ELS Q4 2023: Equity Lifestyle continues steady growth despite accounting change

Equity Lifestyle (ELS) recently announced its Q4 2023 results.

Days before the Q4 2023 release, ELS announced that they were required to restate prior periods. That sounds horrible, but it’s mostly just an annoyance.

They had an accounting dispute with how to classify a small portion of their investment expense.

I’ll keep it simple. Regulators wanted it done one way. ELS was doing it a different way. The difference negatively impacts FFO/share by about $.10/year.

For comparison, FFO was $2.77 and normalized FFO was $2.75 per share. Therefore, without this change, normalized FFO would’ve been higher by 3.6%.

2023 guidance for normalized FFO was:

• $2.85 before the retroactive adjustment to remove $.10.
• $2.75 after the adjustment.

The $2.75 perfectly matches up with the results.

Growth Rates

Easy math:

• In 2022, normalized FFO per share was $2.72.
• If we apply the same treatment, it is $2.62 to $2.63.
• Year-over-year growth in 2023 was 4.7%.

Looking ahead to 2024:

Guidance for 2024 includes this adjustment.

• Guidance for 2024: $2.88.
• Projected forward growth rate: 4.73%.

That’s pretty good. Remember that even though ELS is primarily running manufactured homes, they are still going to face some impact from the surge in apartment supply. Consequently, 2024 and 2025 should be harder years.

Historically, ELS has been growing FFO and AFFO per share around 5% to 8%, though there have been some outliers. The solid growth can make up for the much lower yield. Currently, it’s a 2.6% yield. However, the yield is only part of the consideration for any position. For our equity REITs, it’s a smaller part. ELS could juice the dividend by simply raising the payout ratio (and reducing growth). Some investors would love that, but it wouldn’t fit our goals.

Management is guiding for core income from property operations to increase by 5.1% to 6.1% (5.6% at the midpoint).

AFFO Multiple

ELS presently lands slightly below our target “buy under” price. However, several other equity REITs are offering much larger discounts.

ELS is a great REIT. They keep their debt leverage low and they use long-duration debt to reduce their exposure to a spike in rates.

However, the valuation just isn’t as appealing as peers.

Note: I’m going to use AFFO in this discussion. AFFO is not the same as normalized FFO because of certain adjustments for non-cash items.

Prices as of February 1st, 2024. Most prices are slightly lower today as Treasury yields surge (bond prices down, REIT prices down in sympathy) on a surprisingly strong employment report.

ELS ($69.39) trades at about 27.5x forward AFFO. That’s based on a prior consensus estimate of $2.52.

However, ELS also trades at 28.1x the 2024 estimate of $2.47.

Normally, updating forward AFFO to use full-year 2024 projections (rather than Q4 2023 + the first 3 quarters of 2024) would result in higher AFFO projections. However, that isn’t the case due to the accounting adjustments. Analysts are still projecting growth, but the retroactive adjustment to 2023 complicated the math.

For comparison, their closest peer is Sun Communities (SUI).

SUI ($129.39) trades at about 20x forward AFFO of $6.46. That’s using Q4 2023 plus the first 3 quarters of 2024.

If we apply 2024 consensus estimates of $6.68, the multiple would drop to 19.37x.

I find SUI more attractive based on the difference in valuation.

My view is also supported by my allocations.

• 1.93% of my portfolio is in ELS.
• 6.78% of my portfolio is in SUI.

Using apartment REITs for comparison, we see AFFO multiples in the range of 15.35x to 18.73x.

ELS should regularly have a higher multiple than any of the apartment REITs, but the gap between 27.5x (or 28.1x) and somewhere around 16x is probably a bit too large.

The Tricky Part With Ratings

This is one of the tricky parts with ratings. Our “buy under” target for ELS is set at $69.98. Shares have a discount to that price, but it’s less than 1%.

On the other hand, we have other equity REITs with discounts greater than 20% and other housing REITs with discounts in the 16% to 18% range.

I don’t see anything wrong with ELS, but I find discounts to targets around 17% to be much more appealing than discounts around 1%.

A Potential Change

I may consider swapping part of my ELS for an alternative investment.

When I reviewed my position, I noticed that a small portion of my ELS allocation is in my solo 401k. Those shares were purchased in 2018 for only $43.26 per share.

Since it is in my solo 401k, I could take the gain on that without getting hammered on taxes. That would also be nice because any replacement equity REIT allocation could go into my taxable account. That would leave more of my tax-advantaged space available for trading preferred shares, mREITs, and BDCs.

Conclusion

The accounting update was negative for normalized FFO and AFFO. It could weigh on valuations some as it makes the historical multi-year growth rate look weaker.

I think the rest of the forecast was fairly positive given the headwinds I’m anticipating for housing REITs. The additional supply for housing will cause all housing REITs to report weaker growth across most metrics. That’s fine. We knew that was coming. No surprise. We want to evaluate how the REITs are performing within the macroeconomic environment that exists. In that case, ELS did quite well.

Not amazing, but still pretty good.

Rating: I’m looking at a 7.5 to 8.0 rating for the quarter. That considers the macroeconomic factors, but not the spread in valuations between ELS and other housing REITs. I’d like to see ELS pulling an 8.5 or higher given the spread between their valuation and peers. Housing REITs trading at multiples in the teens (IE: 16x AFFO) would be quite happy if they achieved a 7.5 or 8.0.