Manufactured Housing — An Industry in Transition

Staff -- April 18, 2005

Background

Over the past 40 years, the manufactured housing (MH) industry has dramatically changed. Today the term "trailer park" is a misnomer when used to describe the current state of this greatly evolved industry. Once considered an inferior form of shelter, a number of factors have combined to cause the industry to gain significant mainstream appeal as a source of quality, affordable housing. Currently the value of the stock of manufactured homes, including land, is estimated at $60 billion US. This does not include manufacturing operations, financing and other services related to the industry. From an investment perspective, this industry has remained below the radar of many institutional real estate investors, due to the fact that it is highly fragmented.

Evolution of MH Construction

Over the past several years, the growth of MH communities has been hindered by municipal restrictions. These restrictions arose due to concerns about the impact of these new MH communities on local infrastructure and nearby property values. In the past, this latter concern had some validity, given the fact that a large proportion of MH units were essentially temporary structures built without consistent manufacturing standards. Following the decision by the U.S. government in 1976 to impose a uniform Housing and Urban Development (HUD) code on MH units, their quality has improved significantly. Consumer demand has also forced manufacturers to produce units that more closely resemble traditional houses. According to the U.S. Census Bureau, nearly 70% of new units are "double-wide" and, in the last decade alone, the average floor area of a MH unit has increased by 20%, to its current average of 1,600 square feet. Today, manufacturers are building MH units with porches, bay windows, central air conditioning and more, so that in many cases they are indistinguishable from a traditional single-storey bungalow.

The structure of the MH industry is vertically integrated and consists of three components: manufacturing, community ownership and financing. The manufacturing aspect is straightforward. Units are built to HUD code requirements in indoor plants and moved to dealers for sale to end-users. Dealers can and often do facilitate the process by offering financing. MH community owners lease land to unit purchasers who are responsible for moving costs, completing the foundation and connection to utilities. Unit owners usually lease the land on a monthly basis and the community owner retains the right to renew the lease every month, evict the tenant or raise the rent.

Owners of MH units on leased land take a chattel or personal property loan to finance their dwelling as they would a car. Interest rates are generally about 5% above prevailing mortgage rates. Interest payments are made monthly and are generally tax deductible. An owner who vacates a property is responsible for the cost of removing the dwelling unit (estimated at $5000). Owners who, for whatever reason, are unable to meet interest and/or lease payments will often sell their unit to the community owner at significant discounts due to the high cost of relocating the unit to another site. These units can be sold or rented to new tenants. If the unit is rented, the community owner now has a dual source of income, from both land rental and unit rental.

Finally, by law, if the unit owner defaults on a chattel loan payment, the bank is bound to pay the rent on the land until it can sell or remove the unit. This legal obligation for the bank to pay the rent protects the community owner and provides an additional opportunity to acquire units, in this case from the bank, at significant discounts.

Two factors have played a major role in the location of MH communities. The first is temperate weather. Communities in Florida, Texas and California are populated by retirees or snowbirds seeking an escape from cold northern winters. The second is income or more accurately, the lack of it among young and financially distressed individuals in the blue-collar states of Ohio and Michigan. These five states contain nearly half of all the MH communities in the U.S. The North East has some MH communities; however, low land availability and low population density have discouraged their penetration on the Great Plains.

In general, the same factors that have driven the demand for traditional housing have contributed to the growth of MH ownership. Record low interest rates over the past 3 years, plus a large number of baby boomers looking for a first or a second home, have caused a significant increase in ownership rates of both traditional and manufactured homes. The main difference in the two types of housing is price. In 2003, the average price of a single-family house ($168,950) was more than three times the $54,900 cost for an average manufactured home. Indeed, over the past 24 years, the average price appreciation of MH dwellings (175%) has just about matched that of traditional single-family housing, although in both cases there are regional differences.

Short Term

As they have in the past, interest rates will continue to be a key factor affecting housing demand in general — and the MH industry in particular — over the near term. Since mid 2004, in an effort to forestall a resurgence of inflation, the Federal Reserve has increased the Federal Funds Rate by 175 basis points. This increase has put upward pressure on interest rates that will lead to a reduction in the affordability of traditional homes. In view of fact that manufactured homes are significantly more affordable than traditional homes, despite the increase in interest rates, demand for this lower-priced housing alternative will likely experience a cyclical increase over the next 12 to 18 months.

Longer Term

Over the longer term, two key demographic drivers should contribute to the relative strength of MH demand. First, the structure and size of the average U.S. household has changed markedly over the past several years, and is likely to continue to do so. A steady increase in single-parent households will cause the total number of households to increase. Since these households have only one income earner, this development should lead to a relative increase in the demand for more affordable MH units. This structural shift should be reinforced by the changing attitudes of individuals towards MH homes, due to their larger size and increased amenities.

The most important driver of MH demand over the next 5 to 10 years will be the aging baby boom. The over-55 age group already dominates the ownership of MH units, and the group's sustained growth over the longer term will no doubt be the major source of demand going forward. One of the reasons that this age group is likely to be so important over the longer term is that they are not purchasing an MH unit for asset appreciation, but rather as an economical source of shelter in a temperate region. Furthermore, this group tends to have a stable financial situation compared to younger age groups who have lower, less secure incomes. By and large, this demand will be focussed on MH communities located in the sunbelt states.

It is worth noting that the relative growth of the 25- to 34-year-old age group will also lead to an increase in demand for affordable housing. Demand for both rental and MH housing is likely to rise from this younger age grouping. However, MH demand will probably benefit more than it has in the past, given that it has become a more accepted form of housing.

During the 1980s, placements of MH units outpaced shipments, leading to a steady shrinkage in dealer inventories. This situation changed in the 1990s when dramatic easing in credit availability caused production to outpace placements. This caused a backup of inventories of unsold units on dealer lots. In an effort reduce stocks, dealers and lenders offered loans to less credit-worthy buyers. This, in turn, led to a collapse of the lending market and triggered a flood of repossessions. Several loan underwriters were hit hard by this collapse and the largest, Conseco, was forced into bankruptcy. Since 2001, the excess dealer inventory has been worked off and placements are currently running ahead of shipments. Having experienced this market correction, lenders have tightened underwriting standards. This should prevent credit-driven overproduction in the future.

In the early 1990s, the development of the real estate investment trust (REIT) market started the first major upsurge in manufactured housing community ownership. Manufactured Home Communities (MHC) formed the first publicly traded manufactured home REIT in March of 1993. This was followed by Sun Communities, Chateau Communities, American Land Lease, United Mobile Homes and, more recently, Affordable Residential Communities. Currently, the REIT market capitalization of the manufactured housing sub-sector of the residential index is close to $2.4 billion US. In comparison, the apartment sub-sector totals $41.7 billion US.

Over the past ten years, the manufactured housing REIT market has exhibited relatively strong performance. This encouraged institutionally backed companies to enter the market in the second half of the 1990s. A company such as Hometown America, with the full backing of pension funding, was able to build a significant asset base that enabled it to acquire Chateau Communities when that company experienced operating problems.

Although the industry remains fragmented, there are plenty of opportunities for new entrants. Moreover, the industry has matured and gained credibility and is now, more than ever, viewed as a viable alternative to traditional housing. This credibility was given a major boost by the purchase of two fully integrated MH companies, Clayton Homes and Oakwood Homes, by Warren Buffet's Berkshire Hathaway.

Probably the most significant advantage of investing in MH communities is that they can provide a reliable and predictable cash flow over time. This occurs once a community has a stable occupancy level with a steady income flow. The reason for this reliable cash flow is due to the very low turnover (about 5% annually) within MH communities. This compares to apartment turnover rates of close to 55%. The low rate of MH community turnover is due to the fact that it costs much more (approximately $5000 US) to leave a MH unit than it does to quit an apartment. Also, as mentioned earlier, in the event that a unit owner defaults on the chattel loan, the MH community owner's land rental payments are protected.

Because of the relatively shallow depth of the MH investment pool compared to other conventional property types, stronger investment in a particular metropolitan area may bid up asset prices and squeeze cap rates. Another risk is the depressing effect of higher apartment vacancy rates on rental rates, which in turn is likely to depress demand for rental substitutes such as MH units. This situation has been exacerbated by excess investor demand for rental units that has supported rental construction despite weak rental demand. Another concern is household debt burdens that have ratcheted higher, well into the expansionary phase of the current business cycle. As a result, households with mortgages or loans are particularly vulnerable to the effects of higher interest rates. Given that younger MH unit owners are likely to have significant debt relative to their incomes versus older owners (aged 55+), they are more exposed to the adverse effects of higher interest rates.

For those looking for alternative real estate investment opportunities, the manufactured home industry is definitely worth consideration. Longer-term demographic trends hold considerable promise for this maturing alternative to traditional housing. On the supply side of this business, local municipalities continue to have a negative view of MH communities, due to their potential negative effect on adjacent property values. Having said this, because there are relatively few major investors in this industry, prices have not been bid up to the same extent as in other more traditional housing sectors.

The foregoing is a condensed version of the report, Manufactured Housing Industry: Changing Perceptions, authored by Nancy Chesley, Senior Real Estate Economist, and Brian Lambert, Real Estate Economist, of PPR Fundamentals (Property & Portfolio Research, Inc.). To order the full 17-page report, including tables and graphs, please visit www.ppr.info.