Sun Communities - Q4 2014

Transcript

Operator (participant)

Gentlemen, thank you for standing by, and welcome to the Sun Communities Q4 2014 Earnings Conference Call on the 24th of February, 2015. 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 meanings 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, 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. If you would like to ask a question on today's call, please press star one on your telephone keypad. Please make sure that your mute function is turned off to allow your signal to reach our equipment. 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 $35.2 million or $0.69 per share for the Q4 of 2014, compared to $30.7 million or $0.78 per share in the Q4 of 2013. For the year, FFO was $148.4 million or $3.37 per share, compared to $121.5 million or $3.22 per share for 2013. These results exclude certain items as detailed in today's press release. Revenues for 2014 increased by 13.6% from $415.2 million in 2013 to $471.7 million in 2014. Now turning to the portfolio for an overview, the Q4 operating results reflect continued positive trends in key aspects of the portfolio. This is our fifth consecutive year of increased annual occupancy growth, fifth consecutive year of increasing same-site NOI growth, and ninth consecutive year of home sales growth.

Turning to occupancy during the Q4 of 2014, we added 475 revenue-producing sites, bringing the total annual increase to 1,890 compared to 1,885 in 2013, setting again a historic high for the company. Total portfolio occupancy was 92.6% at year-end. Guidance for 2015 includes occupancy improvement of 2,100 sites, which will bring portfolio occupancy to approximately 94% at the end of 2015. In the same-site portfolio of 163 communities, NOI growth for the quarter was 6.2%, bringing the total NOI growth for the year to 7.7%, the highest annual same-site NOI growth achieved since 1999. For the year, revenues grew by 6.6% while expenses increased by 4.1%. Same-site occupancy increased by 1.7% from 91.5% at December 31, 2013, to 93.2% at December 31, 2014.

The 2015 same-property portfolio guidance is based on 177 communities, and revenues are expected to increase by 6.3% with an expense increase of 2.6%, resulting in NOI growth of 7.9%. During 2014, 1,966 homes were sold as compared to 1,929 in 2013. This record number of home sales was the result of a 32.9% increase in new home sales. At the same time, we received over 34,000 applications to live in our communities in 2014, again an increase of 12% from 13 applications. Included in this increase in the applications is a same-site year-over-year increase of 10%. The guidance for 2015 projects an 18% increase in the number of home sales to 2,300 for the year, including 214 new and 2,086 pre-owned home sales, nearly a twofold increase in new home sales and a 13% increase in pre-owned home sales.

Now turning for a review of the RV performance, we continue to increase the number of annual and seasonal residents in our RV communities, as well as maximizing occupancies and rental rates in our transient and vacation rental sites. Revenue growth for the annual seasonal contracts in the same-site portfolio was 10% for the quarter and 7.2% for the year. Revenue per available site in the same-site portfolio grew 11.4% for the quarter and 10% for the year. Our call center continues to handle increasing call volumes, receiving just under 100,000 calls in 2014 and increasing the average revenue per reservation of the call center by 5% from $338 per reservation in 2013 to $355 per reservation in 2014. Our internet digital presence continues to get stronger, demonstrated by our year-over-year increases.

Page views have increased by 144%, internet sessions have increased by 127%, and unique online users have increased by just over 100%, all of which has translated in a year-over-year increase of 170% in revenue generated from digital-related RV activities. Guidance for 2015 projects an increase of 8% in RV revenue. And now I'd like to turn to our expansion activity. With 7,600 sites owned and zoned for either MH or RV expansion, we continue to add incremental growth to the portfolio by utilizing our development experience in high-occupancy, high-demand communities. Over the past three years, we've added nearly 1,400 sites to the portfolio, 375 of which were added in 2014. We continue to experience high demand in our expansions, with absorption rates averaging over 9 sites per month. Plans for 2015 include developing approximately 800 expansion sites in eight communities located in Texas, California, Ohio, and Maryland.

5 are manufactured housing communities, 4 of which are at 95% occupancy with strong continued demand, and the 5th is currently filling up the recent expansion sites brought online in 2014. The remaining 3 expansion properties are RV communities where we have an opportunity to satisfy an increasing demand. A special note is our acquisition activity during 2014. The 59-community American Land Lease portfolio acquisition was completed in two stages, one in November of last year and the final stage on January 6, 2015. During the second half of 2014, a cross-functional team of Sun staff members met regularly to examine all aspects of the integration of the American Land Lease portfolio. This included technology systems, hiring of team managers, data conversion, licensing and permitting, training, marketing, home sales, and numerous other details to develop timelines and migration plans to seamlessly integrate the properties and their staff into the Sun portfolio.

We're very pleased to report that the properties are up and running on all of our systems, and business is strong. Our disciplined approach to onboarding properties and people created immediate positive momentum in the property performance, indicated by RPS gains of 51 and home sales of 61 within the first 2.5 months of ownership. 2015 expectations for the portfolio include NOI growth of 45% and year-end 2015 occupancy of 92% up from 90%. In addition to the American Land Lease acquisition, we also acquired an additional 8 RV communities for approximately $192 million during the year. In December, we announced the intention to acquire 6 additional high-quality communities in the Q2 of 2015. The $257.6 million Berger acquisition includes 3,150 developed sites with occupancy of 96% and includes 380 sites available for expansion. 60% of the developed sites are in age-restricted communities.

With the addition of these properties, we will have increased the size of age-restricted portfolio from 10% to 12% over the last year and increased our presence in the highly sought-after Florida market. In 2014, we sold 10 properties, primarily located in Michigan and Indiana, for proceeds of over $75 million. An additional Indiana manufactured housing community containing 798 sites with an approximate occupancy of 50% was put under contract in 2014, but due to seller financing and delays, did not close until January 2015. Proceeds from the sale of this community were $18 million. No prospective dispositions are included in 2015 guidance, although we continue to actively evaluate the portfolio for potential future dispositions in 2015, seeking to redeploy capital to properties and locations providing greater future returns to our shareholders.

Driven by the continued strong performance of same-site portfolio and accretive acquisitions, we expect 2015 FFO per share to be in the range of $3.53 to 3.63. At the midpoint of guidance, this reflects an increase of 6.2% in FFO per share. FFO per share for the Q1 of 2015 is expected to be $0.84 to 0.86 per share. Included in guidance is a $5.5 million manufactured housing community acquisition expected to close within the next few weeks and the previously mentioned Berger portfolio acquisition. No other prospective dispositions are in guidance, or no other acquisitions are in guidance. Additional information on 2015's guidance, including estimates of other income, ancillary revenues, the expected performance of non-same-site communities, and the seasonality of transient RV revenues, can be found in today's press release. At this time, Operator, I would turn it over for Q&A. Thank you.

As a reminder, if you'd like to ask a question, please signal by pressing star one on the telephone keypad. Please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, press star one to ask a question. We'll take our first question from Jana Galan with Bank of America Merrill Lynch.

Jana Galan (Equity Research Analyst)

Thank you. Good morning. I was wondering if you could provide some comments on the current size of the potential acquisition pipeline and whether it's MH or RV.

Gary Shiffman (Chairman and CEO)

So, Jana, I would say that it stays pretty steady with what has been traditional in an environment like this. There always seems to be right around $100 million of acquisition in the pipeline. And I would say that it's a pretty even mix between RV and manufactured housing. And there is a lot of inbound traffic. I think that there's been a lot of notoriety to the extent that Sun has been in the market as strong as it has been for acquisition. So we expect it to continue. We will be focused for the next six months on integrating the AOL transaction as well as the Berger transaction. So it wouldn't surprise me if there was a slowdown for the next six months as we assimilate those properties.

Jana Galan (Equity Research Analyst)

Thank you. And it looks like on the Berger acquisition, you have the financing plans in place. I guess, anything extra that you do throughout the year, how are you thinking about funding that? And is that where you see potentially dispositions coming into play?

Gary Shiffman (Chairman and CEO)

Yeah, I think that's an excellent question and comment. I think I would share with the market that the purpose of the ATM was to pretty much match fund the cash needs for Berger, about $31 million to close that transaction. The company has previously committed to pretty much a debt-neutral approach to future acquisitions after we did a lot of work to reposition our balance sheet. After the close of the AOL transaction, we were slightly more levered. I think that we will continue to look for that pretty much neutral approach for acquisitions. I think that we're in pretty good shape with cash on hand, but have the intention of maintaining that debt neutrality.

Jana Galan (Equity Research Analyst)

Thank you.

Operator (participant)

As a reminder, if you'd like to ask a question, please signal by pressing star one. We'll take our next question from Paul Adornato with BMO Capital Markets.

Paul Adornato (Equity Research Analyst)

Thanks. Good morning. Sorry if I missed this, but with respect to the rent increase in guidance at 3.4%, I was wondering if you could perhaps break that down by property type, RV versus age-restricted, etc. Is it slanted one way or the other?

Gary Shiffman (Chairman and CEO)

I think that, Paul, it's Gary. What we shared with the market is that we anticipate RV revenue for 2015.

Karen Dearing (CFO)

Revenue is expected to be up about 8%, but that's both rental increase and just occupancy increases. But I would say that it's split pretty evenly. The RV may be a bit higher than the MH portfolio, but I wouldn't say it's a significant difference, Paul.

Paul Adornato (Equity Research Analyst)

Okay. Okay. Great. And I guess related to that as well, now that occupancy is increasing nicely in various properties, I was wondering if you'll be pushing rates a little bit more or anticipate pushing rates a little bit more either in those properties or in, again, certain portions of the portfolio as occupancy increases?

Gary Shiffman (Chairman and CEO)

I think, again, Paul, that's something we have shared historically with the marketplace is that when you look at our historical operations, we have been able to gain significant momentum in our rental increases at periods where we're at mid-90s% occupancy. I think that in looking at 2014, we've slowly begun to push our rental rates in many of the communities where we have that occupancy. And with the anticipation that we'll be at 94% occupancy by the end of 2015, I'm sorry, we would expect to see the ability to get more aggressive with the rental rates in 2016 beyond what we're already experiencing. So I do think that is something that we will be able to implement by close of this year. And also.

I did one of the things that it's important to understand that in Florida generally, rental increases have to be notified 90 days in advance of them taking place. And the vast majority of them are notified so they can take place in January. And so I think about 50% of our rental increases for 2015 are already in place by Q1. So again, as we go through the year, I'm looking forward to being able to share that growth in 2016. Great.

Paul Adornato (Equity Research Analyst)

And I guess related to that notification, are there rent restrictions or rent controls on any of the properties in the combined portfolio that is your legacy as well as American Land Lease?

Gary Shiffman (Chairman and CEO)

Yeah. In our overall portfolio, there are no rental restrictions with regard to Florida. There is what we reference as Chapter 723, which provides the information of how rent will increase in a prospectus to the resident before they move in. So it is not rent controlled except for the fact that such things as notice that you will be tied to CPI or CPI plus a certain percentage or the higher or lower of CPI or another increase. Things like that exist in our Florida all age-restricted communities. Many of them are defined just as market rent. Other than that, I only know of one other community where there is some limits to rent increases, but nothing that would not allow us to get our normal rental increases.

Paul Adornato (Equity Research Analyst)

Okay. Thanks so much for that.

Operator (participant)

We'll take our next question from Nick Joseph with Citigroup.

Nick Joseph (Managing Director)

Thanks. I just want to touch on the rental program for a minute. So, it looks like your NOI from the rental program in 2014 increased by $11.8 million. Can you break that down between the benefit from the $74 million of incremental spend versus kind of a same store number from your end of 2013 portfolio?

Karen Dearing (CFO)

I do not have that type of breakdown for you, Nick.

Nick Joseph (Managing Director)

Okay. Thanks. Could you walk through, I guess, how you think about that incremental spend in terms of an IRR? So basically, what the average home price for a rental you acquire, what your growth rate assumptions are, how long the hold period is, and kind of the terminal value at the end?

Karen Dearing (CFO)

How we look at that rental program is really on this basis. When you look at the average market rent for those homes at $825 a month, average cost for a home, let's say, is $40,000. When you take out 10% for vacancy during the year or $820 and you take out $200 of monthly rental expenses, you net around $525 a month. You're going to be a little over $6,000 annually for that home. And on that $40,000 home, you'll have about a 16% return.

Michael Bilerman (Managing Director)

I guess I'm curious, why don't you guys ask Michael Bilerman, how come you can't provide the breakdown, same store NOI with and without the rental program and what contribution it is? It seems like it's a big part of the earnings stream and same store. How can you not have those numbers available?

Karen Dearing (CFO)

I just don't have those numbers available for you right at this time.

Michael Bilerman (Managing Director)

But it's a big piece of same-store growth out of the portfolio.

Karen Dearing (CFO)

I mean, you can see in our rental table each quarter, you can see the amount of site rent that is applicable to the rental program. So, you can see a total number. We have not provided that between same-site and non-same-site.

Nick Joseph (Managing Director)

Now, is the benefit from that $74 million incremental investment in 2014, does that hit the same store pool?

Karen Dearing (CFO)

Some of it does. A majority of it does. Although we have been growing this rental program, and a lot of it is based on growing it in expansions and acquisitions and in core portfolio where we haven't reached 95% occupancy. So yes, some of the benefit of that additional spend is in same-site, and some of it is in the non-same-site acquisition portfolio.

Nick Joseph (Managing Director)

It'll be very helpful to have the financial details. If you want to provide it next week at our conference, that's fine. I do think that active disclosure in terms of the items related to same store in terms of the breakdown core versus rental, given the fact that you are putting this capital in, and it's truly not a same store operating. It's a rental program. It's not a lease program where you own the homes. I think it needs to be disclosed.

Karen Dearing (CFO)

Well, we thank you for the suggestion.

Gary Shiffman (Chairman and CEO)

I think for those interested in a little color on what's happening in the rental program, by year-end 2014, we have actually reached what we refer to as an inflection point in the overall rental program whereby, we generally intend to use the rental program to accelerate occupancy in our acquisitions and our expansions. We do, in fact, and are seeing the expectation that there is a steady decrease in the core portfolio. We've seen it for 2015 as we laid out the budgets for those properties that have generally reached full occupancy of the 87 core properties. 30 are actually budgeted to apply in the rental program in 2015 and about 35 properties. Nearly every core and expansion community in Texas and Colorado is expected to reduce their rental program in 2015, exclusive of expansions that we're doing there.

And then even in 38 of the acquisition communities that we bought since June of 2011, that are now showing full occupancy, rental programs in 15 of those communities for 2015 are scheduled for significant decline. So, I think that we've utilized the program for many, many years. We no longer defend it because it has been an excellent program to enhance shareholder return and accelerate growth. But true to form, as we've been trying to demonstrate, is that as those communities do fill up, the rental program will decline in the full communities. But we will use it to accelerate growth in the AOL portfolio and where we can do expansions and in other portfolios where we can buy vacancy based on existing cap rates. And as we've shared in our presentations before, accelerate same site NOI growth.

Nick Joseph (Managing Director)

Thanks.

Gary Shiffman (Chairman and CEO)

Sure.

Operator (participant)

As a reminder, if you'd like to ask a question, please signal by pressing star one. We'll take a question from Ryan Burke with Green Street Advisors.

Paul Adornato (Equity Research Analyst)

Thank you. You're finding some success on the use of OP units as an acquisition currency. Do you view the recent OP deals more as isolated incidents, or are we seeing a shift towards potential sellers becoming more aware of and also more desirous of OP unit deals?

Gary Shiffman (Chairman and CEO)

It's Gary. I think that we don't see a shift. I would suggest that Sun has a history of using OP units and the preferred operating partnership units, which I think goes all the way back to us using them the first time 20 years ago. One of the things that we are seeing as we maintain relationships, and the Berger transaction is a perfect example. We issued OP units on a purchase of two properties to those same sellers 20 years ago. They were very satisfied with how the OP units had performed for them. And fast forwarding to this Berger transaction, which is basically the balance of the portfolio, their first request was to take the OP units and an American Land Lease.

A little bit similar, I think that there's been some recognition of the transformation of the platform at Sun, the improved balance sheet, the success of growing through a very, very challenging period, i.e., I think good management and good systems. So, in looking at the valuation, there has been more interest, and it hasn't required much sales from us to be able to use the OP units and other similar tools to acquire the properties. But I don't see a general shift on what's going on.

Paul Adornato (Equity Research Analyst)

Okay. What types of things did you do on the ground in terms of educating owners of manufactured home properties on OP units? I'd assume there's a fair amount of owners out there that perhaps wouldn't sell due to the tax effect, but if they knew about OP units, they may be more willing to. Do you have people out on the ground doing certain types of things?

Gary Shiffman (Chairman and CEO)

Yeah. So I think the way that we manage it is because each instance is different and can get quite complicated due to tax matters and estate planning. Generally, our acquisitions team goes out there, and then they, in the process of talking to a potential seller, discuss the tax ramifications and determine the complexity. And then we really do bring it back to our third-party experts who have been with the company for over 20 years and have structured many of these. And then it becomes either a phone call or a sit-down meeting to discuss the individual aspects of what one seller might need and to try and create a tax solution for those needs. So the general acquisitions team does not get too deep into it, but they're aware of the arsenal and the tools that we have to discuss with them.

Paul Adornato (Equity Research Analyst)

Okay. Thank you. One separate question on the composition of home sales. Do you have in front of you the percentage breakout of the 2014 home sales that were in all age versus age-restricted communities? Do you have a similar breakout for what you expect for 2015?

Gary Shiffman (Chairman and CEO)

We don't. That's something we can share with the market. I think that we've gone from 10% to 20%.

25%.

25% in all-age in the last 12 to 18 months or so. So we haven't broken it apart like that, and we'll be happy to do so. Generally, we've shared before, age-restricted communities tend to have much lower turnover, higher occupancy. The cause of a vacancy is usually related to health or, in some cases, death. So unless we're buying vacancies, new home sales in our age-restricted communities are probably much lower just due to the fact that the amount of available sites is much lower because the occupancies are higher than our core portfolio.

Paul Adornato (Equity Research Analyst)

All right. Thanks for the color. That's all for me.

Operator (participant)

We have no further questions in queue. Thank you for your questions. I would now like to turn the call back to Mr. Shiffman for closing remarks.

Gary Shiffman (Chairman and CEO)

Thank you, Operator. And I just conclude by saying we appreciate everyone participating on this call. Both Karen and I and others are always available for any follow-up questions. And we certainly look forward to sharing with you results next quarter.

Operator (participant)

This concludes the Sun Communities 2014 Q4 conference call.