2023-04-16 09:17:37 ET
Summary
- It's time for me to diversify my real estate exposure, as I own only two stocks - operating in the same segment.
- I'm looking for a mix of growth and value, which is provided by Equity LifeStyle Properties, a residential REIT with secular benefits and a stellar business model.
- While macroeconomic headwinds persist (providing buying opportunities), I expect ELS stock to deliver strong long-term dividend growth and outperforming total returns with subdued volatility.
Introduction
In a number of articles, I've said that I wanted to increase my real estate exposure. I have 9.2% real estate exposure while I am writing this. This consists of Extra Space Storage ( EXR ) and Public Storage ( PSA ). In other words 100% self-storage. One of the stocks I had on my radar for many years is Equity LifeStyle Properties ( ELS ) . This residential real estate company is focused on manufactured housing communities, recreational vehicle communities, and marinas. The company is perfect for my dividend growth portfolio, thanks to secular tailwinds, inflation protection, a healthy balance sheet, and a fantastic track record of dividend growth and outperforming capital gains, which I expect to continue.
In light of current economic developments, I will walk you through my thoughts and explain why I am now preparing to add ELS shares to my portfolio.
So, let's get to it!
I Want Growth And Value
In general, investors tend to buy REITs for one major reason: yield. While I do not disagree with that, I prefer REITs that come with decent total returns. I want a combination of growth and value.
For example, over the past ten years, the Vanguard Real Estate ETF ( VNQ ) has underperformed the S&P 500 by a wide margin, returning just 64%, including dividends.
Again, there is nothing wrong with buying stocks that underperform. For example, if investors retire, they might want to prioritize stocks with high dividends, as it allows them to cover costs - and to retire in the first place. In that situation, it doesn't matter too much if these investors don't outperform the S&P 500.
However, as I prioritize the mix between growth and value, I look for real estate niches that serve my needs. So far, that place has been self-storage.
Now, I want to diversify.
Why I Like The Equity LifeStyle Business Model
Founded in 1969, ELS has become one of the largest residential real estate firms in the United States. With a market cap of $12.5 billion, the company is the 8th-largest residential REIT.
However, ELS is different. It doesn't own traditional homes.
The company owns land that is leased to customers who own manufactured homes, cottages, RVs, and/or boats on a long-term or short-term basis. They offer individual developed areas or right-to-use contracts, known as membership subscriptions, which provide limited stays at specific properties.
Compared to other real estate companies, ELS' business model has low maintenance costs and low customer turnover costs. They have a geographically diversified portfolio of over 110 properties with lake, river, or ocean frontage, as well as more than 120 properties within 10 miles of the coastal United States.
As of December 31, 2022, the company owns 449 properties in 35 states and one Canadian Province. These properties cover more than 171 thousand sites and are maintained and managed by roughly 4,200 employees. Through 2025, the company plans to add roughly 1,000 sites per year.
Generally speaking, manufactured housing attracts aged 55 and older. This group is expected to grow by 17% between 2022 and 2037. Roughly 10,000 Baby Boomers will turn 65 every day through 2030.
More than 70% of ELS MH properties are age-restricted, which helps when it comes to capturing growth in this demographic.
Moreover, there's a huge cost benefit. According to ELS, which uses US Census Bureau data, the host of a typical manufactured home is $124 thousand. This is 76% below the average price of a single-family home. While upfront costs are 18% higher, the monthly costs are 71% lower.
According to the Manufactured Housing Institute , a quarter of MH residents had a household income of less than $20,000. When adding household incomes under $40,000, we end up with roughly 2/3rd of residents. 75% of residents have an age of at least 39.
Since the pandemic, the difference in costs has changed in favor of manufactured homes.
Needless to say, a direct comparison isn't extremely fair. After all, there are differences between MH and SFH options.
However, MH communities aren't trailer parks anymore. Over the past few decades, the quality of MH has increased significantly and improved the cost of living tremendously.
According to the Manufactured Housing Institute, MH homes come with significant benefits besides lower costs:
- Floor plans are available that range from basic to elaborate – vaulted or tray ceilings, fully-equipped kitchens, walk-in closets and luxurious bathrooms.
- A variety of exterior siding is available – metallic, vinyl, wood or hardboard and stucco.
- Our industry has also launched a new class of homes known as CrossMod™ that are indistinguishable from site-built homes, with pitched roofs with shingles and gabled ends, porches, garages, permanent foundations, and more.
Benefits also include safety (housing quality), including strict government guidelines.
Moreover, ELS' MH communities offer a wide variety of amenities, which improves the quality of life.
The photos below are from the Manufactured Housing Institute.
It also helps that supply has been subdued for many years. The development of MH in the United States has never recovered from the Great Financial Crisis, thanks to factors like zoning and regulation and related planning issues.
Furthermore, 89% of ELS' revenue comes from stable income. It has 95.1% core MH occupancy and roughly 96% homeowners in its mix. In other words, the share of renters is lower, which increases the predictability of income. After all, homeowners are far less likely to leave. It also helps that 78% of its residents have FICO scores of more than 680.
Moreover, I believe that targeting retirees or people close to retirement brings additional benefits when it comes to income security.
The company is also rapidly growing its Thousand Trails business, which covers its RV assets. Since 2016, the company has expanded its member count by 23% to almost 130,000 people. 27% of its members have been members for at least 20 years.
Shareholders Benefit From ELS' Business
Between 2013 and 2022, ELS has grown its revenue by 4.9% per year. Expenses have grown by 4.7%, resulting in 5.1% annual net operating income growth. This was caused by a rapid spike in income during the pandemic. However, even 2022 was very strong. Even during the Great Financial Crisis, the company maintained positive NOI growth.
Going back to 1998, the company has grown its NOI by 4.3% per year, beating the REIT industry by 120 basis points per year. The apartment average was 3.0%.
This has translated to a fantastic stock price performance.
- Going back to 2004, ELS shares have returned 14.0% per year. This beat the S&P 500 and the Vanguard Real Estate ETF by a wide margin.
- Shares have outperformed the market with subdued volatility. The standard deviation of ELS is lower than Vanguard Real Estate ETF's standard deviation. This is a fantastic result, thanks to a max drawdown of just 39% during the Great Financial Crisis. Hence, ELS has a great risk-adjusted return compared to the market and its peers.
With regard to dividends, since 2006, the company has grown its normalized funds from operations by 9% per year. Its dividend has grown by 21% per year during this period.
- Over the past ten years, the average annual compounding dividend growth was 14.0%
- Over the past five years, that number was 10.8%.
- The three-year annual average is 10.4%.
On February 8, 2023, the company hiked its dividend by 9.1% to $0.4475 per share per quarter. This translates to a yield of 2.8%.
2.8% is not a high yield, but it is backed by a 62% payout ratio and fast growth with secular benefits. That's a very fair tradeoff, in my opinion.
Valuation & Balance Sheet
ELS shares are down 24% from their 52-week high. Shares are down roughly 28% from their all-time high. Year-to-date, shares are down 1%.
Real estate stocks have a hard time in this market as inflation is pressuring the ability to raise rates and deal with financing. After all, REITs do well when inflation is low, as it improves pricing. Also, acquiring growth is much easier when rates are low.
Moreover, average rents are now declining in the United States.
According to Redfin :
Rents surged during the past two years because incomes increased and household formation rose as more millennials started families. But household formation is now slowing , partly because many people are opting to stay put rather than move during a time of economic uncertainty.
This is an industry average, which mainly covers single-family homes. While this trend isn't great for the industry, I'm not worried, as ELS should be in a better spot thanks to demographic and geographic benefits.
That said, ELS has a fantastic balance sheet. The company has a total debt-EBITDA ratio of just 5.3x. It has ten years to maturity (on average) and a weighted average interest rate of just 3.7%. Only 12% of its debt is due within three years.
These benefits also explain why the stock has a low-volatility profile. Well, that and its anti-cyclical business model.
On a full-year basis, the company expects to generate normalized FFO per share of $2.79 to $2.89. In its core portfolio, the company expects at least 6.0% base rent growth in the MH segment. Operating expenses are expected to outperform rent growth by at least 100 basis points. However, income from property operations is still expected to grow between 5.0% and 6.0%.
Note that the company reports earnings on April 17. After the earnings call, I will likely cover new developments in a real estate-focused article.
Using the lower bound of FFO guidance, the stock is trading at a 22.8x multiple. Using the midpoint, that valuation multiple comes in at 22.4x FFO.
This valuation is the most attractive it has been in almost ten years.
The median sector valuation is at 12.4x FFO. I believe that the premium is justified.
In January, I wrote that I would be a buyer at $60. I stick to that and will likely become a buyer at some point in the next few months - unless other opportunities require a big part of my cash.
Takeaway
It's time to diversify my real estate exposure. While I have multiple attractive names on my watchlist, I really like the company behind the ELS ticker. Equity LifeStyle Properties has a huge footprint in MH communities and a business model that provides investors with safety, growing income through dividends, and the potential to benefit from outperforming capital gains.
In the past few years, I have always watched the stock go up without having any exposure. Now, that might change. Thanks to macroeconomic headwinds, ELS shares have lost more than a quarter of their value, pushing the valuation almost to a decade low.
While it's hard to tell how far ELS can fall, I'm highly interested in starting a position in the next few weeks or months.
For further details see:
Building Wealth: Why Equity LifeStyle Properties Is The Perfect REIT For Me