Sun Communities, Inc.
Q3 2012 Earnings Call Transcript

Published: 25 Oct 2012

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities Third Quarter 2012 Earnings Conference Call on the 25th of October, 2012. At this time, management would like me to inform you that certain statements made during this conference call which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the company believes that expectations reflected in any forward-looking statements are based on reasonable assumptions, the company can provide no assurance that its expectations will be achieved. Factors and risks that could cause actual results to differ materially from expectations are detailed in this morning's press release form and, from time to time, in the company's periodic filings with the SEC. The company undertakes no obligation to revise or update any forward-looking statements to reflect the events or circumstances after the date of this release. Having said that, I would like to introduce management with us today, Gary Shiffman, Chairman and Chief Executive Officer; Karen Dearing, Chief Financial Officer; and Jeff Jorissen, Director of Corporate Development. [Operator Instructions] I would now like to turn the conference over to Gary Shiffman. Please go ahead, sir.

[Gary A. Shiffman:]

Thank you, operator, and good morning. Today, we reported funds from operations of $21.5 million or $0.71 per share for the third quarter of 2012, compared to $18.6 million or $0.75 in the third quarter of 2011. For the 9 months of 2012, FFO was $70.5 million or $2.39 per share, compared to $55.1 million or $2.32 per share in a similar period in the prior year. The results exclude transaction costs related to acquisition activity in all periods. Revenues for the 9 months increased by 17% from $212.7 million in 2011 to $248.6 million in 2012. The quick summary of the portfolio review for the quarter and year-to-date is that everything is going exceptionally well at the company. Occupancy in the first 9 months of 2012 has increased by 975 sites. This is nearly 100 more occupied sites than we added in the entire 2011 year. Total portfolio occupancy increased 150 basis points from 85.3% at the end of 2011 to 86.8% currently, including the addition of 218 newly developed but vacant sites from our expansions. Adjusting for these sites would bring our total portfolio occupancy to 87.1%. At our average rent, each site adds approximately $5,000 of annual revenue for the 30 or so years the home remains in our community. A number of our markets and communities with high occupancy and zoned land are being actively developed as expansions. Texas, with 98% occupancy at June 30, 2012, has opened 234 expansion sites, with an additional 1,000 sites to be added in 8 Texas communities during the next 12 months. Colorado, currently nearing 97% occupancy, will open 160 sites over the next year, and nearly 300 more sites will open as substantially full communities in North Carolina and Ohio. Woodlake in San Antonio and River Ranch in Austin, Texas both opened in September 2012 and gained 14 and 28 sites, respectively, in their first partial month. In the aggregate, expansions will add and supply about 1,500 additional sites in our strongest markets over the next year. Home sales continue to set new records at 1,253 for the 9 months. This is running about 15% ahead of our 2011 performance which, to date, has been the company's best year for home sales. Over 50% of the sales represents the conversion of renters into owners, and we continue to turn about 12% to 14% of our renters at the beginning of the year into owners. Growth in occupancy and home sales is a direct result of the traffic in our communities and is reflected in applications. We have over 20,000 applications through September compared to nearly 18,000 the same time last year and third quarter applications exceeded 7,000. This is the demand that results in strong occupancy and growing home sales in our communities. Applications have been steadily increasing year-over-year for the last 5 years and continue to reflect the increasing demand for affordable manufactured housing. Same site growth in revenue continues at nearly 5% top line, while growth in net operating income for the 9 months is just below 6%. This, of course, excludes the annual rental increases which, so far this year, are averaging 3% and the occupancy growth, as I just discussed. At this time, what I'd ask is that Karen briefly highlight some of the balance sheet items.

[Karen J. Dearing:]

Okay. So first, I'd like to talk a bit about dilution. The dilution has exacted a cost in FFO per share this year as we've issued about 8 million shares to strongly position the company for growth through acquisitions and expansion, and I'll share some of the facts about that impact of the equity offerings. As I said, our shares outstanding have increased by nearly 8 million, as we've raised approximately $300 million through the offerings. This has increased our available liquidity from $51 million at 9/30/2011 to over $200 million at 9/30/2012. Certainly, this substantially increases our ability to respond quickly to acquisition opportunities. During the past year, our outstanding debt has declined from $1,356,000,000 to $1,272,000,000. Our debt to total market capitalization percentage has declined from 62% to 48% and our debt to growth assets percentage has declined from 71% to 59%. Our EBITDA-to-interest ratio has improved from 2.2X to 2.6X and our EBITDA-to-debt ratio has improved to 7.7 from 9.6 in 2011. In addition, we've also continued to improve our payout ratio with an expectation that it will be in the low to mid-80s this year.

[Gary A. Shiffman:]

We expect that our FFO per share will return to solid period-over-period growth as we deploy our liquidity for acquisitions and investments. Our recently announced acquisition and financing of the Red Gate portfolio will deploy approximately $70 million of liquidity at favorable returns. In addition, we continue to see many attractive acquisition opportunities. We believe our acquisition pipeline remains full as the cost of rebuilding occupancy requires capital that current owners do not have or are not able to access. This problem has been compounded by maturing debt, new underwriting standards and lower NOI to underwrite for refinancings due to the vacancies in those communities. To summarize, business begins with demand and the demand for our product continues to be strong and growing. As we meet that demand, we continue to exhibit the pricing power which has driven our growth and profitability over time and through the most difficult times. And meeting that demand requires more sites and opportunities for residents. We are accomplishing this through the expansions we discussed and the acquisitions that are in our pipeline right now. And we have not lost sight of the need to manage and balance -- or manage our balance sheet and leverage, which continues to strengthen as we go through what we refer to as a transfer -- transformative time of the company. And Karen, Jeff and myself would be pleased to answer any questions, operator.

[Operator:]

[Operator Instructions] The first question comes from Andrew McCulloch.

[Andrew McCulloch:]

You guys spent a lot of attention in your press release on the RV business. Is there anything you see happening in the RV business that makes it more attractive to you today than it has been in the past? Or is that just kind of the product you're seeing come to market?

[Gary A. Shiffman:]

I think that the combination of the 2. I think that there are statistics showing that there is a lack of quality opportunities for the owners of RVs to actually find locations near the attractions that they want to be at. So in our strategic way of looking at acquisitions, we're looking to be at those places the RV travelers want to be at, so placing special focus on that. RVs, like the manufactured housing business, we believe, are coming off of a long slump and we expect to see a continuation of the growth of homes, of RVs being sold this coming year. So that was how it, I think, strategically improves the economies of scale that we have in place in our southern communities, so that we can put to work the staff and the systems that really are only fully engaged December through May, April, May, in the South. They can be fully engaged as we expand our Northern footprint. So I think it's a combination of increased demand and lack of good opportunities to have us focused on that kind of -- expanding that part of our business.

[Andrew McCulloch:]

And then on the $400 million in acquisition guidance that you talked about, can you give a little more color on whether that is mostly RV or mostly MH and are there any specific markets you're targeting?

[Gary A. Shiffman:]

Yes, I think that I comment that we are definitely looking to expand their geographic footprint. The company is heavily weighted in the Midwest, Southern Florida, Texas, Colorado. We are looking a little bit more towards the West and more towards the Northeast. And it would include equal representation in manufactured housing as RV. But I would also emphasize that in our press release, we're looking to expand what's roughly around 10% of rental revenues coming or the revenues coming from RVs now to roughly right around 20% short term, so we have a strong focus on RVs for the near term.

[Andrew McCulloch:]

Great. And just one more question on the balance sheet. You guys made some very good strides recently in improving your balance sheet metrics and prudently used equity that was trading well above many [ph] way to do it. Do you have any plans to continue to improve balance sheet metrics next year or are you kind of where you want to be?

[Gary A. Shiffman:]

Yes. And Karen can add anything, but I think we've shared with the marketplace that we're pretty much where we expect to be. The large amount of acquisitions as we expect them to be both accretive and debt neutral as we set our parameters. And I think that leaves us in a position, that Karen shared, with about $200 million of current capacity on our balance sheet. And if acquisitions go beyond that, then we'll have to take a look at what they warrant to maintain a debt neutral and accretive position.

[Operator:]

The next question comes from Jana Galan.

[Jana Galan:]

Following up on the plans to increase RV income, is 20% kind of adequate to get the scale that you'd like? Or would you want to grow that even further longer term?

[Karen J. Dearing:]

I think that's pretty adequate to get us where we're anticipating strategically.

[Jana Galan:]

Then just a quick question on more accounting. There's a gain on dispositions of assets. And I was curious if you sold any communities or sites or is this referring to home sales? It's about $1.4 million in the quarter.

[Karen J. Dearing:]

Is that -- Jana, are you looking at our FFO table? Is that where you're seeing that or...

[Jana Galan:]

Yes.

[Karen J. Dearing:]

Yes. That is a combination of sales of just the operating assets or actually the net book value of operating assets that have been replaced and also the gain on sale of the rental homes.

[Operator:]

The next question comes from Jeff Lau.

[Jeffrey Lau:]

I just had a question, I guess, in terms of -- historically -- I don't know if this was discussed in the past. But what -- in terms of Indiana, what keeps that state or that region more or less in terms of occupancy, I guess, compared to your overall portfolio?

[Gary A. Shiffman:]

Jeff, that is a very good question. And while it's been some time since we've discussed it, we have what we call the one-two punch there. It's a double hit. Obviously, the Midwest is still recovering from the strong recession. In particular, Michigan, I think, is outpacing many other areas in the Midwest that were deeply hit. But what happens in Indiana, it was also the absolute centerpiece of manufactured housing manufacturers. And when we saw manufacturing dip from about delivery of 370,000 homes in 1999 to what has been averaging 45,000 homes over the last couple of years, that manufacturing, that job market just absolutely dried up, especially in Goshen, South Bend and other southern areas of Indiana. And that has impacted actually occupancy in Indiana. And I will tell you that it's been slower than other parts of the Midwest to recover it's a large part of what's going on there as the result of what we just discussed. But we're starting to see an actual bottoming out of there. The inventory, the competitive housing seems to be drying up. The rental rates and multifamily seem to have stabilized and occupancies are increasing. So I think we'll start to see a lift in Indiana, but it's a much slower lift and it certainly would be buoyed by either increased manufacturing taking place in our industry or other industries in that Indiana market.

[Jeffrey Lau:]

Okay. And Texas, the sites that, I guess, the additional sites through the expansion, how are those coming along? Are those being filled? Are they still sitting -- kind of empty -- how are those looking?

[Gary A. Shiffman:]

They're looking very, very good. As we developed these sites, I'd share with everybody, we're very cautious to make sure that there's not only a high occupancy existing but continued strong demand as a backlog. We only open. We're doing very small expansions at any given community, so there's not too much exposure. And we pro forma fill up of absorption at 4 to 6 per community and we've been averaging somewhere around 8 per month. And as I shared with you in the 2 communities that we've opened in September, and on the first partial month, we were 2x to 3x what we expect in the normal monthly absorption. So we're feeling very, very good about the expansions. And what's certainly good there is that this expansion ground has been dormant for probably close to 12 to 14 years now. We have paid for it. We have paid the cost of entitlement and zoning and, in some cases, much of the front end loaning -- loaded development costs are in place. So as we fill these sites, the incremental revenue strongly drops to the bottom line. So it's nice to be able to share with the market that we anticipate opening 1,500 new sites over the next 12 months.

[Operator:]

The next question comes from Paul Adornato.

[Paul E. Adornato:]

Given the improvement in the balance sheet and given the continued success of the home rental business, I was wondering if it were possible or if you are considering increasing investment in the rental business?

[Gary A. Shiffman:]

It's a good question, Paul. I think that we've shared with the market the strategy that on a same site basis, we'd like, as much as possible, to be able to increase the purchase of new rentals by the amount of the conversion of home sales and redeploy that money in those communities to the extent that we expand communities or acquire communities with vacancy. That's where we'll continue investing more in the rental program. And it's kind of the same basis when we can buy a really quality community at a cap rate based on the existing NOI and get vacant sites that we kind of refer to as free with the acquisition based on the cap rate. We can then use the rental program to fill those vacant sites and then slowly convert those renters into owners at a rate of, as we said, about 10% to 12% per year.

[Paul E. Adornato:]

Okay. Are you meeting all demand, all qualified demand, I should say, with respect to the home rental business? Or are you having to turn people away?

[Gary A. Shiffman:]

I would say that, from what Karen and I know meeting with operations basically weekly on the rental program as we review purchases against sales and authorize budget spends, you will have areas that are continuing to show high growth and high demand such as Texas. And we're not meeting all that demand right now, obviously, with 97%, 98% occupancy. So the expansions will help us with that and we believe it will also helps us with next year's rental revenue growth rates. And it's a balancing act of not deploying capital. It'll stay idle in rentals and making sure it kind of meets the demand. So we're pretty balanced, with the exception of what would normally come up in unusual demands month-to-month.

[Paul E. Adornato:]

Okay. And just looking, I mean, given the kind of stabilization of the all-age community business, I was wondering if you're noticing an increase in institutional interest in this market, be it either more capital or more players looking for acquisitions out there?

[Gary A. Shiffman:]

I think that I would share with you that while our acquisition pipeline is very, very strong and I believe we're comfortable with our growth opportunities near term, there is definitely institutional capital out there today, recognizing, I think, the stability of cash flow from our industry, recognizing some of the opportunities there by the low cost of debt and leverage today and obviously, the fact that the capital marketplaces have strong operating capital. And while we have not encountered anything head-to-head with anybody, in particular that I point to, I am aware of transactions that are taking place out there and they're probably more aggressive as a result of that institutional capital being out there.

[Paul E. Adornato:]

Okay. That's helpful. And just one more question with respect to the customer experience. Has there been a better financing environment for customers looking to get into the product?

[Gary A. Shiffman:]

I would say that there is an improving environment out there and there is a lot of dialogue and discussion taking place with financial institutions that we are having at the company. And we would expect at least 2 new financing sources. One of them a very traditional banking group and the other one a finance company that have put forth structures and interest in entering into the financing. So I think it's going to continue to improve but putting that in reference where there has been almost minimal or no improvement over the last 12 years. Any improvement is big improvement at this point.

[Paul E. Adornato:]

Okay. And just to be clear, so the 2 new sources would be to help customers in general, not just ones at your properties?

[Gary A. Shiffman:]

That's correct.

[Operator:]

[Operator Instructions] We have a follow-up question from Andrew McCulloch.

[Andrew McCulloch:]

Just one follow-up on the rental program. You've been in this business for a while now. As you're selling the rental homes, do you notice any trends in which houses buyers are actually buying. Meaning, are they buying the newer houses in your inventory or the more discounted older inventory?

[Gary A. Shiffman:]

Andy, the sales of these homes are really pretty proportional to the vintage years of these homes in that rental portfolio. So that it's not like they're just buying the 2000 and more recent vintage homes. They're also buying the 1990 homes in the same proportion that they exist in our portfolio. Because we've monitored that pretty closely to make sure that, that's occurring in that fashion and that we're not building up a rental portfolio of very old homes.

[Operator:]

The next question comes from Michael Bill [ph].

[Unknown Analyst:]

In terms of -- you've mentioned the pipeline and we're -- obviously, we've made a lot of property acquisitions. Can you talk about the going in cap rates we're paying versus sort of a longer-term historical range of those? And I guess what I'm getting at is -- these look attractive, certainly relative to current interest rates and you mentioned the free spots. But where have you been -- at some point where debt matures in the future and there won't be near the spread we're getting today?

[Gary A. Shiffman:]

Sure. I think we've got to be cautious in all asset classes obviously, with what you just pointed out. I think I continue to share my thoughts on this particular industry probably even more so than many other asset classes. But the cap rates just have not changed a lot. I've been in the industry for, I don't know what it is now, 30-plus years, and you see that same range of the bottom end right around the 6 cap rates for the institutional quality communities, those that are high amenitized and at desirable locations. And you see it up to 9 cap rates in all-age communities that are older, have less amenities and probably some functional obsolescence. And the only change that I see to that is, as Paul or someone else on the call pointed out, from time to time, some form of institutional or other money will chase a certain property type or portfolio and must have more patient or less, a lower hurdle in their returns. But overall, between us and our competitors, I think you would hear similar scenario. We don't see a lot of cap rate compression and we don't see a lot of cap rate expansion. You could get to areas like, we talked about Indiana, that have just been sluggish for 10 years or other areas that have fundamental issues in their housing market or the job market. And then you will see increase in our cap rates. But generally, things don't change a lot. Everything that we're seeing that we're very interested is in that midpoint, probably of the low 7s and it will be slightly below that whether the quality is slightly higher and that's the more the challenge is with the property. The only thing I'd add in there for everyone's benefit is that we will seek properties that either have a lot of deferred maintenance, so that we feel we can put some capital improvements then and might pay a higher cap rate for some opportunity that we see. But other than that, I've shared my thoughts with you.

[Unknown Analyst:]

Two other quick things. What sort of average same site rental growth would you sort of hope to see over the next couple of years? And then what sort of payout ratio coverage to FIFO do we have to get at before we consider dividend increase or distribution?

[Karen J. Dearing:]

Well, with regard to the same site rent increases, we've been -- right around 3% for the past 3 years. And I would expect to continue at that level into the future.

[Gary A. Shiffman:]

As far as net [ph] rents, pretty robust.

[Karen J. Dearing:]

Certainly, we take a look at every year. It's a community-by-community look at what the market rates are, what the competitors rates are. Certainly, if we can push them higher, we will.

[Gary A. Shiffman:]

The difference between our sector and the apartments is that during bad times, apartment rents will be crashed and dropped significantly. We've never had to reduce rents in our portfolio, irrespective of the economic times. So we look for our annual increases in the 2.5% to 4.5% range, depending on the particular community and we don't have the crashing of rents during adverse economic times like the apartments have.

[Jeffrey P. Jorissen:]

And the only thing I would add to that, when we look at occupancy and we suggested that we believe our occupancy will approach or just exceed 90% in the upcoming year, I think that we have a history at around 94% occupancy, as Jeff was indicating, as I look back. We're able to begin to push our rental increases at that upper end that he suggested. And some of it's also tied to CPI and some of our portfolio, not a lot of it, but certainly in the retirement, it's tied more to CPI growth.

[Unknown Analyst:]

And then on the distribution coverage, where we might get to feeling comfortable to bump it?

[Gary A. Shiffman:]

Sure. I think that we've always shared that the Board reviews the dividend policy basically on a quarterly basis, but certainly at the end of each year in particular, and has shared kind of the concept that low 80% is an area where historically, they have viewed increasing the dividend. I think that the impact of all of the balance sheet items that Karen shared earlier, especially with regard to the equity that was raised this year, the decision was made to reduce leverage, to increase liquidity and to solidify the balance sheet. And there were some costs to a potential dividend that most likely would've taken place where the dilution not there for the shares that were issued.

[Operator:]

There appeared to be no further questions. Please continue.

[Gary A. Shiffman:]

Well, we'd like to thank you for participating on our third quarter call. We hope fourth quarter will be another positive quarter and look forward to the next call. And as always, Karen, myself, Jeff are available, if anyone would like to follow-up with us. Thank you.

[Operator:]

Thank you. This concludes the third quarter 2012 earnings conference call. Thank you for participating. You may now disconnect.