AGB 2023.10 - Equity Lifestyle Properties (ELS)

Consistent Rate Increases

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Equity Lifestyle Properties

Equity Lifestyle is one of the two largest owners of manufactured housing (MH), recreational vehicle (RV), marina properties. As of the third quarter of 2023, the company owns and operates 72.7k MH sites, 62.7k RV sites and 6.9k Marina slips across 450 properties in 35 U.S. states and Canada. Many of the properties are located near retirement and vacation destinations, of which many are near lake, river and coastal areas. Equity Lifestyle was founded in 1984 by real estate investor, Sam Zell.

The company operates a relatively straight forward business model. Customers rent sites at Equity Lifestyle owned properties under annual or monthly terms. Most leases are annual and usually have rate changes during renewal. There are certain properties that are under longer-term leases and most of these are also subject to annual rate changes. In exchange for the rental fee, customers get access to live on the site, either in a MH, RV or dock their boats in a marina. Customers also get access to the common area facilities and amenities, which sometimes includes a clubhouse, swimming pool, laundry facilities, golf courses, tennis courts, exercise rooms, etc.

The MH segment represents over 51% of total available sites and annual MH revenues are over 60% of property operating revenues. Since 2000, annual rate increases in the MH portfolio have averaged +3.9%. This is higher than the Cost of Living Adjustment growth calculated by the Social Security Administration, which averaged +2.6%. Specifically for the MH segment, a quarter of the company’s leases are linked to CPI growth, of which half (or 12.5%) are directly linked to CPI and the other half have price increase floors of 3%. Rates for the remaining 75% are market driven. These rate changes are generally accepted by most of Equity Lifestyle’s customers, given the low annual turnover rate. In certain states like Florida, rate increases are negotiated between the company and representatives of the home owners association.

Typical MH customers of Equity Lifestyle are older (new home buyers are near 60 years old) with good credit scores (700+ FICO). Customers are looking for a second home near a vacation destination, which is more affordable than a typical single family home. Most customers purchase the MH outright without a mortgage. Many use part of the equity in their primary residence to fund the MH purchase. And while this is a large sum of cash and is more than a typical down payment on an average single family home, the monthly cost is much lower because there is no mortgage payment. MH owners only pay the rental rate to gain access the site and community amenities.

In 2023, the average upfront cost for a MH was $127k with a monthly cost of $797. Comparatively, an average single family home had an upfront cost of $106k (20% down payment on a $528k home) but came with a monthly cost of $2.6k. On a per square foot basis, MH owners pay less in the range of 25%-30%. A small minority (just 2% over the past 3 years) finance their purchase with Equity Lifestyle. This is partially due to the stringent mortgage regulations and higher cost of debt for homes on land that is leased from another party.

Most of the company’s MH customers own their home, with just 4% renting in 2022. Renters made up a larger portion of the Equity Lifestyle’s customer base in the past at 9% in 2013.  The percentage of renters has since trended lower each year. That’s also reflective of a stronger economy so that trend could reverse in a downturn. The company views its rental program as a try “before you buy” option for its customers. These conversions are meaningful. In 2019, 33% of total MH sales were the result of a renter conversion.

The RV and Marina segment represents 49% of total available sites and RV and marina revenues are 32% of property operating revenues. RV customers can choose annual, seasonal (up to 6 months) or transient memberships. Annual customers pay a lower effective daily but pay for the full year. Annual RV rents are close to $500/month and transient rents are ~2x that amount. Revenues from seasonal and transient customers are higher in the first and third quarters of the year.

Equity Lifestyle seeks to convert transient RV customers to seasonal and then eventually to annual. While the effective daily rate for annual memberships are lower than seasonal or transient, the occupancy rates are much higher. Based on Sun Communities’ data, occupancy rates for transient are 1/3 that of annual, and a successful conversion to annual results in a 40%-60% increase in revenues after the first year. Furthermore, there are fewer marketing costs necessary to retain an annual customer. For Equity Lifestyle, transient RV revenues are ~7% of total RV revenues. The company has averaged 20%-30% conversion rates each year and has decreased the number of available transient sites.

Occupancy is decent measure of the collective health of the company’s customer base. Equity Lifestyle had steadily increased its “same store” occupancy rate from the great recession up to 2019. Since then, the occupancy rate has ranged between 94.9%-95.3%. Things that impact overall occupancy include the percentage of sites that are annual vs. seasonal/transient and how much exposure the company has in MH vs. RV. Ground up builds and expansions also have an impact on occupancy because these take much longer to fill vacancies than if the company had acquired an existing property. Within the MH portfolio, the company states that occupancy for more than half of its communities are over 98%, so there is still more room for improvement.

The markets for MH and RV properties are fragmented with Equity Lifestyle and Sun Communities each commanding less than 10% of these markets. The top 10 command close to 30% of these markets. The marina market is even more fragmented with Equity Lifestyle and Sun Communities commanding less than 10% combined. Fragmentation implies there is still more room for acquisition led growth, especially since new builds are harder to construct near highly valued vacation destinations.

Most of the company’s property growth in recent years has been in the RVs and marina segments. Since 2017 when the company first disclosed its acquisitions by segment type, MH sites have accounted for just 16% of total acquisitions. RVs were 58% and marinas 26%. In terms of total number of sites, the company has increased MH sites from 2013 to 2022 by 2.8k or 4%, while RVs increased by 20.2k or 48%.

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Why is it a good business?

Owners of MH, RV and marina properties benefit from the lack of new entrants entering the market. Supply of new properties are usually constrained due to the difficulty of obtaining zoning permits from local authorities. This has somewhat to do with a negative perception of manufactured housing from local existing home owners and due to lower property taxes from MH and RV owners. MH development in the U.S. has declined to under 20 developments annually since 2007, while demand has increased since then. From a financial perspective, the development of a new property from the ground up can take up to three years, which may dampen returns.

MH customers tend to exhibit low turnover compared to other rental types. This is because customers tend to own the MH, long-time customers have a sense of community of where they live, and physically moving a home to another property has a high cost. For Equity Lifestyle, its MH customers live in their homes for an average of 10 years and 50% of new and used home sales come from residents already living in the community (as renters) or from resident referrals to family and friends.

Equity Lifestyle’s customers skew more towards the older demographic than other property owners. Almost 70% of the company’s MH communities are age restricted at 55+ years, higher than Sun Communities at ~45%. This benefits the company because the older demographics tend to be retired and living on predictable or fixed income. This somewhat contributes to the steady rent growth at the company’s MH and RV properties. Even during the great recession rate increases were common. And the 65+ age group is projected to outgrow the rest of the population in the near future. States where Equity Lifestyle has the most exposure like Florida, Arizona and California have projected population growth of the 65+ cohort to be 9%-12% higher that the rest of the population.

As one of the largest owner/operators of MH and RV properties, Equity Lifestyle benefits from certain scale advantages. First, the company has more buying power when procuring manufactured homes from builders. Second, Equity Lifestyle benefits from being an acquirer of choice due to its long history of acquiring properties in the sector. In fact in 2019, the company completed three acquisitions in the second quarter all from the same seller. This specific seller has sold 20+ properties to the company over 20 years.

And lastly specific to Equity Lifestyle, the company benefits from its Thousand Trails membership program. The membership grants access to its RV sites for up to 2 consecutive weeks. As of 2022, the company has 128.4k annual subscription members, of which 26k are free trial members. RV dealers that partner with Equity Lifestyle provide a free membership to buyers of an RV. Conversions for customers that use the pass are roughly 20% after the free trial year. Annual members that choose to pay for a membership after the free trial year are much stickier, usually amounting to a 90% renewal rate. More than a quarter of all Thousand Trails memberships have been with the company for more than 20 years.

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Returns on incremental capital?

Over the past 10 years, Equity Lifestyle has spent 49% of its capital on capex and 51% on acquisitions. Capex spend is related to new builds on undeveloped properties (including expansion projects), maintenance and renovations of existing properties, and build-out/purchases of new homes. In 2022, the breakdown of these expenditures were 22%, 37% and 40% respectively. Over the past 10 years, a larger portion of capex spend has gone towards property development, partly due to the fact that acquisition multiples have increased.

For new MH builds on land that the company owns, it costs about $25k-$30k to build a site (using 2019 data). After a home is built on the site, rents can range from $6k-$7k per year (also 2019 data), which equates to 24% pre-tax return on capital. Average MH rents for the company in 2022 were $8.3k, or 20%-38% higher from the 2019 calculation.

The company typically builds 25 to 50 sites at a time and fills them out with new tenants as the homes get built. The issue with new site builds is that it takes time to fill those sites as they are developed. The company sells between 1.2k-1.9k new and used home each year. It takes years to fill out new greenfield developments (up to as many as 10-15 years). New RV properties fill out much quicker than MH properties and so the cash flows tend to come earlier.

Upgrades to existing properties, which include enhancements to amenities, typically are met with incremental revenues. An example that the company likes to give is installing EV chargers at RV sites. Equity Lifestyle can charger higher rates for customers that want that amenity. However, the returns calculations aren’t so clear for property upgrades.

Acquisitions are the growth engine for the company, especially since ground up builds are difficult to get approval for zoning. When evaluating acquisitions, the company considers the potential for expansion, occupancy vs. other properties in the area, and opportunity to enhance value through better management in addition to the standard calculation for cash flows, returns and growth potential of the property.

Over the past 10 years, Equity Lifestyle has acquired 28k sites across MH, RV and marina properties. The company ended 2012 with 115.5k sites, implying an increase of 24%. Since the company has disclosed the property types for each of its acquisitions, the company has purchased 2.8k MH, 10.3k RV and 4.6k marina sites since 2017.

2021 was the most acquisitive year for the company, most of which were Marina properties. The company hasn’t made any large enough or public company acquisitions over the past decade, so valuations on its acquisitions are not clear. Equity Lifestyle did make a non-property acquisition in 2021 of MHVillage and Datacomp. The company used MHVillage for over 25 years to list new and used homes on the site and has been a great source for new resident leads. Datacomp conducts appraisal reports for MH properties. The company paid 9x EBITDA, implying a return on capital of 11%.

Sun Communities has made much larger acquisitions that have disclosed purchase prices and deal multiples. In 2021, Sun acquired Park Holidays, a U.K. based owner of MH/RV properties for $1.3B. The EV/EBITDA of that deal was 12.9x, implying a return on capital of just 7.8%.

We estimate that Equity Lifestyle has generated returns on incremental capital between 10%-15% over the past 5 years. This calculation includes all capex spend, including maintenance and renovations of existing properties and acquisitions. And while new builds on land which the company already owns have much higher returns (close to 24% from the example above), purchases of existing properties and empty land likely have lower returns.

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Reinvestment potential?

The company estimates that there are a total of 50k MH properties and 8.7k RV properties in North America and 4.5k marinas in the U.S. When considering properties of institutional size (200 sites or more), Equity Lifestyle estimates that there are 3.8k MH properties, 1.3k RV properties and 500 marinas. The company owns and operates 450 properties across all types, which implies a penetration rate of 8% based on available properties with 200 sites or more. Many of these properties are not owned by large institutional operators.

For RVs specifically, there are 1M sites in the U.S. in over 8.7k privately owned RV properties. There are also an equal number of public RV properties that are owned by various state and local governments, but they tend to have fewer amenities and modern improvements.

RV ownership has increased over the past few years with over 11.2M households owning an RV, a 26% increase from 2011 and 62% increase from 2001. The age cohorts for RV owners are more evenly distributed vs. MH owners. The 18-34 age group represents 22% of RV ownership. RV ownership compares favorably vs. traditional vacationing from a cost perspective. A couple can save 11%-48% and a family of four can save 27%-62% according to a 2014 vacation study done by PKF Consulting.

For marinas, the total supply of sites has decreased over the years, due to repurposing many into private properties. According to Sun Communities, the number of marinas in the U.S. has declined to just 900k-1M wet slips and dry storage racks. Marinas have similar rental characteristics to MH, with most renters under annual contracts with high renewal rates.

Equity Lifestyle benefits from the upcoming growth in the number of baby boomers reaching the age of 65. The older cohorts that seek an active lifestyle and/or a second property should help demand for the company’s properties. This combined with very little new supply of MH, RV and marina properties coming to market should allow for continued rate increases across its portfolio of properties. The U.S. Census Bureau estimated that 10k baby boomers will turn 65 everyday until 2030.

With a reinvestment rate between 60%-80% and a return on incremental capital between 10%-15%, we estimate that Equity Lifestyle has increased its intrinsic value between 8%-9% over the past 5 years. The reinvestment rate does fluctuate depending on the amount spent on acquisitions each year. The high reinvestment rate results in muted returns for the couple of years following, but that reverts back since rate increase are predictable.

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What else is important?

Natural Disasters and Insurance

Natural disasters and in particular, hurricanes, are of concern to Equity Lifestyle. The company has the highest concentration of its sites in Florida (45% of total sites). Insurance is a large expense of the company (along with utilities) and rates tend to go up much more after a natural disaster occurs and during inflationary environments. After Hurricane Irma hit Florida in 2017, the company’s insurance bill increased 20% annually until 2022.

And in 2022, Hurricane Ian caused damage related to flooding, winds and debris across the company’s portfolio of sites in Florida. The company recognized $40.6M related to debris removal and clean-up costs and $5.4M losses in the carrying value of certain assets that were impacted, all which were covered under its insurance policies. In the first quarter of 2023, Equity Lifestyle saw its insurance premiums increase by +58% y/y, higher than its internal target of +45%. This coupled with higher utility rates due to increasing energy prices meant that these two expenses make up about 1/3 of total property expenses for the company.

Equity Lifestyle vs. Sun Communities

The two largest owner/operators of MH, RV and marinas are Equity Lifestyle and Sun Communities. Equity Lifestyle had always been the larger company in terms of the number of sites, properties and financials. However, over the past 8+ years Sun Communities has been much more acquisitive even as deal multiples have increased. After the Park Holidays acquisition, Sun Communities became larger than Equity Lifestyle.

Sun Communities made three large acquisitions over the past decade. The company acquired American Land Lease for $1.3B in 2014, Carefree Communities for $1.7B in 2017 and Park Holidays for $1.3B in 2022. In total, Sun Communities has spent $8.9B in acquisitions over the past 10 years.

In contrast, Equity Lifestyle has spent a total of $1.8B in acquisitions since 2013. The company has elected to shift more capital spending to property upgrades and development in recent years. However, the company’s investments have paled in comparison to Sun Communities. So comparatively, the company’s growth rates of lagged. But the other side to that is that Sun Communities has had to increase its share count by a factor of 4.5x over the past decade. Equity Lifestyle’s share count only increased by 7%.

It’s likely that Equity Lifestyle had been much more conservative on the acquisition front over the past decade. And because asset values have gone up so much and rent increases have likely outpaced internal expectations for the past decade (hindsight is 20/20), it’s likely that the company missed out on a few acquisition opportunities that seemed expensive at the time. Equity Lifestyle has funded most of its capital requirements through its own cash flow generation and debt, which is impressive given its REIT classification.

Optionality

International expansion is an option for the company, but unless property deal multiples are materially lower in either Canada or Mexico, there really isn’t a material benefit to the company in expanding internationally. This is because there are limited synergies or scale advantages nationally. Many of the benefits described in earlier sections were local advantages. And since there are still ample opportunities to consolidate the U.S. market, making costly investments to expand in other jurisdictions is likely to result in muted returns.

The company does own a few properties in Canada and have customers that live in Canada that travel down to warmer climates for vacation. When the Canadian border was closed in 2021, the company stated that there was a $8M headwind related to the closure.

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