Sun Communities - Q2 2015

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities second quarter 2015 earnings conference call on the 30th of July, 2015. At this time, management would like 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 these 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 recorded presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. You may signal to ask a question by pressing star one on your telephone keypad. I would now like to turn the conference over to Gary Shiffman. Please go ahead, sir.

Gary Shiffman (Chairman and CEO)

Thank you, Angela. Good morning. Today we reported Funds From Operations of $52 million, or $0.87 per share, for the second quarter of 2015, compared to $34.7 million, or $0.79 per share, in the second quarter of 2014. For the six months of 2015, Funds From Operations were $100.4 million, or $1.76 per share, compared to $72.9 million, or $1.74 per share. These results exclude certain items as detailed in today's press release. Revenues for the six months ended June 30th, 2015, increased to $321.1 million from $231.6 million in the six months ended June 30, 2014. Revenues for the three months increased to $165.9 million from $118.5 million in a similar 2014 period.

Now turning to a review of the portfolio, during the first six months of 2015, revenue-producing sites increased by 999 as compared to an increase of 987 sites in the first six months of 2014. Total portfolio occupancy increased to 93.5% at June 30, 2015, compared to 91% June 30, 2014. Now reviewing same property performance in the same site portfolio of 177 properties, revenues grew by 8.2% while expenses increased by 6.8%, resulting in an increase in NOI of 8.8% for the three months ended June 30th, 2015. NOI growth of 8.7% for the six months ended June 30th, 2015, was driven by increases in revenues of 7.4% and expenses of 4.6%. Same site occupancy increased to 94.6% at June 30th, 2015, compared to 93.1% as of the prior year, June 30, 2014.

Reviewing just the RV portfolio performance, RV revenues increased by 12.6% for the same site properties for the second quarter 2015 over second quarter 2014, and by 11.4% for year-to-date 2015 over year-to-date 2014. The strong growth is attributable to increased daily rates and occupancy of our transient sites, strong demand for vacation rental cabins, and additional conversions of transient guests to seasonal annual guests. The Memorial Day and Fourth of July weekends in our northern resorts contributed strong year-over-year revenue growth of 10.4% and 8.1% respectively. Our resorts continue to reap the benefit of increased traffic due to our best-in-class amenities and strong marketing outreach through our social and online media strategy, and ultimately an extraordinary guest experience at our resorts as evidenced by unusually high Net Promoter Scores, a program put in place to monitor customer service and satisfaction.

If we turn to home sales, primarily driven by increased demand in our Florida and Arizona age-restricted communities, new home sales have increased by over 140% quarter-over-quarter and year-to-date 2015 over year-to-date 2014. New home sales were 131 for the six months ended June 30, 2015, as compared to 54 for the same period in 2014. Total home sales in the second quarter were 576 compared to 521 in the second quarter of 2014. For the six months, current year home sales were 1,119 compared to 890 in the first six months of 2014. On a same-site basis, the average selling price of a new home sold during the first six months of 2015 was $91,122, an increase of 8.1% from 84,310 during the same period in 2014.

The increase in average selling price for pre-owned homes was 10.3%, or $26,529 as compared to $24,046 for the first half of 2015 and 2014 respectively. Additionally, our brokered sales have also increased by about 6.2% year-to-date. Applications to live in our Sun Communities increased by over 14% to nearly 24,000 in the first half of 2015. On a same-site basis, year-to-date applications also increased and were up by over 7% from the same period last year. We feel that both the increased retail pricing we're experiencing and the continued increase in applications continues to indicate the positive demand and trends for the increase in demand for affordable housing.

If we take a quick look at reviewing acquisitions to date, in addition to the six Berger properties acquired in April, the company also purchased an age-restricted manufactured housing community located near Myrtle Beach, South Carolina, consisting of 419 sites and zoned land for 276 expansion sites, and a high-end RV community in Austin, Texas, comprised of 241 sites, of which 51% of the residents reside in the community year-round. The two communities, ground for expansion and Associated Manufactured Home Inventory, were all acquired on an all-cash basis for approximately $59.7 million. The company has also entered into agreements to acquire three RV communities containing approximately 1,185 developed sites, inclusive of land for potential expansion of up to 300 additional sites for an aggregate purchase price of $76.2 million.

Although subject to customary closing conditions, we have completed due diligence and expect to close on the three communities in August 2015. The company has also signed an agreement to sell six of its Midwest manufactured housing communities, comprised of approximately 2,200 sites. Net proceeds will approximate $68 million, and although still subject to customary closing conditions, the company has received a significant non-refundable deposit. The sale of one Michigan and two Ohio properties is expected to be completed in mid-August. The remaining three properties located in Indiana are expected to close in mid-October. We have completed 109 expansion sites in Texas during the first six months of the year and expect to complete an additional 576 sites in three Texas communities and one California community before year-end.

The demand in expansion communities remains strong, and the company anticipates completing an additional 1,700 sites in 18 communities by the end of 2016. Turning to a quick review of the balance sheet, we have received a commitment letter from certain lenders for a new $450 million senior unsecured revolving credit facility to replace our current $350 million facility. The facility is subject to negotiation and execution of definitive agreements and is expected to close in August 2015. Also, during the quarter, the company defeased $70.6 million of debt, which had a maturity date of July 1st, 2016. The transaction unencumbered 10 communities, of which six are identified as potential disposition properties.

As discussed in today's press release, we entered into an agreement with certain of the holders of our 6.50% Series A-4 convertible preferred shares to allow the holders to sell their shares to us for $30.90 plus accrued and unpaid distributions. The holders' right to sell their shares to us remains open until August 10th, 2015, and the privately negotiated offer is intended to eliminate potential market overhang and is expected to be accretive. FFO per fully diluted share, excluding certain items, is expected to approximate $3.62-$3.72 per share for the year and $1.03-$1.05 per share for the third quarter. Revised guidance, includes an increase in projected same-site NOI growth from 7.9% to 9.6%, the anticipated acquisition of three RV communities and disposition of six manufactured housing communities.

The repurchase of Series A4 preferred shares is not included in revised guidance as the company has no indication of how many shareholders will execute their sale right. You can please see our press release for other items adjusted in the computation of FFO and additional detailed information regarding guidance assumptions that have been revised from those provided in February of this year. At this time, operator, both Karen and I would be pleased to answer any questions.

Operator (participant)

Thank you. Once again, as a reminder, ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We will take our first question from Nick Joseph with Citi.

Nick Joseph (Equity Research Senior Analyst)

Thanks. Can you provide the cap rates for the acquisitions and dispositions under contract and then in general where you're seeing cap rates across MH and RV today?

Gary Shiffman (Chairman and CEO)

So Nick, what I'd suggest is that as we've talked about before, we have seen compression in both MH and RV. Generally, things had historically been in a 6-8 cap rate range for the type of higher quality properties that we've now been acquiring, and we continue to see probably a 50 basis point compression from there. So it's at 5.5%-7.5% range. On the properties for the disposition and the potential acquisitions, all of which I shared with you, we'd like to defer any discussion of cap rate until those have actually closed. For those acquisitions that we have already closed in the second quarter, they range from a cap rate of about 5.8% to about 6.4%.

Nick Joseph (Equity Research Senior Analyst)

Thanks. And then I'm curious what the role of new development will play in your future growth.

So I think our expectation is that we would like to have 2-3 ground-up developments within areas that we actually operate where we can identify continued high demand and we're not available to supply leasable sites, either RV or manufactured housing, to meet that demand. So we had identified in our last call an acquisition of a parcel of land in California to construct a 350-site RV community, which construction will probably start sometime late 2016. We're always looking for land to acquire to expand our existing communities, and we continue to look at land to develop new communities. That pace, as I said, is something that we'll share with the market in 2016, 2017, and 2018. But we're looking at our strategic plan has us developing 2-3 new communities in those future years along with acquisitions, dispositions, and our expansions.

And then for those 2-3, what's the targeted stabilized yield? I guess I'm trying to compare it to the 5.5%-7.5% you were just quoting on transactions.

Gary Shiffman (Chairman and CEO)

Sure. So we try to target for unlevered IRRs between 10%-12% in a 5-7-year period of time on the new development and construction.

Nick Joseph (Equity Research Senior Analyst)

What's the IRR on acquisitions today?

Gary Shiffman (Chairman and CEO)

On the acquisitions, when we're looking for an increase of about 200-250 basis points in a 3-5-year period of time after we acquire the new acquisitions, and I don't have an unlevered IRR to be able to compare it to with me on hand here, but I'd be glad to share it with you because I do have it available to us.

Nick Joseph (Equity Research Senior Analyst)

Okay. Thanks. And then just finally on leverage, it looks like levels have trended up over the past few quarters. How does today's leverage levels compare with your target level?

Karen Dearing (CFO)

Nick, yeah, there is a bit of a tick up. Certainly, that's on a trailing 12 level. If you were to look at EBITDA, net debt to EBITDA at the end of the year, we're looking to be below 7 times net debt to EBITDA. And that's a comfortable level for us to remain at below 7x net debt to EBITDA.

Nick Joseph (Equity Research Senior Analyst)

Thanks.

Operator (participant)

We will now go to Jeff Spector with Bank of America.

Jeff Spector (Managing Director and Head of US REITs)

Good morning. I just wanted to confirm on the cap rate question. It sounded like you quoted a range of maybe what you're seeing out there today, the 6.8 range, but also maybe the 5.5%-5.75%, but then these deals were 5.8%-6.4%. Can you just clarify your comments, please?

Gary Shiffman (Chairman and CEO)

Jeff, if you could. I'm sorry. I want to make sure I answer the question correctly. Could you repeat the question?

Jeff Spector (Managing Director and Head of US REITs)

So I guess to be clear, what is the cap rate, the range that you quoted on the additional acquisitions you did, the two for $59.7 million? Did you give an approximate range for those two acquisitions?

Gary Shiffman (Chairman and CEO)

For the ones we've closed on or the ones that we're going to close on? The range I gave was 58%-64% for what has already been closed second quarter. I gave no range for any pending acquisitions that have not yet closed or dispositions that have not yet closed.

Jeff Spector (Managing Director and Head of US REITs)

Okay. And then you said something I thought 5.5%-5.75%. What was that cap rate for? What was that describing?

Gary Shiffman (Chairman and CEO)

I had said 5.5%-7.5%, sort of 50 basis points compression that we've seen over the last 12-24 months from what has historically been a 6%-8% cap rate range that we were used to in general for acquisitions of high-quality manufactured housing communities.

Jeff Spector (Managing Director and Head of US REITs)

Great. Okay. Thank you. That helps. And then just a question on the home sales. You mentioned Florida, Arizona driving those results. Clearly, an impressive number in the quarter. Can you talk a little bit more about what you're seeing in those markets, the customer, any change, or it is the same profile, but you're just seeing stronger demand with the improving economy, improving housing market?

Gary Shiffman (Chairman and CEO)

Yeah. I think we're seeing a couple of things that have been taking place over the few years since we've seen the strength in both sales and pricing. The stronger demand for affordability is driven by the lack of the type of lending that was available pre-2008. So it's driving more customers who were previously being qualified for site-build housing and no longer are to affordable housing. And secondly, an improving economy and continued increase in portfolio size in Arizona and in Florida in particular. We're seeing sales of higher-priced houses and all cash payments for those houses. So positive trends to where we're identifying and strategically trying to increase the company's holdings. So all three of them are a factor of why we're seeing the increased housing sales and the increased pricing.

We think it'll translate into increased profits if these trends continue in 2016 on the home sales.

Jeff Spector (Managing Director and Head of US REITs)

Okay. Great. Thank you.

Operator (participant)

We will now go to Drew Babin with Robert W. Baird.

Drew Babin (Senior Research Analyst)

Morning. Clarification on the Series A preferred. Could that be potentially convertible into common stock, or is it cash only?

Karen Dearing (CFO)

The agreement is for cash only. The shares are convertible into common right now.

Drew Babin (Senior Research Analyst)

Correct. Okay. And then second of all, your G&A expense for the quarter, can you break down the items in there that might not be considered corporate overhead? Property management expense, selling expenses, things like that?

Karen Dearing (CFO)

Drew, I don't have a breakdown of that in front of me, but I can follow up with you on that later on.

Drew Babin (Senior Research Analyst)

Okay. Thank you. That's all I got.

Karen Dearing (CFO)

Thanks.

Operator (participant)

As a reminder, ladies and gentlemen, if you'd like to ask a question, please press star one at this time. We will now go to Todd Stender with Wells Fargo.

Todd Stender (Managing Director and Senior Equity REIT Analyst)

Hi. Thanks. Can we just hear a little bit more about the Orlando portfolio acquisition? It seems highly occupied. I guess we're used to seeing you acquire low occupancy and then really drive results and create value. Just wanted to hear maybe what the profile is of the community and maybe talk about the in-place rents.

Gary Shiffman (Chairman and CEO)

Are we talking about the Berger, the six properties?

Todd Stender (Managing Director and Senior Equity REIT Analyst)

Yes. Thanks.

Gary Shiffman (Chairman and CEO)

Yeah. So I think that what they are is really well-located, high-amenitized communities, one of them with a full golf course. And the occupancies tend to be higher. But because of their locations, we do believe we have opportunity on the upside of rent. And one of them or two of them came with expansion sites, good solid prospectuses which are what govern increases in rent in Florida. And I think that as part of realigning our disposition to take funds and redeploy them in areas where we think we'll have longer-term growth, those properties were very appealing to us. We had a long-term relationship with the seller of over 20 years and had bought several properties from them 20 years ago. And we were able to take advantage of the issuance of favorable operating partnership units to actually acquire the equity interest the seller had.

Not what you would typically see because we don't have vacancy or severely undermarket rents, but a good opportunity for continued growth, the expansion sites which we hope to start construction on in 2016, and good geographic placement in our footprint and where we see continued strong growth in our market, Florida, that we've been experiencing for 10 years now.

Todd Stender (Managing Director and Senior Equity REIT Analyst)

Thanks for that, Gary. And can you speak to these specific expansion opportunities? And then just in general, when you do buy properties, do they come zoned and entitled? And how much visibility do you have to actually monetize and create value there?

Gary Shiffman (Chairman and CEO)

So they are all zoned and entitled, and the properties are at high demand and occupancy so that we would go right into development. I think we've shared with the market that we anticipate 12%-14% returns on our expansion sites, in large part due to the fact that all the fixed expenses, community managers, personnel, staff already exist in the community. So where we can expand existing communities, we generally see high returns. That's true throughout the entire portfolio. And certainly, as we're expect to burn through as many as 1,700 expansion sites in 2016 and 2017, we're always looking to acquire properties and land that can allow us to expand the communities because it's very profitable for us.

So in this and also the properties that we have under contract and discussed earlier that we anticipate closing in August, we also look to expand those communities as well.

Todd Stender (Managing Director and Senior Equity REIT Analyst)

Thanks. And can we just get an update on maybe you can speak to the renter profile, if there are any data points that you can highlight? If anything's changed, if we can hear maybe about credit scores, length of stay, propensity to eventually buy their home, any updates on the renters?

Gary Shiffman (Chairman and CEO)

Yeah. I think obviously, as we see the 6%-10% increases in prices, whether it be new home sales and/or pre-owned homes, it's an indication to us that there's a strengthening market to convert our renters into owners. I'd remind everybody that the average stay of a homeowner in our community is about just over 13 years now. So when we convert a renter, we do get the benefit of having them in that home for 13 years. The average amortization of a mortgage on homes in our community is 15 years now. So with a 13-year stay, that's matching up very, very nicely. We have been converting renters into homeowners on average on an annual basis for the last 6 years at right around 10%.

And some of the things that we're seeing are that in our communities I've shared in the past, we expect the rental units to go down as we reach full occupancy. And we're, in fact, starting to see that now. Rental units in the Texas communities where we're at virtually full occupancy, other than in newly expanded properties, are down 6% from last June. And in Colorado, where we've been full an extra year longer than Texas, except for expanded communities, rental units are now down 37% from where they were this time June of last year. We would expect those trends to continue. As we've shared strategically, we view the rental program as an excellent tool now to accelerate growth for the shareholders as we acquire communities with vacancies, as we expand our communities. So that's primarily where we'll be using the tool.

We have a little bit to go, maybe 150 basis points until Michigan reaches what we consider full occupancy, which is right around 95%. And certainly, we have a ways to go in Indiana. So those are the areas we'll be focusing most of our attention to rental programs. And we believe in 2016, you'll see the redeployment of capital from the rental markets such as Texas and Colorado being used more in Michigan as we fill it up in Indiana, which I think will indicate less and less growth in the rental program in the future. I think one other point that I'd point out that when we look at our rental program in 2014, excluding any rentals related to the ALL acquisition, we see a decrease or a reduction of about 23% in our rental program growth over 2014 on that same property basis.

I think we'll be able to share with the market these continued trends throughout 2016 and late 2015.

Todd Stender (Managing Director and Senior Equity REIT Analyst)

Just to stay on that theme, is there any change in your budgeting for new home inventory that you're bringing out to rent? Has that changed since year-end and how you're looking out for the second half of the year?

Gary Shiffman (Chairman and CEO)

I think Guidance still has carrying the same.

Karen Dearing (CFO)

It has the same amount of increase in rental units.

Gary Shiffman (Chairman and CEO)

There is no change. I think that the changes that we're talking about are starting to just take place. We've been talking about them for many quarters now, but we really are actually seeing them happen in Texas and Colorado. And I think that where you'll see the real changes to any addition in the rental program will take place in 2016, where, as I said, they'll be primarily focused on vacancies related to acquisitions or expansions.

Todd Stender (Managing Director and Senior Equity REIT Analyst)

Great. Thank you.

Operator (participant)

We will now go to Dave Bragg with Green Street Advisors. Hello, Mr. Bragg. Could you please check your mute function? We're not able to hear you.

Dave Bragg (Managing Director)

Hi. Good morning. Sorry about that. In the press release, Gary, you cited solid results in acquired communities. And your guidance relative to the beginning of the year is helpful, but you've added in some communities there. Could you talk a little bit or hopefully quantify how Green Courte is performing relative to expectations?

Karen Dearing (CFO)

Green Courte is performing quite well. Dave, I would say that you're correct. We did increase guidance for our acquisition portfolio, adding in the properties. I think it's 6 properties or 5 properties that we didn't have in it previously. The Green Courte portfolio is performing well. There have been some unexpected first-year expenses being incurred there for pre-trimming, painting, minor repairs that we did not anticipate in original guidance.

Gary Shiffman (Chairman and CEO)

I think it's safe to say we would be performing above budget, but we did get in there and incur these expenses. And thought it was important to demonstrate to the residents that Sun is looking after their communities and therefore is in their best interest. So performing ahead of budget, I think on revenues, home sales, and operations. And that amount was sort of soaked up by the first-year expenses.

Dave Bragg (Managing Director)

Okay. That's helpful. Thank you. Earlier on the call, Karen, you were asked about leverage. You said a target of under seven is what you're shooting for. Last call, you said you were a little more specific. You said six. Has anything changed there, or you're just talking about it in more vague terms?

Karen Dearing (CFO)

I think in general, we always kind of discuss being below 7x net debt to EBITDA. We have some updated projections. From what I can see right now, Dave, net debt to EBITDA would be between 6.5%-6.8% by the end of the year.

Dave Bragg (Managing Director)

Okay. Thank you. The last question just relates to the disclosure, which really lumps operating expenses altogether. Can you help us think about the margins, the operating margins that you achieve in the MH business relative to the RV business?

Karen Dearing (CFO)

Well, overall, I would say that they perform pretty similarly. RV has a little bit higher expense factor because of all of the activities associated with them. So in a range, if we're on average around 35% expense, RVs may be at 38%-40%.

Dave Bragg (Managing Director)

Thank you very much.

Operator (participant)

It appears that there are no other questions at this time. Mr. Shiffman, I'd like to turn the conference back to you for any additional or closing remarks.

Gary Shiffman (Chairman and CEO)

At this time, we'd like to just thank everyone for participating in the call. As usual, Karen, myself, and all members of management are available for any follow-up questions. We certainly look forward to sharing results after third quarter is completed. Thank you, Operator.

Operator (participant)

This concludes the Sun Communities 2015 second quarter earnings conference call. Thank you for your participation.