Trailer Trash

DON'T EXPECT THE lowest rung of the housing ladder to be any better than the top.

The housing market is cooling, and some of the largest names on the luxury end of the scale are hurting. On Wednesday, for instance, Toll Brothers (TOL) reported that orders fell by nearly half from a year ago.

That may have some investors looking for safety downscale, turning to the manufactured-home market. Under one theory, more homeowners will move to mobile and prefab homes as interest rates rise and they get priced out of traditional houses.

But, as in a tornado, there's no safety in mobile homes. In fact, most on Wall Street think it's a good idea to take a pass on many of the small-cap names that make up the sector.

"I don't necessarily think people will gravitate toward manufactured housing," says Robert McMillan, who covers the manufactured housing market for Standard & Poor's. "I'm not predicting a recovery anytime soon."

Manufactured homes, as their name implies, are built in a factory, unlike conventional homes built on site. The industry has come a long way from trailer parks filled with "single-wide" and "double-wide" mobile homes. Today, the communities appear more upscale with classic-looking homes of 1,500 square feet and three bedrooms.

Typically, manufactured homes appeal to lower-income people. But, over the past five years, the combination of low mortgage rates and small down payments made conventional homes more affordable. But, the hope in the industry — which includes such stocks as UMH Properties (UMH), Equity Lifestyle Properties (ELS), Affordable Residential Communities (ARC), American Land Lease (ANL) and Sun Communities (SUI) — is that rising rates will again bring those lower-income people back into the manufactured fold.

"The industry has been in an era of home prices increasing rapidly and the ability to finance has been relatively easy, but that has come to an end," says Eugene Landy, chief executive officer of UMH. "When that stops, the public can only buy homes they can afford. That's when our products become attractive. The reason to buy a manufactured house is because it's all you can afford."

To be sure, there are some advantages to the model. For one thing, there's a steady revenue stream since many of these companies operate as real estate investment trusts (REITs). Unlike with a conventional home, owners of mobile homes don't own the land the house sits on. Instead, homeowners rent the lot from the REIT, while also paying off their mortgage.

There are some signs that the manufactured home market is recovering. Since hitting peak sales of 373,000 units in 1998, sales fell to 130,000 units in both 2003 and 2004, according to the Manufactured Housing Institute, an industry trade group. Last year, though, sales jumped to 145,000 units sold. However, there's a catch: Had the Federal Emergency Management Agency not ordered 25,000 homes in the wake of Hurricane Katrina, sales might actually have fallen.

Things are tough throughout the housing sector. Sales of new on-site homes fell 3% in June from May to a seasonally adjusted annual rate of 1.13 million units, according to the Census Bureau. Sales of existing, or previously owned, houses fell 1.3% in June. For 2006, the National Association of Realtors projects total sales will decline 6.5% from last year, with sales of new homes falling a sharper 12.8%. By comparison, manufactured homes look like they're on a tear: For the first six months of 2006, sales of manufactured homes rose 1.7% over the year-ago period.

But there's no guarantee that there will be any real strength in the manufactured-housing business because of weakness elsewhere. "People who can't buy conventional homes don't have to move into manufactured homes," says David Rodgers, an analyst at New York investment bank RBC Capital Markets. "There are alternatives. Apartments are still affordable compared to single-family homes."

Financially, many of the stocks in the sector still need to show that they can consistently deliver on the bottom line. On Wednesday, UMH posted second-quarter net income of $1.2 million, or 12 cents a share, a 47% increase over the $828,000, or nine cents, earned in the year-ago quarter. Revenues rose 11% to $10.3 million.

However, for the six months ended June 30, net income only rose 2% to $3.4 million from $3.3 million. In 2005, UMH, based in Freehold, N.J., earned $6.99 million, or 74 cents, down from $8.2 million, or 95 cents, the previous year, even as sales rose 15% to $39.3 million. The stock, which has traded between $12.50 and $17.50 for the past four years, is down 3% year-to-date to $15.48, as of Wednesday. However, it has increased its dividend for the past 14 years, to an annual 98 cents a share.

By comparison, Sun Communities and Affordable Residential Communities, posted net losses for the past two years. Sun also posted a loss for the first six months of 2006, while ARC posted $2.8 million second-quarter profit after a $1.4 million loss in the first quarter.

Even market leader Equity Lifestyle Properties — in which billionaire Sam Zell, the nation's biggest landlord, is chairman and owns a 0.5% stake — posted a net loss in 2005, after three years of declining profits. Unlike UMH and Sun, which cater to families of all ages, Equity builds stylish retirement communities with many amenities. Still, second-quarter profits at Equity Lifestyle fell 51% year-over-year to $1.2 million.

And results could worsen if the rest of the companies in the broader real-estate sector gets their houses in order quicker than the trailer set.

"I don't necessarily think a weakening housing market spells good news for manufactured housing because builders of traditional homes will cut their prices to become more competitive with manufactured housing to liquidate inventory," says S&P's McMillan. "I just don't see the catalyst for people to all of a sudden start buying manufactured homes."