UMH Properties (UMH) reported 2015 third quarter normalized FFO of $0.15 per share, up from $0.12 in the prior year period. On a GAAP basis, the company’s net loss was $0.03 per share, less than last year’s third quarter loss of $0.06 per share.
This was the third consecutive quarter of improved performance for UMH’s core manufactured home community business. Its strategy of acquiring underperforming communities at attractive prices and upgrading their operations has finally been starting to show results. As the average occupancy rate of the company’s communities has improved, its operating expense ratio (i.e. as a percent of rental income), has declined, for example from 52.6% in last year’s third quarter to 49.2% in the current quarter. As a result, 2015 third quarter community net operating income (NOI) increased 24.3% to $9.4 million. Year-to-date, community NOI is up 23.5% to $26.8 million.
In recent years, UMH has been purchasing mostly underperforming communities, with occupancy levels typically below 80%. After sprucing them up and showing them off, the company has been able to land new tenants, often younger families, boosting occupancy rates.
A typical manufactured housing tenant is one who owns the home and leases the land; but UMH has devoted more of its home sites to full renters (i.e. those who also rent the housing unit). These days, younger households have a harder time qualifying for a mortgage, due to higher downpayment requirements and tougher underwriting standards. They also do not seem to have the same strong desire, as their parents did, to own their own home. UMH is able to offer a 1,000 sq. ft., 3 bedroom, 2 bath housing unit for rent for $700 per month, which is $300-500 less than a typical comparably-sized apartment.
Demand for its rentals is strong. UMH has increased the number of units devoted to rentals by about 700 or 27% to 3,300 units since the beginning of the year. Occupancy levels for UMH’s rental units have been running in the mid-90s (compared to an average UMH community occupancy rate of 81.7% at Sept. 30). Rental units accounted for 23.4% of the company’s total occupied units on that date, up from 16.4%, a year ago.
Since UMH typically buys communities based upon their current level of NOI, it has upside potential on these investments from (1) raising occupancy levels and (2) developing and leasing out new home sites at these communities. Consequently, management says that UMH gets this land development opportunity for free. (It should be noted, however, that it makes little sense to develop new home sites as long as existing sites are vacant; so the free land development opportunity is only there when occupancy approaches maximum levels at these acquired communities.)
Although natural gas drilling activity has been slowing in the Marcellus region (where many of UMH’s communities are located), the company says that the local economies are robust. Management points to notable strength in areas like Elkhart, IN, due to the booming RV industry; Ohio, with Ford relocating manufacturing there from Mexico; and Nashville, TN, which is benefiting from growth in the technology sector and manufacturing.
With continued strength in local economies, UMH anticipates steady improvement in its core community business going forward, by far the biggest driver of its overall performance. The two other UMH segments – retail sales of manufactured homes and investment returns on its portfolio of REIT securities – have not contributed to performance improvement this year. Sales of manufactured homes remain unprofitable. (Nevertheless, management views home sales as a loss leader, since it is often willing to give prospective lot renters a good deal on the purchase of a home to boost occupancy at communities.) Similarly, UMH’s REIT portfolio generates dividends, but capital gains have not been nearly as high as in years past.
Nevertheless, the core community business has driven improvements in UMH’s consolidated performance and management expects further gains. On a rolling 12 month basis (for the period ended Sept. 30, 2015), UMH’s core FFO was $0.56, up from $0.45 in the comparable prior-year period. Although still below the annual dividend of $0.72 per share, that improvement in FFO helped lift the stock to an all-time intraday high of $10.55 on Oct. 22, but it has since fallen back. At the current price of $9.65, UMH stock is roughly in the middle of this year’s trading range, but up about 7% since I first wrote about it on SA in Sept. 2014. With its $0.72 dividend, the stock has delivered an annualized return of 15% in about one year’s time.
The stock has the potential to go higher. Back in Sept. 2014, I set an initial target price of $14-$15 per share, assuming that the market would bid the price of the stock up as the company’s annual FFO moved closer to the $0.72 annual dividend rate. That process began this year and should continue as long as the economy holds up.
However, the upside potential on the stock may be limited by the company’s riskier capital structure. UMH has used its 8% Cumulative Redeemable Preferred Stock to provide a significant portion of the equity required to finance its acquisition program. Lenders are willing to treat the preferred as equity, because the dividends can be suspended without triggering a default. From the perspective of a common shareholder, however, the Preferred is like debt, because it has preference over the common with respect to dividend payments and in a liquidation.
Management is comfortable with this financial strategy. In October, UMH issued 1.8 million shares of 8% Series B Cumulative Redeemable Preferred Stock at a price of $25, for net proceeds of $43.8 million. As long as UMH’s financial performance continues to improve, common shareholders need not worry. In that case, operating profit growth will increase the coverage of the dividend and maybe even provide a modest cushion over time.
However, a downside economic scenario may be risky for UMH common shareholders because it could, for example, force a steeper reduction in the common dividend than otherwise would be the case if UMH was entirely common equity financed. That high risk profile could be reduced, if UMH exercises its right to retire the $95 million Series A Preferred at par on or after May 26, 2016, (as allowed under the original terms of the Preferred). It would presumably do so with the proceeds from a common share offering. Consequently, I believe that the ability of UMH to achieve my original $14-$15 target share price will probably require a take-out of the Series A preferred.
November 9, 2015
Stephen P. Percoco
Lark Research, Inc.
P.O. Box 1543
Linden, NJ 07036