Sun Communities - Q3 2011

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by and welcome to the Sun Communities Third Quarter 2011 Earnings Conference Call on the 25th of October 2011. 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 the 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; 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 you have a question, please press the star followed by the one on your touch-tone phone. If you'd like to withdraw your question, please press the star followed by the two. And if you're 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. Today we reported Funds from Operations of $18.6 million, or $0.75 per share, for the third quarter of 2011, compared to $14.8 million, or $0.69 per share, for the third quarter of 2010. For the first nine months of 2011, FFO was $55.1 million, or $2.32 per share, compared to $46.5 million, or $2.19 per share, for the first nine months of 2010. These results exclude certain items as noted in the table and the press release. I'd like to start out by emphasizing it has been a milestone year for Sun Communities. Simply stated, we have greatly strengthened our balance sheet with dramatically extended and balanced debt maturities while experiencing consistently rising demand for sites in our communities. To top it off, we have assimilated our largest acquisition in 15 years while currently reviewing substantial additional acquisition opportunities.

The momentum from our strongly growing occupancy and the accretion from our 2011 acquisitions promises a strong 2012, and we still have one quarter to go. Specifically, in the third quarter, we entered into a new revolving credit facility to replace our expiring $115 million line of credit. The new agreement is for $130 million with an accordion feature allowing for up to $20 million in additional borrowings for an aggregate of $150 million. The facility's term is three years with an option to extend for one additional year. This is the final major credit market achievement of the year for the company. Previously, we have reported on the various favorable refinancings and maturity extensions. The next significant debt maturity is in July 2014 when a 10-year secured financing matures.

Occupancy continues to surge with an increase in same-property occupied sites of 629 for nine months, a full 23% ahead of this time last year. Additionally, our recent acquisition, Kentland, which closed in late June 2011, added 103 sites of occupancy in the quarter, a much stronger performance than forecast. One of our expansions opened in Austin, Texas, the first week in September. By September 30th, 17 sites were filled, again far stronger than our forecast of 6 per month. In a moment, I'll summarize the expansion activity currently taking place at the company. Occupancy gains of 732 for the nine months were strong across the portfolio. Michigan added 317 sites, Texas added 154 sites, Colorado added 113, Indiana added 80, and Ohio added 34. This represents the strongest occupancy growth in a nine-month period in our history.

While some periods in the '90s had higher gains, they were the result of extremely loose underwriting standards, and most of those gains were illusory as the homes were foreclosed on throughout the early 2000s. These currently reported gains are based on extensive and proven underwriting standards and reflect performance that has taken place in our portfolio since they were implemented over five years ago. Portfolio occupancy is at 85.4% at September 30th. As the 2012 budgeting process moves forward, it is the current expectation that portfolio occupancy will approach 90% by the end of 2013. Same-site performance reflects those strong occupancy gains. Revenue grew by 3.4% for the nine months, while expenses increased by 1.8% and NOI grew by 4.2%. Occupancy improvements drive revenue growth above the average annual rental increase of 2.5%-3%. The modest expense growth reflects strong operational and budgetary controls.

As occupancy continues to gain momentum, we should continue to see strong same-site performance. Home sales within the portfolio also remain strong. They should approximate 1,450 this year, an increase of 5% over 2011, and more than doubling the 712 homes sold in 2007, or a compounded annual growth rate of over 18%. The cash proceeds from home sales are generating about $25 million annually, which is then reinvested by the company in homes generating additional occupancy. While we can't discuss the specifics, potential acquisitions remain very, very strong. We can note that we are looking at more opportunities than at any time previously. The opportunities all play to our strengths: strong operational and sales management teams, refined and well-developed systems, a proven rental program which has filled numerous communities, and experience across the spectrum of communities with overall quality and geography.

This marks our seventh consecutive quarter of growth in occupancy, during which we have added nearly 1,300 residents. The annual revenue increase resulting from these gains approximates $6 million annually. Occupancy growth in 2012 should rival the growth we have generated over the last seven quarters. The growth in same-site net operating income for the nine months is the strongest since 2002. The average NOI growth over these 10 years has been 2.8% for the first nine months, compared to 4.2% in 2011, and this is a result of the momentum being built through steadily increasing occupancy levels throughout the portfolio. We had the strongest quarter for applications to live in our communities in third quarter 2011, with a total of over 6,600, up over 20% from the last quarter and 5% year-over-year.

This demand is filling our communities while providing us with the opportunity for the significant rate increases in our rental program, which hasn't taken place for the last several years and will take place this coming year. As noted previously, our expansions are filling ahead of projections, and we will bring about 450 additional sites on stream in the next 12 months at four of our communities in our strongest markets. These expansions are taking place in communities that are fully occupied, have strong demand for additional sites. The land is zoned and permitted with significant upfront costs incurred years ago. The return on the expansions, including the acquisition of related homes, approximates an unlevered return of 10%. In closing, we expect the trends reviewed today will generate solid internal growth.

In addition, substantial long-term accretiveness should be enhanced, resulting from acquisition opportunities, purchasing off of existing NOI but allowing us to purchase what we refer to as vacant sites for free and then filling those sites up. At this time, Karen, myself, and Jeff would be available for questions, Operator.

Operator (participant)

Thank you, sir. Ladies and gentlemen, we'll now begin the question and answer session. As a reminder, if you have a question, please press the star followed by the one on your touch-tone phone. If you'd like to withdraw your question, please press the star followed by the two. If you are using speaker equipment, you will need to lift the handset before making your selection. Our first question is from the line of Paul Adornato. Please go ahead.

Paul Adornato (REIT Analyst)

Thanks, Ted. Good morning. Hey, Gary, I was wondering if you could talk a little bit about the transaction market since you seem optimistic that there might be more acquisitions out there. Who are the sellers? Is it the mom and pops who might be capital constrained? And who else is looking to buy in this environment?

Gary Shiffman (Chairman and CEO)

Sure. I think that what we found is we've been seeing one and two offs that have now cycled through the banking process and through deed in lieu of or foreclosure properties that we deem to be very, very high quality and positioned, but were started right into the difficult times over the last seven years. Weren't successful in the lease-up stage and are now being offered to the company. We had anticipated this probably happening a year, year and a half earlier, but some of those are funneling through the process, and we would expect to be able to announce on those shortly.

In addition, there are a number of medium-sized syndicators and developers that we have known for many years that have been in the business, and I think as they mature and their intentions and motivation becomes a little bit different in what has been a tough and capital-constrained market, are more inclined to want to review an exit process right now, again, often allowing us to utilize the operating partnership units and the POP units to create some tax-advantaged planning for them. So it's mostly coming through the banks as well as a number of identified medium-sized portfolio owners and strong areas that are now actually looking at the opportunity of exiting versus what's available in the new financing world for them.

Paul Adornato (REIT Analyst)

Could you comment on cap rates in place NOI?

Gary Shiffman (Chairman and CEO)

Yeah. I think they are similar to they have been traditionally, as everyone's aware. Manufactured Housing hasn't fluctuated much at all, even during the difficult times, mostly because of the dividend stability and the cash flow that does come through the communities that are full. So they're from a 6-9 cap rate range. And again, a lot has to do with location and occupancy and age of the community.

But more importantly, what we're really focused on, which I touched on at the end of my comments, is that when we can acquire a property at a solid cap rate or even sometimes an aggressive cap rate and have the upside of empty sites that we deem play strong to the suit and our abilities to leverage what's going on at the company, those sites are free to us to go ahead and apply, whether it be our sales program or the rental program, and generate significant upside for the shareholders while having cash flow on the cap rate basis.

Paul Adornato (REIT Analyst)

Okay. Related to that last comment, you mentioned also a goal of achieving 90% occupancy by the end of 2013. I was wondering kind of what are the constraints to perhaps making that goal sooner. Is it capital required to invest in new homes? Is it personnel on your side, or do you feel like you're kind of meeting the demand in a reasonable fashion?

Gary Shiffman (Chairman and CEO)

Well, Paul, that's an interesting question because there's a bit of irony in it. I think the simple factor is that in some of our strongest markets, our communities are filling up. So the ability to reach a higher occupancy sooner would be enhanced if those strong communities had more sites to fill up. So we have to look towards expansion in those communities that we can, and many of them we do have that ground all set to go, but it takes all said and done anywhere from 12-18 months. In addition, obviously, the markets that are filling fastest, as they fill, the next markets are filling a little bit slower. And so that's the timing involved.

Paul Adornato (REIT Analyst)

Okay. Thanks very much. Appreciate it.

Gary Shiffman (Chairman and CEO)

Sure.

Operator (participant)

Thank you. Our next question is from the line of Stephen Swett. Please go ahead.

Stephen Swett (REITs Equity Analyst)

Yeah. Gary, two questions. You've made good progress in terms of the cash flow relative to the dividend. What needs to happen for the company to resume dividend growth? And then the increase in activity in the fourth quarter, historically, what contributes to that?

Gary Shiffman (Chairman and CEO)

Well, taking your first question with regard to the dividend, I think we have made great progress after a difficult period of time when we refinanced the whole balance sheet, I think in 2004, where our payout ratio did exceed 100%, and we slowly brought it down, and we anticipated dropping below 90% before the board reviews it. They typically review it each quarter when we get together. As we continue to make steady progress, we'll be able to reflect the board's position, I'm sorry, on increasing the dividend. That is something that remains in the board's hands, and it's reviewed each quarter. With regard to fourth quarter, if you could be a little more specific on what you were referring to, I could address it or someone.

Stephen Swett (REITs Equity Analyst)

If you look at sort of FFO comparisons, fourth quarter versus third quarter on a historic basis, there's a fairly significant jump in FFO in the fourth quarter. I would just want to get a sense of what contributes to that.

Karen Dearing (CFO)

Steve, normally you'll see in the fourth quarter our RV business pops back in again, and our property operating and maintenance expenses decrease. Generally, you'll see our first quarter as our strongest, fourth as our second strongest, and second and third kind of go back and forth.

Stephen Swett (REITs Equity Analyst)

Okay. All right. Thanks.

Operator (participant)

Thank you. And our next question is from the line of Todd Stender. Please go ahead.

Todd Stender (Managing Director)

Hi. Thanks. Just looking at your expansion opportunities, you mentioned there's 450. Can you tell us what markets they're going into?

Gary Shiffman (Chairman and CEO)

Sure. I think that there's many more opportunities other than the 450. Do we know the exact amount of expansion sites we have?

Operator (participant)

I think there's over 5,000.

Gary Shiffman (Chairman and CEO)

There's over 5,000 sites within the portfolio, but the 450 is what we're actually currently in the process of bringing to market. I believe the two areas are Texas and Colorado.

Karen Dearing (CFO)

The four that we're planning for next year, they're all in Texas. There's one in Houston and one in Austin.

Todd Stender (Managing Director)

Okay.

Gary Shiffman (Chairman and CEO)

We do actually have our 2013 expansions under review right now, and it looks as if they'll be pretty similar, but they will also open up into Colorado.

Todd Stender (Managing Director)

Okay. Is there anything holding you back from expanding in Florida? Just looked on the trends in your occupancies have been so strong. They're pushing 99%. Any thoughts around Florida in particular?

Gary Shiffman (Chairman and CEO)

I think that the expansion you're seeing is a result of land that we actually own, okay, and that is zoned and permitted. In the Florida marketplace, other than at Water Oak, there's very little land that we currently have for expansion or development.

Todd Stender (Managing Director)

Okay. Thanks. And Gary, you mentioned the 10% unlevered return. How does that shape up or compare to your historical numbers or how you kind of look at that on a return basis?

Gary Shiffman (Chairman and CEO)

Sure. I think that it's prudent to bear a little bit of the carry cost of that home. But at the same time, we're looking at decreased development costs at around $25,000 on average. We're going back 10 years ago. These sites all in were costing us probably about $35,000, so about a $10,000 savings. A lot of that is due to incremental infrastructure that was put in place and paid for 10 or more years ago. So more is dropping to the bottom line because those dollars don't have to be put out today.

Todd Stender (Managing Director)

Okay. Using your equity shelf, you issued shares in the quarter. How do you look at the cost of equity when you're going to issue shares? Is it the share price relative to your estimate of NAV, or how should we think of that?

Gary Shiffman (Chairman and CEO)

I think that what we've been most focused on is that leverage and how we compare to the rest of the REIT world. So we're looking over a period of time to steadily reduce debt and kind of looking at a blended cost of or an overall cost of equity and debt as we look at the acquisition opportunities to kind of accomplish two things: bring future growth into the company and do it on a basis where, at the same time, we can slowly reduce debt to a lower level. But I don't think we have any specific plan that is in place right now that isn't tied to acquisition or expansion growth or needs that we have within the company to make sure that the debt leverage or ratios don't change from where we're at right now. In fact, we're trying to bring them down.

I don't know if that answers your question or not, but that's pretty much how we're looking at it internally.

Todd Stender (Managing Director)

Okay. And just the final question just on that topic. Bringing your leverage down, it's kind of in the mid to upper 50% range now. Can we think about that heading more towards 50%? Is there an internal target?

Gary Shiffman (Chairman and CEO)

Yeah. I think we're being viewed closer to 65% now. And I think the goal is to bring it down from the 65%. And it's something we've discussed on the calls for the last year, year and a half, as we've used the ATM program when we've needed cash for the acquisitions and for the home sales program as well as the expansions. So there's nothing I would expect to change radically, but slowly ratcheting down the overall debt level is something we'd like to achieve. And so if we go out for an acquisition now, it would have less than 65% leverage when we were done with it. And in some cases, we'll start out with those acquisitions if we do close on them at less than 65%.

Todd Stender (Managing Director)

Okay. Thank you.

Operator (participant)

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

Speaker 7

Hi. Good morning. On the acquisition opportunities you're seeing, can you expand on what type of product that is? Age-qualified, all-age, resort, or RV?

Gary Shiffman (Chairman and CEO)

I would say it is an absolute blend of all three. Probably more adult than we've seen, all-age restricted than we've seen in a while. Some of it on the western part of the country, which I think will bring us good geographic diversity as we're not real heavy in that area. But clearly, it has been across all three spectrums that you mentioned.

Speaker 7

Great. Then can you talk a little bit about interest from home buyers on the margin? We know renter demand is real strong, but are there any markets where you're seeing buyer demand come back?

Gary Shiffman (Chairman and CEO)

Well, I think just as a part of our home sales, the buyer demand is certainly there, and it's what's causing us to be able to recirculate our capital into a growing rental program and allow us to look at taking advantage of what we refer to as the empty sites and the new acquisitions. Even in Kentland, where they were—what was the occupancy when we bought Kentland?

Speaker 7

76.

Gary Shiffman (Chairman and CEO)

76%. We are selling homes in Michigan into those communities. So I think the advantage right now is just the affordability factor and the fact that traditional site-built housing for purchase is somewhat closed. But albeit the home sales overall in the country, as reported by the manufacturers, are still hovering in the 40,000, 50,000 unit level. So far, far down from where they were in the late 1990s. But we're getting our share of home sales, and I think as I reported earlier, it's over 20% quarter-over-quarter last year and roughly up 5% for the year. So things are positive, and we anticipate that that trend will continue because there really is nowhere else for the home buyer at that level to qualify or turn to buy a home, even when you consider the foreclosures that are available to them with their base income.

I think there will be strong trends as we continue across our portfolio.

Speaker 7

Do you have an expectation when you think home sales will be large enough to start shrinking your rental program?

Gary Shiffman (Chairman and CEO)

That's a good question. I think that home sales are, or the rental program is a function of how fast we want to fill up occupancy. I think that if we grew rentals a little bit slower at this point and took out our opportunities both in expansion and in our acquisitions, you would start to see the rental program slowly shrinking. It's strictly a factor of our model now using the rental program to go ahead and expand the properties and to acquire new properties. The cycle's pretty simple. We look at putting in, on any given property, a new property, 50%-60% rentals, and the rest are direct sales. Then we take those rentals and hopefully resell them back to the consumer over a four-year period of time.

Our expansion models kind of show us renting until we go up and then converting those into sales over a four-year period of time after that.

Speaker 7

Great. Thanks for that. One last modeling question. On the expansion sites, is the added income from those sites included in your same-store results?

Karen Dearing (CFO)

Yes, it is.

Speaker 7

Great. Thank you very much.

Operator (participant)

Thank you. And once again, ladies and gentlemen, if you have any additional questions, please press star followed by the one. Our next question is from the line of Haendel St. Juste. Please go ahead.

Haendel St Juste (REITs Equity Research Analyst)

Hey. Good morning.

Gary Shiffman (Chairman and CEO)

Morning, Haendel.

Haendel St Juste (REITs Equity Research Analyst)

Just a couple of quick ones here. First on G&A up materially year over year here. The driver there, what was that? Was it related to the closing of the Kentland portfolio?

Karen Dearing (CFO)

No. I think last year, it's actually last year's G&A was a little bit down. There was a reversal of a tax accrual that we had to do in last year. So you're seeing it looks like a bigger variance than it actually is. But if you're looking out into the end of the year where we're going to be, if I remember our forecast right, it's a little less than the average for the three quarters.

Haendel St Juste (REITs Equity Research Analyst)

Okay. And then on the expansions planned for next year, the 450, what is the assumed cost per site, the development cost there? And can you give us some more color on the planned funding, especially as your line starts to creep up here?

Gary Shiffman (Chairman and CEO)

Well, the costs I indicated were roughly $23,000-$25,000 on average per site. I think as it stands right now internally, we see ourselves being able to fund that in part whether off our line or there's a certain amount of paper and notes that we're in the process of selling as well within the company that we think will generate sufficient funds along with, if needed, our ATM program.

Haendel St Juste (REITs Equity Research Analyst)

Okay. And then on the rental home activity, the purchases there, the profit margin continued to be squeezed. It's down, I think, 12% from this time last year. How much further are you willing to sacrifice margins here for volume?

Gary Shiffman (Chairman and CEO)

I think you hit on a big internal debate that takes place, a healthy debate between Sun Home Services, our rental and sales agency, and operations. But I think that our overall goal is the sale of homes. So I think that there is a willingness to bring the capital back in full circle and sacrifice the margins when necessary. If I'm understanding your question right, then be able to use that capital and put another home in the community. So recycling that capital and eventually reducing the rental program over probably what will be a long term now would be priority number one, not the margins.

Haendel St Juste (REITs Equity Research Analyst)

Gotcha. Okay. And one last one. Given your thoughts on the increasing amount of acquisition opportunities you're seeing out there, can you give us some updated thoughts on potential disposition candidates within your portfolio today, where those might be in any sense of, I mean, I'm assuming the pricing would maybe fall at the higher end of the range, the cap rate range you provided earlier?

Gary Shiffman (Chairman and CEO)

Sure. I think that we carefully try to follow an asset management process. We have identified six communities that we would like to put in the disposition bin. But in doing so, I think we're going to wait for the 2012 budget to be completed. It will be completed mid-December, Karen?

Karen Dearing (CFO)

Yes.

Gary Shiffman (Chairman and CEO)

Mid-December. At that time, if we do intend to move forward with any dispositions, we would do so at that time. We also expect to provide guidance at that time. I think both issues will be addressed then.

Haendel St Juste (REITs Equity Research Analyst)

Fair enough. Thank you very much.

Operator (participant)

Thank you. There are no further questions at this time. I would now like to turn the call back over to Mr. Shiffman for closing remarks.

Gary Shiffman (Chairman and CEO)

Well, thank you, operator. I'd like to thank everybody for participating today. As always, Jeff, Karen, and myself are all available for any follow-up. And as we go into fourth quarter, we look forward to speaking either prior to or during our next quarterly remarks. Thank you.

Operator (participant)

Ladies and gentlemen, this concludes the Sun Communities Third Quarter 2011 Earnings Conference Call. You may now disconnect. Thank you for using ACT Conferencing.