Equity LifeStyle Properties Is A Perfect Dividend Growth Stock (NYSE:ELS)

Introduction

I have often said/written in the past few months that I’m working on a bigger real estate portfolio. So far, I own two REITs that are each other’s biggest competitors: Extra Space Storage (EXR) and Public Storage (PSA). In this article, I’m giving you a company I have discussed a few times. However, it’s still flying too far under the radar, despite its ability to generate tremendous long-term wealth. That company is Equity LifeStyle Properties (NYSE:ELS), a REIT gem that doesn’t have a very high yield, yet every other quality I’m looking for in a dividend growth stock.

Unless you’re a retired investor dependent on high cash flows, I think the ELS ticker should be on your watchlist.

Now, let’s discuss why that is.

A Terrific Dividend Growth REIT

I’m a very picky investor. I own fewer than 25 stocks holding 90% of my net worth.

When I pick stocks, I look for a mix between lower-yielding dividend growth stocks and higher-yielding stocks to keep my average yield close to 3%. That’s mainly due to tax reasons – a long story I will tell you another time.

While I am fully aware that investors mainly buy REITs to get high yields, I’m a bit different. I like REITs that can grow rapidly, which includes the dividend. However, I also want REITs with a somewhat decent yield. That’s why I haven’t bought a lot of REIT exposure.

What’s ELS?

Equity LifeStyle is one of America’s largest residential real estate companies.

With a market cap of $13.5 billion, ELS is the second-largest company focused on manufactured housing and recreational vehicles. Founded in 1969, the company has 445 properties in 35 states and one Canadian province. These sites cover more than 170,000 sites and are maintained and managed by the company’s 4,100 employees.

Two major factors make ELS’ business so attractive to me.

What Makes ELS So Attractive

• It’s an efficient and easily scalable business model.

ELS has a unique business model where it owns the land and leases sites to customers who own manufactured homes, cottages, RVs, or boats.

To use the company’s own words:

Our customers may lease individual developed areas (“Sites”) or enter into right-to-use contracts, also known as membership subscriptions, which provide them access to specific Properties for limited stays. Compared to other types of real estate companies, our business model is characterized by low maintenance costs and low customer turnover costs.

Unlike companies that own malls, or other large buildings, ELS has low maintenance costs. On a full-year basis, the company spends close to $80 million on asset preservation (infrastructure) and amenity improvements and renovations. This includes pools, leisure areas, and everything you can think of to keep things clean for the company’s residents. Roughly 65% of total operating expenses go toward utilities, payroll, and maintenance.

The company has a 95% occupancy rate. 54% of its MH communities have an occupancy rate of more than 98%. Roughly 95% of its residents are homeowners, meaning they are usually long-term clients. In 2013, roughly 92% of clients were homeowners. This rising trend is great news for the company.

Concerning inflation, the company is in a great spot to hike prices, even though there is an opportunity for senior residents to lock in good prices on a longer-term basis, which I believe is great too.

[…] all of the leases at our MH communities allow for monthly or annual rent increases, which provide us with the ability to increase rent where justified by the market. Such types of leases generally minimize our risks of inflation. In addition, rental rates for our annual RV and marina Sites are established on an annual basis. Our membership subscriptions generally provide for an annual dues increase, but dues may be frozen under the terms of certain contracts if the customer is over 61 years old. Currently, 20.0% of our dues are frozen.

Thanks to pricing and cost management, ELS has grown its net operating income by 4.3% per year going back to 1998. This beats the average REIT by 120 basis points per year, which adds up over time.

Since 2013, the average annual NOI growth has been 5.1%. That’s the result of 4.8% annual average revenue growth and 4.5% annual expenses growth.

• MH communities are a great alternative

MH communities have evolved a lot since they were mainly known as trailer parks. The quality of MH housing alternatives has gone up tremendously, providing alternatives for people looking for affordable housing alternatives.

The core customer base of ELS is people aged between 55 and 80. The population aged over 55 is expected to grow by 17% between 2022 and 2037.

These people are key when it comes to finding affordable housing that isn’t necessarily located close to office buildings.

However, even younger people are increasingly interested in MH alternatives. In Europe, for example, a new crowd is starting a tiny house trend where people go back to cutting costs to the bare minimum, living a minimalistic life, often independent from utility providers and landlords.

In the United States, the average manufactured home costs $121,600. That is 76% below the average cost of a single-family house. The monthly cost is 71% lower. The only difference is that upfront costs are higher.

This is also good news for ELS as the company has financed only 2% of new home sales. It has a rock-solid customer base. That is even less prone to rising rates than the average home buyer with a fixed-rate mortgage.

Even when it comes to building manufactured homes, benefits include a controlled construction environment, economies of scale resulting in cost advantages, and centralized labor contributing to efficient construction.

Despite these benefits, MH communities aren’t seeing exploding supply. This has everything to do with zoning and regulation headwinds, local planning, and NIMBY (not in my backyard!). MH supply rapidly declined in the early 2000s. It has not recovered.

With that said, let’s dive into ELS’ dividend.

The ELS Dividend

The current ELS dividend is $0.41 per share per quarter. This translates to a yield of 2.4%.

According to Seeking Alpha data, the sector median yield is 4.3%. That makes sense, as investors mainly buy REITs for their yields.

However, ELS’ business model provides a few things that other REITs simply cannot compete with. That’s what makes ELS such a great alternative for everyone who isn’t dependent on high-yield investments.

• ELS has a 10-year dividend CAGR of 11.9%
• The 5-year dividend CAGR is 11.0%
• The sector medians are 3.2% (10Y) and 1.7% (5Y)
• Dividend safety is high. The company has a 71% AFFO payout ratio, slightly below the 73% sector median.

On March 08, 2022, management announced a 13.1% hike.

To give you an easy example, let’s assume that the ELS dividend is growing by 8.5% per year over the next ten years. It will probably be higher, but let’s assume a margin of safety in our calculation. I also assume that the sector’s average annual growth rate will be 3%.

• Ten years from now, ELS will have a 5.4% yield on cost.
• The sector yield on cost will be 5.8%.

The gap is closing rapidly. After that, the difference in favor of ELS will grow. Even if we assume that its dividend growth rate will slow further.

One thing that comes with high dividend growth is outperformance. Over the past ten years, ELS shares have returned 387%. This beats the S&P 500 by a mile. The average real estate stock did very poorly, especially given the fact that dividends are incorporated in the charts below. That’s one of the drawdowns of buying a higher yield. It’s not always that great in the long term. Again, unless you need a high yield because you’re retired. There’s nothing wrong with that.

Using the data below, we see that ELS shares have consistently outperformed the market. Since 2001, ELS shares have returned 14.4% per year. This beats both the iShares U.S. Real Estate ETF (IYR) and the market. Over the past three years, ELS has not outperformed its sector benchmark. However, before that, it consistently outperformed. Moreover, the company has a similar standard deviation to its benchmark! That’s fantastic, as we are comparing a single stock to an entire basket of stocks.

But wait, there’s one more thing you need to know.

ELS’ Balance Sheet

One of the reasons why ELS has low volatility is its balance sheet (low risk). This is also the reason why the company isn’t that prone to the current high-rate environment.

The average time to maturity for ELS’ debt is ten years. This means the company is buying a lot of time when it comes to refinancing in a higher-rate environment. Only 9% of debt is due within the next three years. Its weighted average interest rate is just 3.6%.

Just 10% of the company’s debt is floating rate debt, which means that the impact of higher rates is even smaller.

Valuation

On a full-year basis, ELS aims to generate at least $2.60 per share in funds from operations. Normalized, that number is $2.64. This would imply a 26x NFFO valuation. The sector median is 17x.

That valuation is not too high. However, it’s also not extremely attractive.

When I covered ELS in October, the stock was at $60, which was a much better valuation. However, back then, full-year estimates were also better.

It depends a bit on the market, but I would be a buyer if ELS hits $60.

Given the macroeconomic situation, I’m fairly sure we get a new opportunity, as the market seems to be way too dovish when it comes to Fed expectations.

Takeaway

In this article, we discussed a stock that deserves way more attention than it currently gets. Equity LifeStyle Properties does not have a very high yield, yet it is a terrific dividend growth stock. The company has a decent yield, high and consistent dividend growth, a low-risk and low-cost business model, a very healthy balance sheet, and a history of low-volatility outperformance, which I expect to continue.

I’m looking to add ELS shares to my portfolio as close to $60 as possible, as that’s where I like the risk/reward.

(Dis)agree? Let me know in the comments!