Manufactured Housing: A Stormy End to the Quarter But Outlook Is Bright

ELS & SUI Report Damages Caused By Hurricane Ian

The two large manufactured housing REITs, Equity Lifestyle Properties (ELS) and Sun Communities (SUI) have each reported third-quarter 2022 earnings over the past week. While both companies have substantial exposure to the state of Florida, each was fortunate that only a handful of properties were materially impacted by Hurricane Ian which made landfall two days prior to the end of the quarter. ELS reports 4 RV park and 2 marinas still closed for repairs. The company did not record any expenses related to property damage and restoration work during the quarter given the short time period between the storm and quarter end. They did however take a reduction in the carrying value on their assets for the period in the amount of $3.7 million, and they expect the restoration costs to be included in insurance claims. SUI on the other hand had 3 RV properties and 1 marina with material damage. The company recognized a net charge of $12.2 million.

ELS Reassesses Core Guidance

ELS caused some confusion with their quarterly report by withdrawing previously provided full year core guidance for revenue, expenses and net operating income (NOI), sighting the hurricane and ongoing assessment of damage as the primary reason for pulling the guidance. Funds from operations (FFO) guidance for full year 2022 was updated and revised down slightly due to the timing impact of the hurricane and an expectation that insurance proceeds will not be received until 2023. SUI was able to provide a cleaner narrative on full year earnings as they had a modest beat to 3Q results, established 4Q22 guidance that was above expectations and also bumped up their full year 2022 outlook for FFO, although they did have a modest reduction in same store operating expectations for manufactured housing (MH) and recreational vehicles (RV) for the year.

Operating Expense Lines

Another area of divergence for the two companies came through in the operating expense line with ELS reporting a negative surprise for utility expenses with average electric rates up 14% in 3Q and 11% year to date (YTD). The miss on the operating expense line caused same store NOI to fall short of expectations and added to the questions concerning the withdrawal of guidance. SUI benefited from an easier year over year comparison at the operating expense line, reporting only 1% expense growth in the MH business and a –1.1% decline in operating expenses for the RV business. To add some perspective to these numbers, we note that YTD operating expenses were up +6.3%, reminding us that the reported numbers were good, but somewhat of an aberration.

2023 Guidance For Rental Growth

Perhaps the most important data points from both company reports were the initial 2023 guidance for rental rate growth across business segments. ELS is forecasting 6.2-6.6% rent growth for MH and 7.6-8.0% growth for the RV business. SUI comes in very close to ELS forecasting 6.2-6.4% rent growth for MH and 7.7-7.9% increase for RV. With occupancy levels across both portfolios in the 97% range going into the end of the year, it is not surprising that sustainable pricing power will persist for this property sector into 2023. MH and RV remain truly affordable options for housing and leisure travel for a large swath of the population and those characteristics should hold up well in the current environment with inflation still on the rise and consumers starting to feel stretched. Operating expense management has been a challenge throughout 2022 and pressures on labor, property taxes, utilities and insurance costs will persist into 2023. The good news on this front is that year-over-year comparisons will ease in 2023, more so for ELS than SUI and the potential for overall inflationary pressures to ease later in 2023 is certainly a possibility, providing a potential tailwind to operating income later in the year.

Capital Constraints Affect External Growth in 2023

Given the cost of capital constraints being felt across the REIT universe, we would not expect an aggressive outlook from either ELS or SUI for external growth in 2023. Transaction volumes were relatively light in 3Q and companies will be guarded in how they allocate capital for the foreseeable future. In terms of balance sheet preservation, ELS notes that less than 6% of total debt is maturing over the next three years putting them in an enviable position to manage through the current interest rate cycle. SUI recently entered into interest rate swap agreements to hedge borrowings on approximately $450 million of their credit facility term loan and also received net proceeds of $276 million from a recent settlement of forward equity sales, using the cash to retire borrowings on its credit facility.

Outlook

In summary, we note that ELS and SUI were the most exposed constituents in our portfolio to Hurricane Ian and while the timing of that catastrophe has caused a disruption in operations and financial reporting which will take several quarters to resolve, and result in the continued upward trajectory for insuring assets in coastal markets, we are thankful that the overall impact was minimal with no major injuries or loss of life. Both companies are positioned well to meet the challenges expected for 2023.

Link to Top Ten Holdings

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Footnotes:

[1] Sun Communities – 3Q22 Financial Statements

[2] Equity Lifestyle Properties – 3Q22 Financial Statements

Disclosures:

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