Sun Communities - Q1 2012

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities Gary Shiffman First Quarter 2012 Earnings Conference Call on the 26th of April 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 the 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 filing with the SEC.

The company undertakes no obligation to advise or update any forward-looking statements to reflect events or circumstances after the date of this release. Having said that, I'd 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. Throughout today's recorded presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. If any participant has difficulty hearing the presentation, please press the star followed by the zero on your telephone for operator assistance. I would now like to turn the conference over to Mr. Gary Shiffman. Please go ahead, sir.

Gary A. Shiffman (Chairman and CEO)

Thank you, Operator, and good morning. Today we reported funds from operations of $25.9 million or $0.90 per share for the first quarter of 2012, compared to $19 million or $0.83 per share for the first quarter of 2011. These results exclude acquisition-related costs incurred in each of the reference quarters. Revenues increased to $83.1 million in the first quarter of 2012, compared to $69.7 million in the first quarter of 2011. It was another excellent quarter for the company, as all performance metrics continued to meet or exceed expectations, and I will discuss a few of the most significant drivers of growth and then spend some time focusing on our markets and acquisition strategy. Revenue-producing sites in our same property portfolio increased by 147 sites in 2011, increasing occupancy from 84.8% to 86.1%.

An additional 147 revenue-producing sites were added in recently acquired communities, which are not yet included in the same property portfolio. So in total, we added 294 residents in this year's first quarter, compared to 143 in 2011's first quarter. In our same site portfolio, revenues grew by 5.3%, while expenses increased by 0.3%. NOI increased by 7.3% as compared to 4.2% and 1.7% in the first quarter of 2011 and 2010, respectively. NOI is also benefiting significantly from the continued momentum of quarterly occupancy gains. Home sales topped 400 for the first time in any quarter, improving strongly from the 357 sales in the first quarter of 2011. Applications continue to drive occupancy and sales, as nearly 6,600 people applied to live in our communities in the first quarter. This represents an annual rate of over 26,000, almost 3,000 more applications than in 2011.

And now what I'd like to do is review our markets, and as measured by revenues, approximately 85% of our business consists of open communities appealing to initial homemakers and those seeking affordable housing. It was the business segment which suffered most during the last decade, as the industry recovered from its underwriting excesses and combated the now-defunct single-family credit bubble. The same property NOI growth for this segment, which excludes age-restricted and RV communities, has nearly doubled from 2.7% in 2010 to 5.2% in 2011, as well as the first quarter of 2012. As rental increases have been relatively consistent over the years, this improved NOI performance is attributable to both greater stability of the existing occupancy and resurgent demand for our product in the all-age or open segment of the market.

Narrowing the focus to our Midwest portfolio, which are 100% open communities, a focus on same property NOI growth by region reveals an even stronger market recovery. The NOI generated by Michigan, Indiana, and Ohio, which is how we define our Midwest portfolio, grew by 0.2% from 2009 to 2010. That growth increased 14-fold to 2.9% from 2010 to 2011, and comparing the first quarter of 2012 to the year 2011, growth of an additional 50% brings NOI growth to 4.5%. Again, the above results are strongly supported by occupancy trends. Our Midwest same property portfolio accounted for 27% of the occupancy gains in 2010 and 39% in 2011. In the first quarter of 2012, the same property Midwest portfolio supplied 49% of the occupancy gains, and that really grows to 75% when we consider residents added to our recent Michigan Kentland acquisition.

Rental increases are also a major contribution to growth. A 3% rental increase on 45,000 occupied sites approximates $7 million per year. As we look at these markets, we identify three major markets in the company portfolio. Florida, with 12,500 sites, is notable for its stability and predictable and reliable growth. Florida's MH communities are essentially fully occupied, and the RV communities present opportunities of scale and market penetration to achieve greater seasonal occupancies. Texas and Colorado will have over 7,300 sites by the end of the year, as several expansions come online. Since 12/31/2007, these strong markets have added over 1,500 sites, growing to an occupancy which currently exceeds 96%. There are over 3,000 additional sites available for development in Texas and Colorado in future years. The Midwest portfolio, with 29,500 sites, was the hardest hit by industry and national downturns.

While Florida, Texas, and Colorado were primarily responsible for the company's growth over the last few years, it is, in fact, the Midwest market which is now driving our growth and will likely continue current trends noted above due to the availability of quality sites in strong locations and the bottoming of the economic cycle in this region. We are now benefiting from significantly improving performance of all three of our major markets, which are the primary generators of internal growth. In general, there are also three growth opportunities presented by acquisitions and expansions. As discussed on prior calls, the company has had a solid pipeline of acquisitions under review. We are also under various stages of expansions in seven communities in Texas, Oregon, and Colorado, where the communities are all full and demand remains strong.

Today, I thought I'd share with you the following examples that present some of the basic modeling that we look at: purchasing a fully stabilized community generating $800,000 of NOI at an 8-cap rate with revenue and expense growth estimated at 3% per year. The $10 million investment will be generating an unlevered return of approximately 9.3% after 5 years. The assumptions relative to expansions assume the development of land already zoned and owned by Sun. They involve constructing the sites, purchasing and renting homes to fill the expansion, and then selling the rental homes and thereby recouping the capital investment. The investment of expansion will be generating an unlevered return of approximately 11.75% 5 years after construction is completed. This return is over 25% greater than the return on the purchased stabilized community that we just reviewed. Now consider the acquisition of a 67% occupied community.

The assumptions here are a bit more intricate and include the use of the rental homes to initially fill the community, as well as a 9-cap rate at purchase due to the lower occupancy and assumed deferred maintenance and the need for capital improvement. The investment will be generating an approximate unlevered return of 12.5% after 5 years, more than 30% better than the return on the stabilized community. The lower the initial occupancy or the greater the available vacancies to match up against absorption and demand, the better the return will be. Our focus is a balanced approach to all three of these growth opportunities, with a current emphasis on the acquisition of communities with potential for solid occupancy growth. We own zoned land for expansions in our strongest markets and are active in developing those sites where occupancy is now full, and as I said, demand remains strong.

We believe these opportunities are becoming available because our owners cannot afford the cost of recapturing or regaining lost occupancy, and there is very little or limited third-party help from street dealers today. The rental program is profitable and critical to any community owner who wishes to maintain and build occupancy. Our experience with the program provides us with the capability to drive occupancy and cash flow in our expansions and acquisitions. We apply the same underwriting standards and background checks to rental applicants as we do to potential home buyers, and we're looking for solid rental residents who have the capacity to eventually become our residents and own the home. As a result, less than 50% of rental applications to live in our communities are actually approved. Our average return on capital in the rental program exceeds 16% after considering a vacancy factor and all direct rental expenses.

Manufactured homes today are built to last, very similar to site-built housing, and it's not unusual for an older or newer community to have a number of 30- and 40-year-old homes which are neat and well-maintained. Our rental homes undergo a thorough refreshing and refurbishing upon each lease turn to restore them to like new, all of which is expense. It is because of this program to maintain asset quality that our homes retain their value during the average of 7 years that a home is in the program before it's sold. Upon the sale of a rental home, the owner then pays site rent that approximates $5,000 on average annually, and we have received all or a substantial portion of the capital we had invested in the home.

The goal of the rental program is to fill sites where residents reside for 14 years on average, and the home remains in the community, generating a revenue stream for 30-40 years. We also benefit from being relieved of all maintenance costs on the homes upon sale. It's the success of this program which allows us to aggressively expand our communities and seek to buy communities with opportunities to increase occupancies, which in turn enhance and accelerate growth. So let us now turn to the 2000 acquisition of the Kentland portfolio in Western Michigan and the role the rental program has played as it relates to that acquisition. Kentland consists of 18 communities comprised of 5,200 sites in Western Michigan. When we acquired the Kentland portfolio, it was approximately 80% occupied and had no rental program.

By utilizing the rental program and our performance by utilizing the rental programs, our performance projected the occupancy to increase to 92% within three years and NOI growth of about $3.5 million. That objective for increased occupancy was broken down by year for the first three years at 240 sites, 248 sites, and a 94-site increase in occupancy, totaling 542 sites. I'm pleased to announce that in the first nine months of ownership, we have added 289 sites of occupancy, equal to 53% of our three-year objective. The fill at the rate of 32 sites per month means that each month we are adding $150,000 of annual revenue, nearly all of which translates into funds from operations. So in summary, our primary markets are exhibiting strong internal growth from both rental and occupancy increases.

Our expansions and acquisitions are outperforming pro formas due to strong demand, and we are looking at numerous acquisitions which meet our criteria. With regard to FFO, we reaffirm guidance of $3.17-$3.27 per diluted share, and we note, as with prior years, our first quarter FFO is expected to be our strongest due to seasonal RV revenues, which are primarily recognized in the first and fourth quarters. At this time, myself, Karen, and Jeff would be pleased to take any questions.

Operator (participant)

Thank you, sir. If any participant would like to ask a question, please press the star followed by the one on your telephone. If you wish to cancel this request, please press the star followed by the two. There'll be a short pause whilst participants register for a question. Your first question comes from Paul Adornato. Please state your company followed by your question.

Paul Adornato (Managing Director and Senior Research Analyst)

Hi, this is Paul Adornato from BMO Capital Markets. First, just to follow up on the seasonality comment, I was wondering if you could quantify the seasonality that the company currently experiences in the fourth and first quarters compared to the rest of the year.

Karen J. Dearing (CFO)

Sure, Paul. We have about $29 million in RV revenues, and $10 million of that is seasonal. That seasonal revenue is recognized about 45% in Q1, 24% in Q4, and 18% in Q2, and 13% in Q3.

Paul Adornato (Managing Director and Senior Research Analyst)

Okay. Great. Thanks. And looking at operating expenses, we're very low this quarter. I was wondering what kind of operating expense growth we might expect or what would be a good run rate to use?

Karen J. Dearing (CFO)

Good question, Paul. I would say that, yes, our operating expenses for same site were a bit lower than what was expected for the first quarter. If I look forward, I would expect that total NOI growth for the remainder of the year, each quarter, would be less than the 7.3% that we experienced this year.

Paul Adornato (Managing Director and Senior Research Analyst)

Okay. Finally, you talked about getting more and more applications for the rental program. I was wondering if you could provide an update as to the conversion rate of renters to buyers over time, if that's been seen a better conversion rate over time.

Karen J. Dearing (CFO)

That conversion rate has been between 12% and 15% a year.

Paul Adornato (Managing Director and Senior Research Analyst)

It has remained steady?

Karen J. Dearing (CFO)

Yes.

Paul Adornato (Managing Director and Senior Research Analyst)

Okay. Great. Thank you.

Gary A. Shiffman (Chairman and CEO)

Thank you. Next question comes from Todd Stender. Please state your company followed by your question.

Todd Stender (Analyst)

Hi, Wells Fargo. Thank you. First question, can we get a little more information on the 3 Florida RV communities you purchased in the first quarter? Maybe just include occupancy, give us some rates maybe, and then pricing. Maybe how you look at this on a cap rate basis or price per site.

Jeff Jorissen (Director of Corporate Development)

Sure. I think you're going a little bit back on our memory only because the acquisition closed in two parts. The first part was three communities in the fourth quarter and the three remaining communities in the first quarter of this year. Karen, do you have anything?

Karen J. Dearing (CFO)

The portfolio had about 1,100 RV sites, a significant portion of which were seasonal RVs. So I think there's about.

Jeff Jorissen (Director of Corporate Development)

Looks like 40% permanent.

Karen J. Dearing (CFO)

40% permanent.

Jeff Jorissen (Director of Corporate Development)

The rest seasonal. I'm going back in my notes, and I just did just find something that was right around an 8.5 cap rate.

Todd Stender (Analyst)

Okay. Just in terms of the loan, you guys, there's a $19 million loan that came along with that. Can you just give us the terms if there's a maturity date coming up on that?

Karen J. Dearing (CFO)

That loan is a 5-year loan. It comes up in December of 2016, and it's 2.74%, I believe.

Todd Stender (Analyst)

Okay. Thank you. The proceeds, have you finished allocating the proceeds from the January equity offering? Is there anything left that might impact maybe the results for this year, any dilution?

Jeff Jorissen (Director of Corporate Development)

No. None that wouldn't have been modeled into guidance.

Todd Stender (Analyst)

Okay. Thank you. Regarding the Kentland portfolio, can you just maybe go into some of the drivers behind the better-than-expected top line and NOI growth? What's really contributing to that?

Jeff Jorissen (Director of Corporate Development)

Sure. I think we've shared the concept of a lot of what's taking place in our Midwest portfolio. The bottoming out of the economy, if you will, the flight of those that didn't have jobs seems generally to be over. The uncertainty of expenditures and commitment to want to stay in the area has resided. So there's a stronger-than-ever demand for the affordability feature, if you will, in the Midwest we're finding. And making the home inventory available through the rental program has just surprised us as to how rapid and how strong the growth has been and probably going to allow us to accelerate rents in the area a little bit faster than anticipated.

Todd Stender (Analyst)

Okay. Final question, can you just go into maybe some of the seasonality of your CapEx? The first quarter number looked a little light. Can we expect that quarterly run rate to ramp up as the year progresses?

Karen J. Dearing (CFO)

Yes. You'll generally see CapEx increasing most significantly in the third quarter. But I would say as a run rate, we gave guidance of about $8.4 million, and we would expect that to come in at that dollar amount by the end of the year.

Todd Stender (Analyst)

Okay. Thank you.

Operator (participant)

As a reminder, if you would like to ask a question, please press the star followed by the one on your telephone. The next question comes from Jeff Blair. Please state your company followed by your question.

Jeff Blair (Analyst)

Hi. Good morning. Sidoti & Company. The first question was touching on the G&A, how it kind of dropped a little bit this quarter. I guess you guys talked about guidance, reaffirming guidance. Is the G&A, I guess, real property still expected to be around $19 million this year?

Karen J. Dearing (CFO)

Yes, it is. I would expect the remainder of what hasn't been incurred through March 31st to be pretty ratable over the three quarters.

Jeff Blair (Analyst)

Okay. And then I guess everything else since you're reaffirming guidance, I guess, in terms of home sales and occupancy still remains the same?

Karen J. Dearing (CFO)

Correct.

Jeff Blair (Analyst)

Okay. Thanks.

Operator (participant)

Thank you. As a final reminder, if you would like to ask a question, please press the star followed by the one on your telephone. Thank you. There appear to be no further questions at this time. Please continue.

Gary A. Shiffman (Chairman and CEO)

Thank you, operator, and thank you everyone who joined us today. We look forward to reporting results after the next quarter. As always, both Karen, myself, and Jeff are available at the company for any further follow-up. Thank you.

Operator (participant)

That concludes the Sun Communities first quarter of 2012 earnings conference call. Thank you for participating. You've had.