Sun Communities - Q4 2012

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities fourth quarter 2012 Earnings Conference Call on the 21st of February, 2013. 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 filings with 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 parties will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. If you have a question at that time, it will be star one on your touch-tone phone. I would now like to turn the conference over to Gary Shiffman. Please go ahead, sir.

Gary Shiffman (CEO)

Thank you, Operator, and good morning. Today we reported funds from operations of $26.2 million, or $0.80 per share, for the fourth quarter of 2012, compared to $18.8 million, or $0.81, in the fourth quarter of 2011. For the year, FFO was $96.7 million, or $3.19 per share, compared to $73.9 million, or $3.13 per share for 2011. These results exclude transaction costs primarily related to acquisition costs in all periods. Revenues for 2012 increased by 17% from $289.2 million in 2011 to $339.6 million in 2012. During 2012, as we look at the portfolio, revenue-producing sites increased by 1,069 compared to 892 in 2011. This marks the first time that we have added more than 1,000 sites to occupancy in a single year and the fourth consecutive year of steady occupancy increases. Guidance for 2013 includes the addition of a total of approximately 1,500 revenue-producing sites.

In 2008, the year in which the Great Recession commenced, we lost 47 sites, which demonstrates the recession-resistant nature of manufactured housing. In the same property portfolio, revenues grew by 4.5% in 2012, while expenses increased by 2.2%, and NOI growth was 5.5% for the year. This growth occurred across the entire portfolio as 17 states experienced same property NOI growth. Only one state with one community did not grow, and its decline in NOI was only $26,000. Guidance for 2013 includes projected NOI growth of 5.6%-5.9%. During 2012, 1,742 homes were sold, including 953 homes which were formerly rented. Guidance for 2013 projects the sale of over 2,000 homes, half of which are the conversion of rentals. The sale of rental homes frees up capital to be recycled into further building occupancy.

Demand for homes is so strong that in the last five years, we have sold nearly 6,600 homes, enough to completely fill, on average, 18 communities. Applications, which of course drive occupancy, and home sales, increased 12% in 2012 to 26,100. Applications have grown at a compounded annual rate of over 11% during the last four years, which reflects strong and continuing demand for affordable housing. As competition from housing alternatives has had little effect on our customers and residents, expansions are the build-out of zoned sites that are adjacent to our existing communities, and this allows us to control when we bring these sites on stream, as well as the opportunity to select the market for our expansions. In 2012, we added 354 sites. Over 1,100 new expansion sites are scheduled in 2013, with absorption expected to come towards the later part of this coming year.

An additional 3,300 expansion sites are projected in our five-year plan. These expansion sites are zoned and entitled and are a part of Sun's existing inventory. We generally expand communities when occupancy rises above 95% and strong demand continues in the marketplace. The projected fill rates range from 4-10 sites per month, with an average of 6-7. Unlevered return on investment when the expansion is occupied, which usually takes about 18 months, is expected to approximate 13%. In 2012, 2.5% of our residents moved their homes out of our communities, while an additional 4.9% sold their homes, which then remained in the community. Extrapolating that data indicates that, on average, homeowners remain in our communities for 14 years, while the homes produce revenue for over 40 years.

In 2007, home move-outs were 3.2%, while resales were 6.5%, extrapolated to average residency of 10 years, and an average home in the community of 31 years. So both the length of residency and the revenue life of homes not only remain sticky but have increased significantly. We focused on reducing leverage over the last 18 months, with the result that all related metrics are showing improvement. EBITDA over interest has improved from 2.4 at 12/31/2011 to 2.8 at 12/31/2012. Debt over total capitalization has improved from 62% at the end of 2011 to 53% at 12/31/2012. And debt over gross assets has similarly declined from 71% to 60%. We have discussed that we intend to grow on a leverage-neutral basis and project our debt over EBITDA multiple to be in a range of 7.6-7.8x by year-end.

We expect 2013 FFO per share on a fully diluted basis to be in the range of $3.45-$3.55. After considering recurring capital improvements of about $0.29 per share, the payout ratio should approximate 79%. FFO guidance for the first quarter of 2013 is $0.97-$0.98 per fully diluted share, an increase of 6.7%-8.9% over first quarter 2012. Now I'd like to turn to acquisitions for a moment, as in the last two years, including our recently announced acquisition, we have purchased nearly $600 million of communities, growing our site count by approximately 40%. We continue to see a robust acquisition market, and we are reviewing additional opportunities to broaden the company's geographic footprint, as well as building critical mass in our existing markets.

While guidance includes no prospective acquisitions, we are optimistic that we will be able to continue to add quality properties to our portfolio. Our acquisition strategy has had three principal objectives. First is to buy the property right so that it is initially accretive to earnings. Then we focus our property management team to improve the appearance and operating efficiency of the property. Additionally, where necessary, we invest capital on upgrading and repositioning the properties that have been mismanaged or neglected. And finally, our sales and rental teams accelerate the occupancy growth to maximize the property's profitability over the short term. The result is an attractive, fully occupied community with significant enhancement to the initial accretion. As previously noted, we are strategically increasing our commitment to the recreational vehicle marketplace.

We expect this segment of our portfolio to increase from 11% of income from property in 2012 to 17% in 2013. In addition, we have expanded the geographic footprint of our RV business so that nearly 30% of our transient sites are now in the Northeast and Midwest. Previously, with all of our transient RV sites in the South, our effective season was less than six months. So the effect of the foregoing is to materially increase the importance of this segment to the company while also developing it into a year-round business, the North complementing the South with regard to seasonality. This allows us to devote more resources to promote growth as we bring to bear the systems and management team that has effectively grown the MH business, as well as our southern RV holdings, to increase the profitability and sophistication of RV community management.

To cite an example, we have utilized dynamic pricing in our manufactured housing rental systems, and sales business for the last few years as the economic returns from renting or selling are constantly weighed in the management process. Applying this concept to the RV business, we have empowered our personnel through software and systems to dynamically price reservations and extensions in our RV communities, depending upon the specific occupancy status of the particular community. This practice mirrors the pricing strategy of the airline industry. We have also borrowed an accountability measure from the lodging industry, which uses RevPAR, and we have instituted RevPAS reporting to measure the historical and competitive performance of each of our RV communities on a per-site basis. I think at this time, both myself, Karen, and Jeff would make ourselves available for any questions.

Operator (participant)

Thank you, sir. Ladies and gentlemen, we will begin the question and answer session now. If you wish to ask a question, it is star one on your touch-tone phone, and if you wish to withdraw your question, it is star two. And if you're using speaker equipment today, you will need to lift the handset before making your selection. One moment for our first question. Our first question comes from the line of Paul Adornato. Go ahead, please.

Speaker 4

Hi, good morning. You disclosed investment in occupied rental homes in your supplemental, and it increased 21% this year. I was wondering what we can expect in terms of capital allocation to rental homes.

Jeff Jorissen (Director of Corporate Development)

Hi, Paul. I think that the vast majority of the increase in rental homes is a result of expansions and acquisitions. I think we're just in the process of forecasting the increase, and we expect it to be in a $30 million-$45 million range. I think it's important to also discuss that for the first time, when we look at pick 10 communities randomly and look at what's taken place to the rental program in those 10 communities from the high point of rentals, we are finding that with a 12% rough average of selling the rentals in the program each year now, we're seeing declines from the peak period as we convert the stabilized communities from rental to owner-occupied. So I think the vast majority will be a function of existing acquisitions, future acquisitions, and expansions, and for the rest of the portfolio, we'll see a decline.

Now, Indiana, where we've been a little bit slow to recover occupancy, will probably increase in rentals as a percent of occupancy, while we see the vast majority of the portfolio, especially Texas and Colorado, steadily decline.

Speaker 4

Okay. And related to that, at one time, you were able to buy a lot of homes for pennies on the dollar from the lenders. Has that supply dried up? Are you buying brand new homes at this point?

Karen Dearing (CFO)

Paul, we still continue to have opportunities to buy repossessed homes from lenders. The mix right now is about 60% new homes and 40% repossessions.

Speaker 4

Okay. Switching to your most recent RV acquisitions, I was wondering if you could talk about the going-in cap rate and what's the near-term plan with respect to boosting that yield.

Jeff Jorissen (Director of Corporate Development)

Sure. I think that it's probably, of all our acquisitions, the toughest to allocate a cap rate to, just because of the mismanagement and lack of investment and repositioning that's going to take place in those 10 properties. I think that what we've done is purchase accretive from day one, and we would look to enhance NOI growth on a low double-digit basis 12-18 months after we've made the investment in that community to reposition it and turn it around. And these communities were acquired because of their Class A locations and the opportunity that Sun has to really lever an underutilized RV management team and our systems in the north part of the country where the season is basically May to September, as opposed to the southern season where our other holdings are, which is more December to March.

We have complementary seasons, and now our staff can be working year-round in the RV area. I think that we have continued to state the cap rate has been very consistent in MH and RV land. They have remained in the 6-8 and 8.5-9 range, depending upon the quality, the location of the asset. All of our acquisitions tend to be bought in that range, so we wouldn't expect any difference going forward.

Speaker 4

Okay. Thanks very much.

Jeff Jorissen (Director of Corporate Development)

Yep. Yep.

Operator (participant)

Our next question comes from the line of Steven Mead. Go ahead, please.

Speaker 5

Yeah. I got to ask the question about sort of what happens next in terms of your thoughts on the dividend.

Jeff Jorissen (Director of Corporate Development)

Sure. That's a great question. I think that we continue to share with everyone that the board, on a quarterly and annual basis, carefully reviews that. So far, as I've shared on the previous calls, the board has weighed the strategy of really strengthening the balance sheet and has chosen to reduce debt through most of the absorption of growth that might have otherwise been used to increase the dividend. I think the policy will continue for the board to strategically think about that. It is definitely a topic of discussion, and my expectation would be that we view that on an ongoing basis as we've done in the past. As soon as we have something to share with the marketplace with regard to the dividend, we will be out there sharing it.

Speaker 5

Yeah. I just was wondering whether you look at sort of other revaluations and as a cost of capital, whether that plays into the board's thinking?

Jeff Jorissen (Director of Corporate Development)

I think it's definitely one of the components. I think that it's one of about five or six components that the board carefully monitors and that we carefully look at as relative value is compared to the metrics of premiums that are being applied to other REITs. But I also suggest that if you look at our dividend yield right now in comparison to other REITs, that we would fall out on the high side right now. So I'm not sure that dividend alone would enhance that multiple or the valuation.

Speaker 5

Okay. Going back to the acquisitions, if I could, just in terms of the sort of if you were going to look at a progression of what cap rates were, say, a year ago or two years ago, what's happened in terms of the properties that you're looking at? And then also, are you seeing more competition for the same property? And what do you bring to the table in terms of on the acquisition front to the seller?

Jeff Jorissen (Director of Corporate Development)

Sure. I guess I'd share with you how I've felt from a professional standpoint of being in this industry for quite a few years. We really have never seen much compression or change to cap rates. There are not a lot of consolidators. There are a few. There's ourselves and obviously our competition, ELS, as public companies. I think the current marketplace plays very strong to the public companies with regard to aggregating and consolidating holdings in the MHC arena and the RV arena. I think that obviously the capital marketplaces are favorable, and I see a strong continued pipeline. I think what the public companies have is obvious rapid ability to close a transaction, the ability to issue tax-deferred structures through the use of OP units and other securities that aren't available often to the private competition.

I see that same 6-8.5 range that I looked at 5 years ago, 10 years ago, and 15+ years ago today. Not a lot has changed, nor have I ever seen any real compression or expansion. Debt markets and capital markets obviously have a role, but I think when you point to the steady cash flows of this industry and compare it to other asset classes, that's why there's been a consistency and not much elasticity, if you will, to the Cap Rate. So I don't see much change out there.

On the point of what I see with regard to the pipeline, I think that there are a lot of reasons I could point to, some of which would be the lack of capital by current owners for needs to refinance, to buy back occupancy through things like the rental programs, estate planning, and retirement going on, much stronger and more difficult underwriting when they refinance, and the capital that's available to companies like ourselves to acquire right now, kind of making a pretty robust acquisition environment.

Speaker 5

Okay. Thanks.

Jeff Jorissen (Director of Corporate Development)

Sure.

Operator (participant)

Our next question comes from the line of Andrew McCulloch. Go ahead, please.

Speaker 6

Hi, this is Ryan Burke here with Andy. Just sticking with acquisitions for a second, definitely appreciate the comments on RV portfolio and the fact that cap rates have sort of stayed in this band, in this range. Are you able to provide specific color on cap rates for each of the acquisitions besides the RV portfolio?

Jeff Jorissen (Director of Corporate Development)

Yeah. I think we did in our press releases. We generally do when they're available. I don't know that we have anything in front of us right now, but if you want to call Karen or myself, we'll review anything that we've published previous. But they're all in that range.

Speaker 6

Okay. Understood. And then second question, just in regards to the guidance for 2,000 home sales for 2013, how do you expect those to break out just in terms of homes that were financed versus cash purchases? Any change from the norm on that front?

Karen Dearing (CFO)

No. Generally, 95% of our homes are financed, so we would expect that to continue in 2013.

Speaker 6

Okay. And the bucket that is financed, should we assume that they will continue to be financed primarily by what would technically be the third parties?

Karen Dearing (CFO)

Yes.

Speaker 6

Okay. Thanks. That's all for me.

Operator (participant)

Once again, ladies and gentlemen, if you wish to ask a question, it is star one on your touch-tone phone at this time. For any questions, it is star one. We have a follow-up question from the line of Paul Adornato. Go ahead, please.

Speaker 4

Thank you. Gary, you mentioned that the useful life of the manufactured homes has kind of increased over time. And was wondering if you could talk about the average age of the homes in your communities, if that has similarly increased, or with the addition of new homes, if that has stayed the same or decreased over time?

Gary Shiffman (CEO)

Well, Paul, we have homes that have been in the communities for well over 40 years. I remember a HUD study some years ago that asserted the life of the average manufactured home at something like 54 years. In terms of our portfolio, the fact that something like 2.5%-3.5% of the homes are actually removed from the community each year has the effect of creating a 30-35-year life so that there's always new homes coming into the community to replace what are usually the older homes that are moved out of the community. So it's kind of a gentrification or regentrification process that takes place automatically in our communities.

Speaker 4

Okay. Great. So that's not anything that I mean, that just happens. You can't really affect that except to the extent that you're putting in new homes into the rental program.

Gary Shiffman (CEO)

That's correct.

Speaker 4

Okay.

Jeff Jorissen (Director of Corporate Development)

That was Jeff, by the way, not Gary. But Paul, the only thing that I would add too is I don't think it's a matter so much of their useful life ending, whether it's 31 years or 40 years. As Jeff pointed out, the inventory just shifts out. So whether they go to private land, whether they're no longer some of them obviously don't have a useful life beyond that, but many of them do survive. They're just outside the community.

Speaker 4

Right. Right. Right. Great. Thank you.

Jeff Jorissen (Director of Corporate Development)

Okay.

Operator (participant)

Gentlemen, it appears there are no further questions at this time. I will turn it back to management for any closing remarks.

Jeff Jorissen (Director of Corporate Development)

I'd just like to thank everybody for participating on the call. Gary, myself, and Jeff are available for any follow-up questions. We certainly look forward to sharing additional news and then information on next quarter's results with everybody. Thank you.