UMH Properties: The 7.1% Yielding Preferred Shares Are Attractive (NYSE:UMH)

Introduction

UMH Properties (NYSE:UMH) is one of the largest operator and owner of manufactured home communities: it leases home sites to residential homeowners. Unlike the better-known MHC REITs, UMH focuses on the more ‘industrial’ states in the US where it provides affordable housing solutions to lower income families.

The FFO is pretty strong, and the balance sheet is solid

For a good and very recent overview of UMH Properties, I’d like to refer you to this article from Gen Alpha. I agree with his general thesis that UMH is now cheap enough to have a closer look but in this article, I’d actually like to focus on the preferred shares issued by UMH. While preferred shareholders generally don’t participate in increasing share prices of the common units, they do provide a stable quarterly dividend.

Over the past few years, UMH continued to grow, and currently owns an asset base of roughly 25,000 lots in 132 communities.

Expansion requires funding, and in 2018, the REIT issued the Series D preferred shares, which will be the focus of this article.

While the net income reported by a REIT is not terribly important, it does act as a starting point for the FFO calculation. We see UMH reported a net loss of $9.7M during the third quarter but this appears to be mainly related to a $5.2M loss on the sale of certain assets while the REIT also lost about $7.6M on its marketable securities. And of course, the $12.3M quarterly depreciation expense also weighs on the bottom line of the income statement.

The NOI and FFO calculations are more important to determine UMH’s ability to pay dividends and preferred dividends. The NOI was pretty easy to determine, and came in at $23.7M in the third quarter.

The FFO calculation starts with the attributable net loss of $9.75M attributable to the common unitholders of the REIT and after adding back the depreciation expenses and the losses on the marketable securities, the FFO was $10.3M. There also was an additional $1.4M non-recurring other expense which means the underlying and normalized FFO was $11.7M.

There are currently 55.7M common units of the REIT outstanding (as UMH continues to issue new shares using its ATM program), resulting in a normalized FFO of $0.21 per share. I expect the FFO to increase in 2023 as UMH should be able to continue to push through rent hikes.

This gets me interested in the preferred shares

As mentioned before, UMH Properties issued an initial 2 million cumulative preferred shares Series D in 2018. This series offers a preferred dividend yield of 6.375% based on the $25 principal amount which means this security pays $0.3984375 per share on a quarterly basis. Subsequent to the initial public offering, UMH increased the size of its issue and as of the end of September, there are about 8.62 million preferred shares outstanding. This means the current quarterly preferred dividend payments require approximately $3.45M in cash.

The total amount of preferred dividends paid in Q3 ($4.6M) is higher than the aforementioned $3.45M as UMH retired another series of preferred shares during the quarter. I expect the Q4 financial statements to effectively show a reduction in the preferred dividends to roughly $3.5M. This also means the normalized FFO in Q3 before taking any preferred dividends into consideration exceeded $16M. This means that going forward, the coverage ratio of the remaining preferred shares should be almost 500%.

So based on the current performance of the REIT, I would say the preferred dividends are safe.

We see the total balance sheet size is just under $1.3B, of which $755M is liabilities. The equity value on the balance sheet is just $509M, of which $215M is coming from the preferred equity.

Seeing the preferred equity representing in excess of 40% of the total equity is quite high. But I would like to argue the accumulated depreciation of the investment properties means the book value is too low versus the market value.

Based on the $972M book value of the assets and knowing the most recent quarterly NOI exceeded $23M, the properties are valued at just under 10 times the NOI. That’s too low, even for an MHC REIT. Even if you would apply a multiple of 12.5 times the annualized NOI (which will soon enough increase to $100M), you’d end up at a fair value of $1.25B (using the aforementioned updated $100M NOI) or almost $300M above the current book value. This means the total amount of equity ranked junior to the preferred shares would increase from less than $300M to $575M.

Investment thesis

UMH Properties just hiked its quarterly dividend by 2.5% to $0.205 for an annualized yield of almost 5%, I also like the REIT’s preferred shares. The 6.375% yielding preferred shares ended the trading day at $22.52 on Wednesday, resulting in a yield of just under 7.1%.

And although preferred shareholders don’t participate in increasing share prices of the common units, the higher dividend income and the additional layer of safety knowing there’s hundreds of millions of dollars in junior equity could provide additional peace of mind.

I currently have no position in any of UMH’s securities, but I am putting the preferred shares high up on my radar. The risk/reward ratio looks acceptable and the risk to see the preferred shares being called is rather low as UMH would have to issue common shares or a new series of preferred shares to finance that operation and I just can’t see that happen. And if – against all odds – UMH does decide to call the preferred shares, I’m more than happy to take the 10%+ capital gains and redeploy the cash elsewhere.