Description

I would like to recommend a long in UMH Properties, Inc. (ticker: UMH).  UMH is a REIT focusing on manufactured home communities, having been in business since the late 60s and public since the 80s.  UMH owns 68 communities in 7 states with 12,800 developed sites.  For those VIC members who might not be familiar with the realities of affordable housing, the core business in the rental of home sites; the building itself is usually owned by the occupier.  While technically the building can be moved, in practice this is cost-prohibitive.  The company also owns some undeveloped acreage for expansion near its existing sites, an inventory of manufactured homes, a portfolio of mortgage loans (in its communities), and a portfolio of REIT securities.

Although UMH’s current dividend yield is eye-catching at about 7.5%, I think that the attraction for the investment is more subtle.  In the past couple of years, management has decided to significantly expand their operations, using a combination of debt, preferred stock, and common stock (as a REIT, most internally-generated capital must be paid out as dividends).  The result has been that home sites have grown from 6,800 in 2009 to 12,800 currently, with definitive agreements to acquire another 1,620 (in 14 communities) in late 2013/early 2014.

I think management’s buying spree will end well.  I estimate that recent purchases have been well below replacement cost (perhaps in some cases as low as 50% of replacement cost).  Moreover, these kinds of communities can be more difficult to replicate than it might first appear, with a “not in my back yard” dynamic preventing easy creation of new communities.

Moreover, I believe that housing will turn around, and that there will be demand for the lower end of the market which UMH services.  Manufactured homes have come a long way in the last 50 years, and offer excellent value for purchasers who require decent housing at affordable prices.  UMH has an occupancy rate of approximately 81%, implying a significant possibility of improvement even within its existing communities if/when the market does turn.  Moreover, UMH has the ability to add home sites in many of its communities due to undeveloped land it owns nearby.  Home ownership for traditional single-family homes peaked in 2008; the subsequent bust, combined with more stringent loan requirements, should benefit manufactured housing.

Management points out that a large number of their communities are in the Utica/Marcellus shale region; in fact, management claims that they have more exposure to this region than any other REIT.  UMH owns 1,500 acres in the region; the company signed an oil & gas lease in 2012 for $500k + 20%.  However, the real benefit might come as the region develops economically, driving demand for housing.  I am not sure myself how to handicap this, and regard it mostly as a free option.

UMH also makes money by financing buyers of its manufactured homes; it has approximately $22mm worth of loans with an average interest rate of 10% (10% down, 15 year principal amortization).  One of the problems with this niche is the lack of availability of traditional mortgage access.  UMH has recently lowered the interest rate it requires to 8% in the hopes of increasing sales (and thus, future rents for the home site).

Finally UMH has a portfolio of REIT securities worth approximately $50mm.  Approximately half of the portfolio is in sister company MNR (which I think is also attractive, by the way), with the rest in a large number of issuers.  Management feels that the REIT portfolio adds diversification and liquidity; over time they have shown themselves to be good investors in the space.

On the liability side, the most interesting item to note is $91.5mm worth of 8.25% preferred stock (which trades under the symbol UMH-PA).  Although the interest rate is high in today’s low-yield world, it is permanent capital.  Reading between the lines, I suspect that management expects significant inflation over the next decade, which would certainly help justify issuing the preferred.  (On the other hand, I suspect that the buyers in the preferred will still do ok, although I do not own any myself.)  In terms of other liabilities, the largest is fixed-rate mortgages (92%) and the weighted average interest is under 5%.  Maturity schedules are conservative, with no significant maturities until 2017.

Management is shareholder friendly and has a long track record.  The company has an excellent dividend reinvestment program, which allows dividends to reinvest at a 5% discount to the market; this program is open to shareholders of record only.  Management owns a lot of stock in UMH, and receives more in dividends than in salary.

Valuation

Above I put in the standard metrics required by VIC (EPS, P/E, etc.), all of which are not very useful for REITs.  I think a better method is to estimate the value of the communities and then use that estimate to derive a value for the whole.

One reasonable way to estimate the value of the communities is to look at their recent transactions.  On March 1^st, 2013, UMH purchased 1,854 sites (in 10 communities) for $67.5mm, or about $36.5k per site.  A much smaller purchase, for a 274-site community in Nashville, was purchased for $7.25mm, or about $26.5k per site.  The upcoming purchase of 1,620 sites is estimated to be for approximately $38mm, or $23.5k per site.  The company looks for at least an 8% cap rate on its purchases; if the underlying property has significant vacancies then the cap rate has the potential to significantly improve.

Another way to estimate the value of the sites is replacement value.  I have seen estimates for replacement costs for these kinds of properties between $40-50k per home site, which makes me suspect that management (which has been in this business more than 40 years) is getting a good deal on their purchases.  (The buildings themselves are also often $40-50k for 2/3 bedrooms, implying a total asset value of about $80-100k per home, which is why this form of housing is so competitive with apartments.)

I estimate NAV as follows (numbers in millions):

Communities at $25k per site:    320
Communities at $40k per site:    512
Communities at $50k per site:    640

Cash:                                         14
Securities:                                  50
Home loans:                               22
Other:                                        27

Total liabilities:                          198
Preferred stock:                           92

Common equity (@$25k):           143
Common equity (@$40k):           335
Common equity (@$50k):           463

With 18.6 shares outstanding, this works out to be $7.70, $18, and $25 per share.  Obviously the final number is quite sensitive to the value per home site that you think is reasonable – the current market value per site (perhaps as low as $25k) vs. replacement cost (perhaps as high as $50k).  If you think, as I do, that housing generally will recover and that the “affordable” end of housing will recover with it, then replacement cost seems like a likely destination.

It is worth pointing out that as the REIT grows larger (in absolute size), it is likely to be valued on a per-share basis somewhat higher.  UMH’s current market cap of $178mm is rather small and probably limits the number of interested buyers.  Management has stated an intention of continuing to grow the company significantly due to their belief that manufactured housing communities are attractively priced today (which I agree with).

As you wait for housing to rebound, shale fracking to begin, and so forth, you wait and collect a 7.5% dividend for your trouble.  To be fair, the dividend is not rock-solid, but I think the reported numbers are unreasonably negative as future indicators since they are paying for preferred capital they have raised without having the full benefit of having invested it yet.  (Of course, net income is not as meaningful as funds from operations for REITs).  The company adjusts FFO further to reach “core FFO” by removing costs associated with their acquisition spree.  I’m not convinced, but even regular FFO should be enough to support the dividend.

If in fact things do rebound, then you could make quite a nice capital gain as the company’s assets are revalued in the marketplace, which would combine very satisfactorily with the dividend.

Catalyst