UMH Properties: Elevated P/FFO On A Flimsy Foundation (Rating Downgrade)

Introduction

In my initial piece on UMH Properties (NYSE:UMH), a specialized REIT with a focus on residential manufactured housing, I noted that the company had been executing steady rental increases and improving occupancy, with the potential for further FFO growth in the future. With a balance sheet that could support FFO generation in the future, I concluded that at 20.1x P/FFO, it was worth paying up for UMH Properties growth when we considered the forward valuations. Since my initial piece in April 2024, shares are up 31.3% (including dividends paid over the period). In this article, I’ll provide an update to my original investment thesis, analyze the latest quarter, and provide my outlook before turning to my conclusion of why I feel shares have run up too far too fast, and shares aren’t the opportunity they once were when I looked at it in April.

UMH Properties Overview

UMH Properties, Inc. is a real estate investment trust (“REIT”) that owns and operates manufactured home communities. With a robust portfolio of 136 communities encompassing approximately 25,800 developed homesites—an increase of one community and about 100 sites over the past year—UMH Properties is strategically positioned across key states, including Alabama, Georgia, Indiana, Maryland, Michigan, New Jersey, New York, Ohio, Pennsylvania, South Carolina, and Tennessee.

The company’s business model involves leasing manufactured homesites to private residential homeowners, providing affordable housing solutions. This is especially important in a time where the average detached home price has become unaffordable for the average family.

UMH’s rental portfolio has expanded to approximately 10,100 units, around 5% over the last year, with an anticipated addition of 800 more homes this year. This growth is supported by the company’s current inventory of 3,300 vacant lots and over 2,200 vacant acres, which offer the potential for approximately 8,700 future lots.

Additionally, UMH Properties is well-positioned for continued expansion, bolstered by a joint venture with Nuveen Real Estate. This partnership, which includes UMH’s ownership and operation of two Florida communities, facilitates accretive development opportunities while mitigating capital requirements. The company’s focus on acquiring, managing, and developing manufactured home communities underscores its commitment to addressing the demand for affordable housing and driving long-term shareholder value.

Q2’24 Results and Outlook

UMH Properties announced its second quarter results on August 5. During the quarter, the company reported $60.3 million in total revenues ($51.5 million was rental revenues), which was 9.1% higher compared to last year. This was driven by growth in rental and related income (which also increased 9%) and sales of manufactured homes (climbing 7% year over year).

When we look at what drove growth during the quarter, UMH benefitted from increases in rental revenue as well as occupancy gains. With expenses increasing less than the top line, the company saw community NOI grow 11% (also 11% on a same property NOI basis). On occupancy gains, UMH saw an increase in same property occupancy which grew from 86.4% to 87.7%, an increase of 130bps.

On the sale of manufactured homes side of the business, the company sold 105 homes in Q2’24 (compared to 91 homes in Q2’23), of which 35 were new home sales (compared to 43 last year). Gross margins on these sales also increased 8% from 30% to 38% through a combination of cost reduction, operational efficiencies, and higher sales price per unit.

In my view, this was a good quarter for UMH Properties and reaffirmed many of the investment attributes I laid out about the company in April. For one thing, the rental portfolio continues to experience turnover of 30% of less each year and the time it takes to build a manufactured home has now been cut down to four to eight weeks, in line with pre-COVID levels. Why this matters is that this has enabled the REIT to reduce its interest and carrying costs in addition to managing occupancy rates and revenue gains.

FFO continues to be strong, which should support dividend growth. During the quarter, with FFO of $16.8 million, up 28.7% year over year, I estimate that run rate FFO is approximately $65 million now. With an annual dividend now at $0.86 per share and 71.9 million diluted shares outstanding, total annual dividend payments are approximately $61.8 million, so the company’s payout ratio is about 95% on FFO. In my view, given that UMH Properties started increasing their dividend regularly over the last three years (and has always had some form of a dividend for the last 33 years), it’s likely that we can expect to see further dividend growth as long as FFO per share continues growing.

Risks

In terms of the risks to the investment thesis, the most obvious one might be the company’s debt. At 5.7x Net Debt to Adjusted EBITDA, UMH Properties’ leverage is quite high, despite the fact that it’s come down from 8.1x in 2022. As EBITDA has grown while long-term debt on the company’s balance sheet has gone down by $92 million, so too has leverage.

Mitigating the risk of high leverage is a low cost of debt at mostly fixed rates. Out of the company’s $669 million in total debt, $491 million was community-level mortgage debt and $101 million was through the company’s bonds. These bonds have a coupon of 4.72% and so even on the company’s unsecured debt, there is a relatively low cost of debt. At quarter end, 92% of UMH Properties’ debt was structured as fixed rate, providing some certainty into future interest payments going forward. As central banks cut rates and lower their target terminal rate, I expect this to be a tailwind for UMH Properties, and REITs in general.

Another risk would be UMH Properties’ concentration in the shale region of the eastern United States. The Marcellus and Utica Shale Regions are large natural gas fields located beneath much of Pennsylvania, Ohio, West Virginia and New York. With a heavy presence of the company’s portfolio located around this area, the geographic concentration could be a concern, particularly when shale production is low or when commodity prices are weak. If the energy sector were to see a pickup in demand, more manufactured housing units would be required, and so that could be seen as a tailwind for UMH Properties.

Valuation and Wrap Up

Based on the eight sellside analysts who cover the stock, there are five ‘buy’ ratings with three ‘hold’ ratings. Given the recent run-up in the share price, the upside potential from here seems to be more limited. With an average price target of $21.57, analysts are forecasting just 5.6% upside in addition to the company’s 4.2% yield. While total return potential of 9.8% sounds decent, I don’t think the opportunity is as great as it once was in April 2024.

With a market capitalization of $1.50 billion and run rate FFO of $65 million, UMH Properties is trading around 23.1x P/FFO, a few turns higher than where they traded just a couple of months ago. On a forward basis, the REIT trades for 20.2x and 19.4x its 2025 and 2026 P/FFOs, respectively. Compared to where it traded in April, at forward multiples of 17.0x and 15.6x P/FFO for 2024 and 2025, respectively, I don’t have the same conviction in UMH Properties being an undervalued investment anymore.

Compared to peers, the discount is no longer there. Despite the REIT sector having gone up a lot in the past few months, compared to peers, UMH has gone up the most out of its most comparable companies. Against its peer Sun Communities (SUI), 21.2x P/FFO and 20.7x on a forward basis, I might be inclined to make the switch from UMH Properties to its bigger brother.

All things considered, UMH Properties has demonstrated good growth and operational improvements over the past few quarters. The company’s solid Q2’24 performance and the growth of its rental portfolio underscore its robust position in the manufactured housing sector, with drivers to support FFO growth on a per share basis going forward. However, in my view, the recent surge in UMH Properties’ share price has shifted its valuation to levels that no longer offer the compelling upside potential seen earlier this year. At a forward P/FFO multiple now significantly above what I’d consider fair value, UMH Properties simply isn’t as cheap as it once was. While the company’s fundamentals remain strong, I think the current valuation suggests that the stock may not present the same attractive investment opportunity it once did. As such, I’m downgrading the stock from a ‘buy’ to a ‘hold’ for now, keeping a close eye for a better entry point. At around $17 per share, around 16.8x next year’s FFO, I think shares would offer up better risk reward.