Sun Communities - Q2 2011

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities Q2 2011 Earnings Conference Call on the 28th of July 2011. At this time, management would like me to inform you that certain statements made during this conference call will, 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 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, and Karen Dearing, Chief Financial Officer. Throughout today's recording presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. If you would like to ask a question, please press the star followed by the one on your touch tone phone. If you would like to withdraw your question, please press the star followed by the two, and if you are using speaker equipment, please lift the handset before making your selection. I would now like to turn the conference over to Gary Shiffman. Please go ahead, sir.

Gary Shiffman (Chairman and CEO)

Thank you, operator, and good morning, everyone. Today, we reported funds from operations of $17.5 million or $0.74 per share, the Q2 of 2011, compared to $14 million or $0.66 per share the Q2 of 2010. For the first 6 months of 2011, FFO was $36.5 million or $1.57 per share, compared to $31.7 million or $1.50 per share in the first half of 2010. These results include approximately $0.01 of contribution from our acquisitions and a $0.04 adjustment for a reduction in fees to Fannie Mae, of which $0.02 relates to Q1, non-acquisition costs and other items, as noted in the table of the press release.

Turning to our core portfolio, occupancy grew by 287 residents in the quarter, an increase of nearly 50% from the Q2 of 2010, and by 430 residents for the first half of the year. The quarterly growth represents the largest revenue-producing site increase in a single quarter since the Q1 of 2005. Anticipated RPS growth is now running at nearly 3x the entire cumulative RPS growth achieved during the 2005 to 2010 period. Same site occupancy of 85.3% reflects a 1% increase in occupancy in the past 12 months and bodes well for the attainment of portfolio occupancy levels of over 90% in the next 3 to 5 years.

The rental program currently comprises over 6,400 residents, and the weighted average monthly rental rate has increased by $12 from $735 at the end of 2010 to $747 per month at the end of the Q2. We continue to receive applications at an estimated annual rate in excess of 22,000. The strong continued flow of applications are our best indication of increased demand for both our rental and sales programs. Home sales remain strong. During the first 6 months of the year, we sold 719 homes, as compared to 732 home sales in the first 6 months of 2010.

Home sales for the quarter were 362, as compared to 407 for the Q2 of 2010, a decline of approximately 11%. Our home sales budget and forecast for the entire year anticipate significant year-over-year sales for the second half of the year, resulting in overall year-over-year home sale growth of approximately 10%. We continue to also successfully convert home renters into homeowners as we have sold 416 rental homes during the first 6 months of the year, an increase of 6% from the prior year. Turning to same-site results for the Q2, they reflect another quarter of significant growth as net operating income increased by 3.6%, bringing NOI growth for the year to 3.9%.

Strong revenue growth of 3.3% reflects the contribution of both occupancy gains and our 2.7% annual rental increase. Halfway through this year, we are now ahead of our year-to-date budgeted targets for NOI growth. The Q2 FFO per share of $0.74 represents quarter-over-prior-year-quarter growth of about 12%. On an annual basis, we have been growing FFO per share at an average of 3.2% from 2005 to 2010. In 2010, FFO grew 3.8%, which was above the 5-year average as the momentum from RPS gains from 2009 and 2010 began to have an impact. This growth was accomplished predominantly through annual rental increases and occupancy gains in our core portfolio.

Including the accretion from the acquisitions just closed, 2011 FFO per share growth may approximate 5% to 6% prior to acquisition costs. We expect stronger FFO growth when the impact of our planned expansions and a full year of accretion from our acquisitions are included. Our first expansion in nearly a decade was opened in Firestone, Colorado, in Q3 of last year. The lease-up for this 124-site expansion has been six per month, which actually exceeds the pro forma lease-up rate by about 50%. We are currently planning for the expansion of six of our Texas communities, which are at, or nearly at, 100% occupancy. We expect to complete over 725 sites in the next 12 to 14 months.

If we were to assume a lease-up rate of 3 per month, a typical 100-site expansion produces unlevered returns of approximately 9% when fully occupied. This translates to about $0.02 of accretion. Given the 725 planned expansion sites, we would expect about $0.14 of accretion. Of the over 6,200 sites available for development, over half are located in our Texas and Colorado markets. During the Q2, we acquired a total of 19 communities. In May, we acquired a recreational vehicle community, or an RV community, in Orange City, Florida, containing 525 developed sites for about $6.5 million in cash. The property was later financed as a part of a larger debt transaction.

In late June, we completed the Kentland acquisition, inclusive of 18 communities, 291 homes, and a portfolio of notes receivable for a total of approximately $143 million. The community contained approximately 5,490 sites. The transaction included the assumption of $52.4 million of debt, the payoff of $24.8 million of existing debt, and the issuance of $45.5 million of convertible preferred operating partnership units. The payoff of existing debt was largely financed by $22.9 million of new debt placed on 5 Kentland properties and the Orange City RV community. These acquisitions are estimated to be accretive to our existing 2011 guidance by approximately $0.10 to 0.13, excluding acquisition costs.

We continue to look at acquisition opportunities and currently have executed on a letter of intent on a community located in Texas. Along with implementing strategies for incremental internal and external growth, we have also been working diligently on transactions to strengthen our balance sheet. As of January 1st, 2011, we had $695.5 million mortgage debt maturities coming due in the next 5 years. Exclusive of acquisition financing activity, the refinancing transactions that have been completed to date have decreased the amounts due in the next 5 years by $473.8 million to 221.7 million, and we accomplished this through the following transactions.

During the quarter, we completed a $23.6 million CMBS financing transaction, which replaced currently existing debt on three properties scheduled to mature in 2012 and extended that debt to a maturity of 2021. In July, we reached a final agreement with Fannie Mae and PNC Bank to settle the litigation we commenced concerning certain fees charged on our $152.4 million variable rate facility. Among other things, the terms of the agreement provides us the option to extend our entire $367 million facility until the year 2023, subject to certain new underwriting criteria. Previously, the facility had maturity dates of 2014 and 2015.

So the effect of these transactions, along with the $115 million CMBS financing we completed the Q1, more than doubled our weighted average debt maturity on mortgage debt from 3.7 years to 7.6 years. The settlement with Fannie Mae also provided for a reduction in the facility fee charged on our variable facility. the effect of which lowered the interest expense for the first 6 months of this year by approximately $840,000. The final piece of 2011 maturing debt is our $115 million line of credit. We have been working diligently on the renewal of this and are optimistic about our ability to renew the $115 million line on terms that are comparable to the current market.

Further strengthening our balance sheet is the issuance of nearly $110 million of equity and the issuance of convertible preferred operating partnership units during the last 12 months. Based on performance year-to-date and accretion from our acquisitions, we are revising 2011 FFO guidance to $3.10 to 3.16 per share, excluding acquisition costs. At the midpoint of revised guidance, our payout ratio is anticipated to be approximately 90%. At this time, both Karen and I would be pleased to answer any questions.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question, please press the star followed by the one on your touch-tone phone. If you would like to withdraw your question, you can press the star followed by the two. If you're using speaker equipment, please lift the handset before making your selection. Our first question is from the line of Stephen Mead. Please go ahead.

Speaker 3

Yes, good morning.

Gary Shiffman (Chairman and CEO)

Good morning, Stephen.

Speaker 3

If I could just, can you talk a little bit about when you talk about the accretion from the acquisition, what assumptions you're making in terms of, what the profile of those properties are today and what you can manage them to? I mean, does that accretion include certain assumptions about that? And then I had just a general question. As I look at the different occupancy levels across your different states, and also your acquisition was in Michigan. Michigan has the lowest occupancy. But I was wondering how much variation there is in net interest - not net interest margin, but net operating margin, as you increase the occupancy?

Gary Shiffman (Chairman and CEO)

Okay. So, taking your first question, I think we’ve shared on previous calls that the Kentland transaction, we feel, will be very accretive for growth to the shareholders based on the fact that the previous owners had limited capacity for capital investment into the rental program.

Speaker 3

Mm-hmm.

Gary Shiffman (Chairman and CEO)

Basically, there were no rentals in the community. As part of our strategy to grow FFO, we anticipate operating a rental home program in many of those communities, as well as continued sales efforts, which they've been very successful at within those communities. We have basically taken the previous historical NOI, placed our anticipated rental increases for the coming year into our model, showed no significant growth for the first 6 months. Then, in the second half of our model year, we show about an increase in occupancy of three sites per community for about 14 of those communities going forward, till a 90+% occupancy rate has been achieved. That's pretty similar to our experience with our Michigan portfolio.

In Michigan, as we've shared previously, on our calls, we have been experiencing a very rapid occupancy growth, similar to Texas, where we're also strong because of the strong demand for affordable housing. And we attribute much of that in Michigan to the uncertainty of what was taking place in the automotive world having gone away over the last couple of years, the stabilization of the job market, those who have lost jobs in the Michigan area and have moved or were reticent about spending because of the uncertainty. That seems to have stabilized into a base of customers that are leasing sites from us. And I think that our expectation is that will continue based on everything we're seeing right now.

Karen Dearing (CFO)

Stephen, if I can just add that if you look at our revenue-producing site growth for this first six months of the year, 50% of that revenue-producing site growth has occurred in Michigan, Indiana, and Ohio. So we feel pretty strongly about the occupancy increases we can gain in that portfolio.

Speaker 3

And then the variability of margin or profitability across the different states, in terms of, you know, if I look at Indiana with a 67% occupancy and Michigan with an 81%, how would you-

Karen Dearing (CFO)

You know, I don't really-

Speaker 3

Margin?

Karen Dearing (CFO)

Okay. I don't really have that information by state, but how we look at the portfolio really is that many of our operating expenses are fixed really. And when you add sites, you're just adding incremental revenue. When we do projections, we put, you know, potentially a 10% increase in expenses based on that revenue. But in general, our the expenses to run a community, to have personnel on site, isn't going to change if you're adding sites or adding occupancy.

Speaker 3

Okay.

Gary Shiffman (Chairman and CEO)

I would say a good rule of thumb is, we look for, roughly around 85%, incremental dollars drop to the bottom line. And 10% to 15% is about what we anticipate from filling sites, both on an expansion side, and that's where you get the 15%, because things like insurance, and other, fixed costs might go up slightly, but the overall fixed costs of management and personnel at the property, are all in place.

Speaker 3

Okay. I'll turn it back, and then I'll ask you other questions later.

Gary Shiffman (Chairman and CEO)

Sure.

Operator (participant)

Thank you. The next question is from the line of Paul Adornato. Please go ahead.

Speaker 4

Was wondering if you could talk about the home sales that you expect for the rest of the year, down year-to-date, but you expect there's still a very healthy increase year-over-year. What's the dynamic at work there?

Gary Shiffman (Chairman and CEO)

Yeah, I think the only reason we're down to date, April-to-April, was the only funny month. And if you remember last year, April ended the big home buying incentive the government had, so I think we attribute it to that. But every other month, basically this year has been to budget or above last year.

Speaker 4

Mm-hmm.

Gary Shiffman (Chairman and CEO)

Based on the applications that are coming in and the orders on hand, I think we anticipate approximately. I don't want to get this number right. This is,

Karen Dearing (CFO)

Total sales?

Gary Shiffman (Chairman and CEO)

Yeah.

Karen Dearing (CFO)

1,525.

Gary Shiffman (Chairman and CEO)

1,525 sites for the year, and then reforecast that was done as recently as last week, Paul. All operations felt comfortable with it.

Speaker 4

Okay. And do you expect them to be balanced between new home sales and rental home sales?

Gary Shiffman (Chairman and CEO)

I don't have that breakdown.

Karen Dearing (CFO)

No, the sales will generally be pre-owned home sales, which are inclusive of both the rental homes and just regular pre-owned homes. The new home sales have been not very significant over the past several years, and we wouldn't expect that to change.

Speaker 4

Right.

Gary Shiffman (Chairman and CEO)

I'll say, of that number, is it 800 to 900, roughly, or...

Speaker 4

Right.

Karen Dearing (CFO)

865 of them are rental homes, Paul.

Speaker 4

Okay. Okay, great. That's the number I was interested in. And then, looking at the rental business, if you were to look at the rental applications, both in terms of the gross number of applications coming in, as well as the credit quality of the applicants, could you just talk about those trends and what you're seeing among the folks that are looking to rent?

Gary Shiffman (Chairman and CEO)

Yeah, I'd simply say that we have always underwritten our renters as buyers in our F&I department, and that's something that has helped us to, you know, successfully navigate through a difficult process of being in the rental business. So we see pretty steady credit as we've seen, you know, for the last couple of years, as we've seen the improvement, and not a whole lot has changed there. Of the over 20,000 applications we get in, the vast majority are for rental.

Speaker 4

Mm-hmm.

Gary Shiffman (Chairman and CEO)

We've always looked at that as our ticket, if you will, to take those qualified buyers and move them into homeownership and show them how it can be much more cost-effective for them. So nothing's changed too much, in excess of 75% of all the applications come in for rental.

Speaker 4

Mm-hmm. And what's your acceptance rate of those applications?

Karen Dearing (CFO)

It's about 50%, Paul. It's been running that for the past several years.

Speaker 4

Mm-hmm. And no change in your, underwriting criteria? That is, are you using the same cutoff, if you will?

Karen Dearing (CFO)

No change in the underwriting criteria.

Speaker 4

Okay. Thank you.

Gary Shiffman (Chairman and CEO)

Just of the 50%, how many actually go to closing?

Karen Dearing (CFO)

I don't have that sheet in front of me.

Gary Shiffman (Chairman and CEO)

I think it's about half of the 50%, around 25% to 30% actually do go to closing that are actually approved.

Speaker 4

Okay, got it. Yep. Thank you.

Operator (participant)

Thank you, ladies and gentlemen. If there are any additional questions, please press the star followed by the one at this time. As a reminder, if you are using speaker equipment, please lift the handset before making your selection. The next question is from the line of Andrew McCulloch. Please go ahead.

Speaker 5

Good morning, guys. This is Chris Van Ens in with Andy. First question, with the settlement of the Fannie litigation, are you guys still capped out with them, or are they willing to lend more to you moving forward?

Gary Shiffman (Chairman and CEO)

I think that we have an excellent relationship with them. I think that it was recognized that the litigation was over something that quite possibly was out of their hands at the time. Fannie Mae was going through what they were going through. So the mediation, the settlement was very reasonably discussed around the table subsequent to that settlement, there was Fannie Mae debt on the Kentland acquisition, and that exceeded any floor or any ceiling they had put on us before. Our expectation is Fannie will continue to work with us going forward, and we will take advantage of any opportunity of debt through them.

Speaker 5

Okay. Then secondly, you know, you guys have been pretty aggressively tapping the CMBS market over the past two quarters. Are you guys still in that market, and have you seen spreads start to gap out at all?

Gary Shiffman (Chairman and CEO)

We are not in that market right now. I think we've completed the transactions that we needed to complete. Again, our focus right now is on the renewal line of credit. And, in between our first CMBS and our second, we saw a little bit widening of spreads, and then we saw them come back in just towards closing. So I'm not current at this particular time on where they're at.

Speaker 5

Okay, thank you. That's all for me.

Operator (participant)

Thank you. The next question is a follow-up from the line of Stephen Mead. Please go ahead.

Speaker 3

Yeah, I'm just looking at the page 12 of the supplement, and the question I was on move-outs and what the seasonal pattern of move-outs is. And, you know, those have been trending very well, but you had, you know, basically 400 move-outs as of June 30th, which compares favorable to last year on an annualized basis. But I was wondering, just seasonally, how does that tend to work for you?

Gary Shiffman (Chairman and CEO)

What page are you at?

Speaker 3

Page 12 of the supplement. It has operating statistics-

Gary Shiffman (Chairman and CEO)

Okay.

Speaker 3

It has a move-out column.

Gary Shiffman (Chairman and CEO)

I don't think we have in front... Oh, hold on a sec.

Karen Dearing (CFO)

Stephen, I don't think that we see significant seasonality in those move-outs, but I don't have that information in front of me.

Speaker 3

Okay.

Karen Dearing (CFO)

If you want to follow up with a call with me, I can-

Speaker 3

No, no, I was just wondering, as you look ahead into the second half of the year, you're trending very favorably in a number of statistics as a company, and-

Gary Shiffman (Chairman and CEO)

Okay.

Speaker 3

If there's anything to kind of suggest that, you know, from the-

Gary Shiffman (Chairman and CEO)

Yeah. No, we, we have, Steve, and then it took me a moment to get to the page here. We have had historical seasonality the second half, where we've had more move-outs than the first half. That seems to have stemmed last year.

Speaker 3

Mm-hmm.

Gary Shiffman (Chairman and CEO)

Was slowly diminishing as second-half gloom, as we called it here. They are anticipating a strong second half, and in fact, they're anticipating a strong Q4, and Q4 was always the most challenging quarter for us. So, I think that we are not anticipating much seasonality. In fact, we are anticipating growth through the end of the year.

Speaker 3

The other thing is just going back from a corporate standpoint, looking at the growth of the portfolio now in terms of new investments, improvement of the existing portfolio from a cash flow standpoint, at what point, you know, would you be in a position to start to increase the dividend?

Gary Shiffman (Chairman and CEO)

I think there certainly have been a lot of goals that we've had the last few years, and starting with our financing from being an unsecured unsecured borrower to secured borrower. We were at a payout ratio above 100%, and we're there for a few more years than we would have liked. Now, as we've stated in the guidance, we anticipate at the midpoint to be at right around 90%. The board reviews the dividend policy each quarter. It would be our expectation that they will continually or continue to review that.

They had had a previous policy of increasing dividend about equal to CPI, and I would expect that that will take place at some time as the dividend begins, the payout ratio begins to decrease below 90%, but I don't know at exactly what point that would be.

Speaker 3

Mm-hmm. And then, what are you seeing in terms of just the financing of the purchase of manufactured housings in terms of any movement in terms of securitizing manufactured housing mortgages or. And is there anything going on in that space?

Gary Shiffman (Chairman and CEO)

I would tell you that we see very little. There's always a lot of discussion about a lot of different deals and different ways of wrapping and ensuring some securitizations, but we have not seen much change, you know, across the entire portfolio.

Speaker 3

What about the availability of credit to a purchaser of a manufactured house at this point?

Gary Shiffman (Chairman and CEO)

I think it's very, very limited. I think for those, certainly that have their nest eggs or, have great credit and have, savings in the bank, they can go to their traditional sources.

Speaker 3

Mm-hmm.

Gary Shiffman (Chairman and CEO)

For the balance of those, there's a handful of companies that are still in the business and still brokering on behalf of other third parties, but nothing's changed at all. It's just, there's no new financing that I'm aware of in the market right now.

Speaker 3

Okay.

Operator (participant)

Once again, ladies and gentlemen, if you'd like to ask a question, please press the star followed by the one at this time. If you are using speaker equipment, please lift the handset before making your selection. One moment, please. I'm showing that there are no further questions at this time. I will turn it back over to management for any closing remarks.

Gary Shiffman (Chairman and CEO)

Well, certainly on behalf of the entire staff at Sun Communities, we appreciate your participation. Both Karen and I are available for any follow-up questions, and we certainly look forward to reporting on Q3. Thank you.

Operator (participant)

Ladies and gentlemen, this concludes the Sun Communities Q2 2011 earnings conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030, and enter in the access code of