UMH - NIMBY And BANANA Opportunities In Real Estate And Energy

2023-03-31 13:51:27 ET

Summary

• Supply constraints are often overlooked.
• They drive long-term success of real estate as exiting inventory is allowed to raise rates without threat of increased supply.
• This article will discuss supply constraint opportunities.

More demand is good for a business.

Competing supply is bad for a business.

This is a universal across all sectors of the economy. Given all the moving parts with recession fears, interest rate volatility, inflation, etcetera, it is quite difficult to estimate demand. Supply, however, often has a bit more visibility, particularly in real estate where there is a paper trail of permitting/zoning and in cases where those are kept private there is a physical construction site.

So while we don't know where demand is headed we can find stocks with great supply outlook, meaning minimal supply. In some cases, low supply growth happens the fair way in which developers see that an area already has sufficient supply and choose not to build, but in other cases, real estate has unfair advantages. Some of the key advantages are:

• Land scarcity - demand is there but nowhere to build.
• Worker shortages in construction - want to build but can't
• Red tape - delays in the permitting or zoning process deter new construction

In this article I want to focus on a subsection of the Red Tape referred to as NIMBY and BANANA as I believe it is responsible for quite a few overlooked opportunities.

NIMBY stands for Not In My Back Yard. It refers to the idea that while people recognize the merits of certain property types, such as low income housing, they don't want it near them. City committees and other such local governance organizations will essentially establish blackout areas prohibiting zoning/permitting of certain types of real estate in certain locations.

BANANA is an upgraded version of NIMBY and stands for Build Absolutely Nothing Anywhere Near Anyone. It is basically when NIMBY gets to a level where rather than not being able to build in certain areas, it becomes difficult to build at all.

I think there are prevalent misconceptions about red tape with regard to its financial implications. It is commonly viewed as hurting real estate because it is real estate that is being blocked. However, the actual financial impact is significantly more nuanced.

1. It hurts developers
2. It helps incumbent real estate

Any time a development is blocked it reduces the incoming supply with which existing properties would otherwise have to compete. Thus, for owners of existing properties NIMBY and BANANA are wonderful.

There are a few real estate asset classes that have always had NIMBY characteristics with the most classic example being manufactured housing (MH). Homeowners think of manufactured housing as lowering property values so they fight hard to block it.

The result is that the MH asset class has been chronically undersupplied which allows the existing MH inventory to raise rent every year for decades as can be seen by Equity LifeStyle's ( ELS ) same store NOI growth.

The undersupply appears likely to persist and demand for low income housing is always high so I think MH will continue to perform well. ELS is a fine company but trades at a lofty valuation so most of the growth is likely priced in.

I see more opportunity in its peer, UMH Properties (UMH) as it trades at a much lower valuation and has a key advantage with regard to NIMBY.

The rust belt focused manufactured housing REIT owns a large portfolio of land, much of which is already zoned/permitted for MH. By having already gotten through the red tape, UMH is positioned to develop in areas where others can't. There is proven demand for these communities and UMH is one of few entities that can supply that demand.

In recent years, NIMBY seems to have spread to other property types.

Industrial warehouses used to be one of the least blocked property types because they are well known for creating jobs and increasing tax revenue, but there has been a wave of attempted moratoriums and development blocking . Apparently people are upset about the traffic in and out of warehouses as well as the potential air pollution.

This bodes well for areas where land for industrial development is already scarce. Unfortunately, the industrial REITs with significant exposure to these areas already trade at high multiples so I don't see clear opportunities to capitalize.

Warehouses may have trouble developing in population centers but developers have a backup capacity to build out in the boonies. Empty stretches of land along highways make great industrial locations and there is significantly less red tape there. The main challenge is being close enough to residences to source workers while being far enough away to avoid NIMBY.

The energy sector takes red tape to the next level. Dirty energy has been gated in its locations for a long time, but more surprisingly, green energy is almost equally prohibited. Despite most of the population being in favor of green energy infrastructure it seems almost nobody wants to be near it. This is full on BANANA territory.

Solar farms are thought to reduce property value of nearby homes so homeowners often fight against them .

Wind farms are considered noisy so they are usually relegated to farmers' fields and distal locations but even those far locations have challenges. The further a plant gets from the use of the electricity the more costly and wasteful transmission gets.

Offshore wind seems like one of the better solutions as it can be somewhat close to population centers but not adjacent which reduces the problems with noise and property value. Yet even this category has faced substantial blocking.

• Near Martha's Vineyard a windfarm was delayed by fishermen
• Burying cables for transmission has been blocked due to concerns over an endangered whale

Even once green energy projects are complete they can be torn down if proper zoning was not followed the whole way through which happened in Iowa .

I have no idea who is right and who is wrong in each of these instances, my purpose here is to discuss the financial implications. Just as in the other kinds of real estate, the more difficult it is to build something, the more valuable the existing properties become.

A potential opportunity here is with Dominion Energy (D). The stock has gotten rather cheap and now yields close to 5%.

Dominion has a massive $9.8B 2.6 Gigawatt offshore wind project that has made it through a large portion of the permitting process. While completion is not expected until 2026, they had a significant victory in getting approval of their offshore wind cost sharing agreement as per the 4Q22 earnings call .

"Our offshore wind cost sharing settlement agreement was approved, which allows the project to continue moving forward on schedule and on budget."

They also had good news on a few other projects including their nuclear portfolio. Again from 4Q22 call:

"In Virginia, the State Corporation Commission approved several rider-eligible investment programs, including our offshore wind project, subsequent license renewals of our four nuclear units, our second clean energy filing of new solar and energy storage projects and Phase 2 of our grid transformation program"

Dominion's current earnings comfortably cover their dividend and I think there is potential for significant dividend growth as the offshore wind project comes online. At $9.8B this project is quite substantial relative to the $45.7B market cap.

The bottom line

Real estate usually goes in cycles where it is undersupplied then as success rolls through it gets overbuilt. Supply constraints can minimize or even eliminate the downside of the cycle allowing certain types of real estate to be consistently undersupplied. Such advantaged areas enjoy superior growth and when that growth is not priced into the stocks it can be great opportunity.

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