VRAI - Manufactured Housing: Recession-Resistant REITs

Summary

• Manufactured Housing REITs snapped an incredible streak of nine straight years of outperformance over the REIT Index in 2022, impacted by headwinds from higher interest rates and hurricane-related disruptions.
• Despite their REIT-leading growth rates, Manufactured Housing ("MH") REITs have historically been among the most interest rate-sensitive sectors due to their counter-cyclical demand profile and remarkable operational consistency.
• While rent growth has moderated from record-high levels across other residential property types, MH revenue growth is poised to accelerate in 2023, driven by their under-appreciated inflation-linkage and Cost-of-Living-Adjustment effects.
• Nearly half of MH residents receive monthly Social Security benefits, which are poised to rise 8.7% beginning this month - the highest COLA increase in four decades - which will give MH REITs and senior housing REITs plenty of room to push rent growth.
• Longer-term fundamentals remain compelling given the lack of supply growth and unmet need for affordable housing and we reiterate our high-conviction positive outlook on several MH REITs.

REIT Rankings: Manufactured Housing

This is an abridged version of the full report and rankings published on Hoya Capital Income Builder Marketplace on January 9th.

Manufactured Housing REITs ("MH REITs") have emerged over the past decade from relative obscurity into several of the largest and most well-run publicly-traded property owners in the world, but uncharacteristically struggled in 2022 amid a historic surge in interest rates and from hurricane-related disruptions, snapping an incredible nine-year streak of outperformance over the broader REIT index. Within the Hoya Capital Manufactured Housing Index , we track the three U.S.-listed MH REITs, which account for roughly $30B in market value: Equity LifeStyle ( ELS ), Sun Communities ( SUI ), and UMH Properties ( UMH ). We also track small-cap Flagship Communities , which trades on the Toronto Stock exchange and owns MH communities in the U.S. Midwest.

Manufactured housing REITs have historically been viewed as one of the most "recession-resistant" property sectors given the countercyclical demand trends of manufactured housing demand, which is generally the cheapest housing option available in the United States. 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 perhaps at the expense of higher risk related to major storm events, 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 20%, respectively. UMH and newly-listed FLGMF focus exclusively on traditional manufactured housing communities.

While rent growth has moderated from record-high levels across other residential property types, MH revenue growth is poised to accelerate in 2023 driven by their underappreciated inflation-linkage and "catch-up" effects. More than half of residents in ELS and SUI communities are retirees - many of whom will see a significant income bump beginning this month from the Social Security cost-of-living adjustment ((COLA)). Linked to the CPI Index, the 2023 COLA will result in an 8.7% increase in benefits to the 65 million Social Security beneficiaries - the largest increase in decades. We expect MH REITs to leverage this record-setting COLA increase to drive rent growth of between 6-7% in 2023, which should translate to a third-straight year of double-digit FFO growth - irrespective of potential broader macroeconomic weakness.

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 - despite the cool-down in recent months - will have rise by approximately 7% in 2022 per the latest Zillow ( Z ) report. As a result, we expect MH rent growth to accelerate meaningfully over the coming quarters irrespective of broader trends across other residential property types.

Manufactured Housing REIT Fundamentals

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 20%, but uncharacteristically lagged in 2022 despite a steady - and perhaps even strengthening - fundamental backdrop. The Hoya Capital Manufactured Housing Index declined 28% last year compared to the 25% decline on the broader All Equity REIT Index - snapping a nearly decade-long streak of outperformance over the broader benchmark. Notably, MH REITs are trading essentially flat with their pre-pandemic levels seen in late 2019 despite delivering cumulative FFO growth of nearly 30% and cumulative NOI growth of over 20% during this time.

As discussed in our REIT Earnings Recap , the focus over the past quarter in the MH REIT sector has been on the impact of Hurricane Ian - Florida's deadliest storm in nearly a century. Reports from Equity LifeStyle and Sun Communities noted that while the storm resulted in significant damage to a small handful of MH REIT communities, the anticipated storm-related impacts total less than 1% of annual revenues. ELS specifically cited five properties that did "suffer significant flooding and wind-related damage" which included three RV properties near Fort Myers - Gulf Air RV, Fort Myers Beach RV, and Pine Island RV - and two marinas in the area - Palm Harbour Marina and Fish Tale Marina. SUI incurred more muted impacts, noting that three RV properties in the Fort Myers area, comprising approximately 2,500 sites, "sustained significant flooding and wind damage" and one marina property suffered damage to the sea wall and docks. Both REITs noted that they believe they have adequate insurance to cover most or all storm-related charges.

Despite the storm impacts, Sun Communities reported better-than-expected third-quarter results and raised its full-year outlook driven by strength in its RV and marina division and expectations of accelerating rent growth in its core manufactured housing communities for the 2023 renewal season. SUI now expects its full-year FFO to rise 12.9% this year - up 120 basis points from last quarter - which follows a strong 2021 in which SUI grew FFO by nearly 30%. Equity LifeStyle , which was impacted more directly by Hurricane Ian, revised its FFO growth lower by 240 basis points this past quarter and withdrew its property-level guidance as well, primarily related to its expectation of recognizing insurance payments in subsequent periods. ELS now expects its FFO to rise 5.5% in 2022 following growth of 17% in 2021.

Transient RV demand has been a focus in recent quarters following a period of uncharacteristic weakness in early 2022 due primarily to the surge in fuel prices. While both ELS and SUI have been working to convert their transient RV sites into annual sites, transient and/or seasonal sites still represent roughly 12% of revenues for both companies. The stabilization in fuel prices in Q3 was enough to convince some RV-ers to hit the roads again, relieving some of the demand pressure. Fuel prices continued their decline into the fourth quarter with consumer gasoline prices turning lower on a year-over-year basis in December, which we expect to drive an upside surprise in RV metrics in Q4.

While these REITs did not yet provide FFO guidance for 2023, both ELS and SUI did provide a preliminary outlook for 2023 rent growth this past quarter. These REITs expect to send out record-high rent increases for the 2023 renewal season in the range of 6-8%, consistent with our expectation that MH REITs will leverage the record-setting cost-of-living adjustment ((COLA)), which resulted in a nearly 9% increase in benefits to a significant percentage of MH REIT residents. ELS noted that it anticipated 2023 MH rent increases to average 6.4% at the midpoint of its range while its RV rents are expected to increase by 7.8%. SUI reported that it expects its MH revenues to rise 6.3% at the midpoint while its RV rents are expected to increase 7.8%, and its Marina rents to rise by 7.5%. UMH commented that it expects to raise rents by roughly 5% in 2023 - up from the 4% increase in 2022.

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 $3 billion in assets over the last year - the largest twelve-month haul on record. The most significant deal in 2022 was Sun Communities' $1.3B purchase of Park Holidays, which is the second-largest owner and operator of holiday communities in the UK, with 40 owned and operated communities and an additional two managed communities. The acquisition is expected to be accretive to 2022 Core FFO and now represents 7% of the Company's properties.

Fundamentals of RVs & Marinas

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 - has provided a pro-cyclical counterbalance that should neutralize some of the potential headwinds from rising rates and inflation. While sales levels are expected to return to pre-pandemic levels this year, 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 also accelerated significantly during the pandemic despite ultra-lean inventory levels. The recreational boating industry - which includes MarineMax ( HZO ), Malibu Boats ( MBUU ), MasterCraft Boat ( MCFT ), and Brunswick Corporation ( BC ) - delivered very strong earnings results in 2021 despite the ongoing supply chain constraints. 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 41,275 slips across 114 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.

MH REIT Stock Price Performance

The Hoya Capital Manufactured Housing Index snapped a nearly decade-long streak of outperformance over the broader benchmark in 2022, declining by nearly 30% last year - lagging the broader All Equity REIT Index by about 200 basis points. Notably, MH REITs are trading essentially flat with their pre-pandemic levels seen in late 2019 despite delivering cumulative FFO growth of nearly 30% and cumulative NOI growth of over 20% during this time.

ELS held-up better than its peers with its 24.5% pull-back while SUI has declined by 30.3% and UMH has dipped nearly 40%. 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 11.6% - nearly triple the broader REIT average of 4.2% during that period.

The non-REIT players in the manufactured housing and RV industry were also under pressure in 2022 following a robust 2021. After leading the gains in the prior year, MH builders Skyline Champion ( SKY ) and Cavco Industries ( CVCO ) were each off by roughly 30% while RV retailer Camping World ( CWH ) slid by nearly 40% in 2022. RV manufacturers including THOR Industries ( THO ) and Winnebago Industries ( WGO ) each saw similar declines of 30-35% in 2022, as did RV and marine parts dealers Patrick Industries ( PATK ) and LCI Industries (NYSE: LCII ).

Deeper Dive: Inside Manufactured Housing

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 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.

Despite their enviable growth profile, MH REITs are more "bond-like" in their investment characteristics than most would otherwise assume, due in part to their remarkably consistent pattern in delivering 3-4% annual rent growth year-in-and-year-out. That said, we believe that MH REITs' inflation-hedging potential is underappreciated by the market as MH rents are more closely linked with the CPI Index than any other residential sector. As noted, this CPI linkage comes in two forms - indirectly through the positive wage effects of the Social Security Cost of Living adjustments which affect a significant percentage of residents - and directly through the direct CPI linkage on MH site leases that are longer than the typical one-year term.

Manufactured Housing REIT Dividend Yields

Manufactured Housing REITs pay an average dividend yield of 2.6%, ranking toward the bottom of the REIT sector and below the market-cap-weighted average of 3.8%. 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 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 four MH REITs, UMH pays the highest dividend yield in the sector at 4.86% 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 2.50%, while Sun Communities pays a dividend yield of 2.45%. 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.

Takeaways: High-Conviction Positive Outlook

Manufactured Housing REITs snapped an incredible streak of nine-straight years of outperformance over the REIT Index in 2022, impacted by headwinds from higher interest rates and hurricane-related disruptions. Despite their REIT-leading growth rates, MH REITs have historically been among the most interest rate-sensitive sectors due to their counter-cyclical demand profile and remarkable consistency in delivering steady rent growth. While rent growth has moderated from record-high levels across other residential property types, MH revenue growth is poised to accelerate in 2023 - irrespective of macroeconomic conditions - driven by their underappreciated inflation linkage and "catch-up" effects. Longer-term fundamentals remain quite compelling given the lack of supply growth and unmet need for affordable housing.

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Disclosure : Hoya Capital Real Estate advises two Exchange-Traded Funds listed on the NYSE. In addition to any long positions listed below, Hoya Capital is long all components in the Hoya Capital Housing 100 Index and in the Hoya Capital High Dividend Yield Index . Index definitions and a complete list of holdings are available on our website.

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