Because rents are so low, tenants can generally cover 100% of their fixed expenses on a fixed income. The average social security benefit was $1,503 per month in January of 2020. This permits those living on a modest income to save for annual vacations, visit children, et cetera.
The other benefit of fixed income tenants and the modest rent liability is manufactured home parks’ cash flow’s very low correlation with the overall economy. In fact, data suggests that demand for this type of housing increases during recessions as people try to downsize or lose a permanent stream of income.
3. Extremely Low Capital & Maintenance Requirements
In general, owners of mobile home parks do not own the housing, but instead rent out land to the owners. These tenants often pay cash or 50%+ down for their $40,000-$55,000 building (assuming single-wide). Owners of the parks provide minimal infrastructure, and given they don’t own the buildings, near-zero maintenance is necessary compared to other types of commercial real estate. These are the same attributes that made self-storage so popular to individual investors long ago.
(Source: iREIT/Williams Equity Research)
While self-storage scores well at 4.7% of annual revenue needed for CapEx, manufactured housing does even better at 3.5%. Now that we have a better understanding of how these properties work, that shouldn’t be too much of a surprise.
4. Structural Supply & Demand Imbalance
This variable one is perhaps the easiest to understand. Despite growing demand, there were only 10 new manufactured housing parks established in the U.S. in all of 2019. The reason? “NIMBY.”
Adjacent neighborhoods in the suburbs aggressively fight new developments. The only thing governments despise more than the optics of manufactured housing are the lack of taxes. This has reached such extreme levels that there are multiple organizations fighting “discriminatory zoning mandates” against manufactured housing development.
Despite rents and traditional home prices skyrocketing around the U.S. in the midst of above-average unemployment, it doesn’t look like any progress will be made on this in the near term.
The impact on the nation and U.S. citizenry is arguable, but it’s certainly a benefit for existing manufactured housing park owners. As difficult as it is to build new apartment buildings in places like New York, directly contributing to above-average rent costs, it pales in comparison to the challenges involved in getting a new manufactured housing project approved. Professional managers and REITs can go around the nation purchasing properties with little to no fear of greater competition, regardless of the economics involved.
The 55 and older population in the U.S. is expected to grow by 18% from 2020 to 2035. The average manufactured housing new resident is 59 with RVs only slightly lower at 55. Demographics seeking affordable housing away from urban areas is expected to grow considerably over the next 15 years. If the current climate in large U.S. cities is any indication, we’d expect this to accelerate rather than decline.
5. A Partial Solution To A Big Problem
Affordable housing is almost a cliche saying today, but many major cities, due to increased regulations, worsening traffic, and rising building costs, are in a serious battle with housing costs. It’s not just the U.S. either. The natural solution to greater demand – greater supply – is often constrained. The average cost to build a manufactured home is $49 per square foot compared to $107 per square foot for traditional homes. That’s a clear advantage but not the whole story.
Manufactured homes are generally not built to last as long as a well-made traditional home. For this reason and others, their resale value is indeed poor. What most homeowners fail to realize, however, is this isn’t an apples-to-apples comparison with traditional homes. Homes generally don’t appreciate significantly, the land underneath them does.
As any long-term homeowner knows, even the best constructed traditional home costs a fortune to maintain over 15 to 25 years. Manufactured homes have no land attached to them and therefore don’t benefit from urban land’s tendency to rise in value in line with inflation.
This is a negative and a positive.
As mentioned earlier, no land means no property taxes (I cannot guarantee that for California or other states that tax their citizens per liter of air breathed). The manufactured homeowner passes those costs on, but their tax efficiency is much higher than an individual’s. In addition, homes in suburbia are typically taxed much higher than the equivalent plot of land in a mobile home park.
This all translates into much more cost-efficient housing compared to traditional homes and nearly 100% of comparable multi-family units. Manufactured home parks are designed for those living off around $30,000 per year.
Assuming a $35,000 mortgage (most manufactured homes are purchased with 50%+ down), 20-year term, and 5.0% interest rate to reflect the bank assuming higher risk, the monthly mortgage payment comes to $192. Add in the average manufactured home park’s rent of $280, and the total cost is $472 per month. The average single-wide manufactured home is 12-16 feet across and 60 feet in length or 840 square feet. That’s not giant but is less than a third of the average apartment in Austin, TX, or other states.
Crime rates and general standards of living are also far superior in a medium-quality manufactured home park compared to urban areas with similar levels of income.
There are Risks
Warren Buffett’s Berkshire Hathaway has owned Clayton Homes, the largest manufactured homebuilder in the U.S., for many years. Not only that, but Berkshire also owns the two largest manufactured home lenders, Vanderbilt Mortgage and 21st Mortgage and Finance.
By investing in the construction and financing of manufactured homes, Berkshire’s commitment to the sector is undisputed. Here is the fun part if you didn’t already see it coming:
“April 18, 2019. Forbes: Warren Buffett’s Exploitative Mobile Home Investment
April 3, 2015. Seattle Times: The Mobile Home Trap: How A Warren Buffett Empire Preys On The Poor“
The Oracle of Omaha is far from the only investor receiving criticism.
John Oliver, a late night TV show host, dedicated a segment to bashing Blackstone’s (BX) investment activity involving manufactured home parks. WER’s portfolio manager has worked with Blackstone extensively, but has never received compensation from the firm directly or indirectly.
In his opinion, Mr. Oliver lacked even a fundamental understanding of the situation based on watching the video, but his emotional appeal was nonetheless effective and garnered considerable media attention.
Especially in this hyper-sensitive environment, headline risk matters. In the past, and regardless of which party was in office, a half-way reasonable process would take place before making structural changes to an industry or policy regime.
In today’s world, outrage on social media often flows directly into congressman’s speeches later that day. If manufactured housing parks became a hot topic, the risk of rent controls for those on government payments, mandatory property enhancements, sector-specific taxes, and other regulatory risks are very real. This is incorporated into our risk-adjusted return expectations.
This is mitigated by manufactured homes providing a true low-cost housing alternative (factually speaking) and mostly residing in red states in the southwest and southeast, such as Texas, Florida, South Carolina, and Louisiana. That doesn’t eliminate federal regulatory risk, however, from the likes of the U.S. Department of Housing and Urban Development.
The two highest-quality REITs in this segment are Equity Lifestyle Properties, Inc. (ELS) and Sun Communities (SUI). This isn’t designed to be a comprehensive review of the companies, but we’ll provide enough to familiarize readers.
As of June 30th 2020, Equity LifeStyle owns 413 properties containing 157,713 sites across 33 U.S. states and British Columbia in Canada.
Source: Equity LifeStyle
Of those properties, 90 (21.8%) are adjacent to a lake, river, or ocean and 120 (29.1%) are within 10 miles of a coast. Equity LifeStyle Properties has been around for over 50 years. The REIT has 204 manufactured housing communities, 198 RV resorts, and 11 marinas. In aggregate, 90% of revenue is derived from stable, annual leases.
From a portfolio and cash flow perspective, Equity LifeStyle ended July 31st with 95.2% occupancy. Core Community base income, defined as properties owned and operated since January 1, 2019, grew 4.4% in July. Resort base income growth was more modest at 1.0%, but remained positive. More importantly, normalized FFO growth is 9% annualized since 2006.
Due to extremely conservative initial payout ratios, the dividend has increased by an incredible 24% annualized over the same period. That’s slowed to 14% in the past year, but so has the REIT average at only 3.3%. That certainly casts a different light on the REIT’s modest current yield of 2.02%.
In terms of the balance sheet, ELS ended July with an enterprise value of $15.7 billion and debt to enterprise value of only 16.1%; it’s one of the lower levered REITs we follow. Total debt over Adjusted EBITDAre was 5.0x, another metric in line with stronger investment-grade REITs.
Perhaps most impressively, only 14% of debt matures in the next seven years. Not far behind is Equity LifeStyle’s average term to maturity of nearly 14 years; that’s twice REIT averages. Things change quickly so the most recent transaction data carries a lot of weight. ELS just closed $387 million in secured financing at a weighted average interest rate of a mere 2.55%.
Notably, the REIT does not carry a rating by a major credit agency. This is likely because most of its debt is secured against property rather than unsecured against the parent company. This should be kept in mind when evaluating its balance sheet in general.
Equity LifeStyle trades at an eye-watering 32x 2020 FFO. The 22x forward FFO multiple at March lows was attractive but didn’t last long. Investors highly confident in ELS’s ability to increase rents at 4-5% for many years to come can justify paying up to $62 per share, or just under a 30x FFO multiple.
Source: Sun Communities
Sun Communities is the other higher-quality manufactured housing park REIT. Sun is very similarly sized to ELS with 426 communities across 143,000 sites. Like ELS, it even has a little exposure to Canada with properties in Ontario. Demand remains strong with a 17% increase in rental home applications in Q2 compared to the same period in 2019. Occupancy is almost identical to ELS at 96.5%.
Source: Sun Communities
Sun manages to beat the industry average with tenants staying at its properties for 15 years. Since 1998, Sun has generated same community net operating income growth 190 basis points greater than the apartment sector’s average.
Source: Sun Communities
The performance during downturns is where Sun truly “shines.” Even though apartment REITs have an excellent track record in times of crisis compared to the broader REIT market, Sun’s track record is in a different league with no real periods of NOI decreases going back to the late 1990s.
Source: Sun Communities
Sun’s acquisition activity has been profitable but sustainable. This has enabled it to decrease its net debt over EBITDA from 7.5x in 2016, an elevated level, to 4.8x as of the end of Q2, a metric in line with higher-quality investment-grade REITs. The firm has zero maturities this year and next and only $82.2 million in 2022.
Source: Sun Communities
The rubber meets the road here. Sun’s three-, five-, and ten-year total return has completely outclassed not only the MSCI US REIT index but also the S&P 500. At the same time, much of that has been derived from multiple expansion, a variable that cannot grow indefinitely (outside of technology stocks, but that’s another story).
Unfortunately, SUI trades at almost the same FFO multiple as ELS at 30x forward estimates; the stock’s yield is also approximately 2.0%. $140 a share is the highest we can justify for those bullish on SUI’s fundamentals compared to the stock’s 52-week low and high of $96.34 and $173.96, respectively.
(Note: We included another nano-cap pick in the marketplace article that we have recommended as a Super Speculative Buy).
Conclusion & Special Note
We covered a lot, but I’ll leave you with one more interesting data point and recommendation before we finish. This relates to a mundane but critical element of REIT accounting and cash flows.
Manufactured home park depreciation schedules typically average 15 years compared to apartments of 27.5 years and commercial properties (e.g. office and industrial) of 39 years. What difference does that make?
The higher depreciation rate equates to higher after-tax cash flows to investors based on an identical income generation.
We aren’t the only ones to notice the attractiveness of manufactured housing parks.
Per Green Street Advisors, manufactured housing REITs have the highest premium to gross asset value of any real estate segment they cover (which is all of them). This is a double-edged sword and not all bad news.
Existing REITs in this sector, Equity LifeStyle Properties, Inc, Sun Communities, Inc., and UMH Properties (UMH), buy essentially all their properties from individuals or families at around net asset value. (Again, we provide a nano-cap pick in the marketplace article).
Once in the REIT, however, they are immediately valued at a ~20% premium. This creates immense value for shareholders. On the other hand, shares trade hands at 21-31x FFO multiples (UMH is the cheapest; ELS the most expensive), and the best-run REITs generate yields 50-100 basis points lower than quality apartment REITs.
We hope this analysis on the manufactured housing sector and several of its constituents has been educational and useful. As Ralph Block explained:
“…this property type will appeal to investors who appreciate stable cash flows, predictable rent increases, and very modest capital expense requirements; three REITs-Equity Lifestyle Properties, Sun Communities, and UMH Properties-serve this niche.”
Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
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Disclosure: I am/we are long MHPC. 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.
Originally published on Seeking Alpha