Sun Communities - Q4 2016

Transcript

Operator (participant)

Good day, ladies and gentlemen. Thank you for standing by, and welcome to the Sun Communities Fourth Quarter 2016 earnings conference call on February 23rd, 2017. 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 the SEC.

The company undertakes no obligation to revise 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, John McLaren, President and Chief Operating Officer, and Karen Dearing, Chief Financial Officer. I would now like to turn the call over to Mr. Shiffman, CEO. Mr. Shiffman, you may begin.

Gary Shiffman (Chairman and CEO)

Good morning, and thank you for joining us. Sun's 2016 was marked by sustained success in achieving strong results for our stakeholders. We delivered another year of industry-leading results with same-community NOI growth of 7.1% for the year and 9.1% for the fourth quarter, driven by revenue increases of over 6% for the year and the quarter. We have now increased or maintained occupancy for 20 consecutive quarters and ended 2016 with same-community occupancy of 96.6% and overall portfolio occupancy of 96.2%. We expect continued high occupancy going forward, given the strong fundamentals creating demand for our communities. In 2016, we received more than 45,000 applications for our available home sites, a ratio of 10 applications per available site, supporting our view that Sun offers a compelling, affordable product in desirable locations throughout the United States and Ontario, Canada.

Home sales, another strong indicator of industry demand, was a consistent contributor throughout the year. In 2016, we sold a record number of homes, totaling nearly 3,200, up approximately 28% over 2015, which was our previous record. Of these sales, over 1/3 were former rental homes, which demonstrates the benefits that a well-managed rental program can offer, including filling expansion sites, generating income from otherwise vacant home sites, and introducing future homeowners to our communities. On the external growth front, we completed our largest single acquisition to date in Carefree, which increased our site count by over 30%. Since 2011, we have executed on our strategic plan to grow our market share in the RV, age-restricted, and high barrier-to-entry markets with either one-off or platform acquisitions. The acquisition of Carefree accelerated our efforts and helped solidify Sun as one of the nation's highest-quality manufactured home and RV owner-operators.

With Carefree, our resident mix is now 33% age-restricted, and our geographic profile is further enhanced with broader exposure in the desirable Florida retirement communities and California market. The breadth and stability of our portfolio provides us with the opportunity to pursue selective value-add acquisitions. Excluding the Carefree acquisition in 2016, we added eight communities, six of which we are planning to reposition, redevelop, and/or re-tenant. These types of activities are not new to us, as we apply and leverage the proven methods we have developed across the Sun platform to all of our acquisitions. We expect these types of value-add acquisitions to continue to be a focus in the coming year as an additional avenue to enhance returns for our shareholders over the next few years.

In support of 2016 growth initiatives, we were active in the capital markets, raising over $750 million in equity and $940 million in new or replacement debt at a weighted average cost of 3.67%. We have also taken advantage of favorable market conditions to address substantially all of our 2017 maturities. We are making solid progress on achieving our target Net Debt-to-EBITDA ratio of below 7x, and Karen will provide more detail later in our call. Given the strength of the Sun platform and our prospects for future growth, the board of directors has decided to raise the per-share dividend by $0.02 per quarter or $0.08 per year, which translates to a 3.1% increase. We are highly encouraged by our market positioning and the inherent levers that will drive Sun's growth.

For 2017, we are anticipating solid same-community growth between 6.4% and 6.8%, and are adding expansion sites in 18 of our manufactured housing communities and six of our RV resorts as a result of continued strong demand. These expansions, coupled with portfolio-wide demand, will in turn support a healthy level of home sales, in line or better than sales achieved in 2016. And lastly, the continued maturation of Carefree and the other 2016 acquisitions will also contribute to a year of double-digit FFO growth. Before turning the call over to John McLaren, our Chief Operating Officer, who will discuss the integration of Carefree and our operational results in more detail, I would like to take this time to thank all of our team members at Sun who once again gave extraordinary efforts to make 2016 such a successful year for the company. John?

John McLaren (President and COO)

Thanks, Gary. It is my pleasure to speak with you about our 2016 operational performance for the fourth quarter in the year. I've had the opportunity to meet a number of our analysts and investors during 2016 and look forward to interacting with more of you in 2017. Before I jump into Sun's operational performance this past year, I thought it would be appropriate to spend some time discussing the integration of Carefree. As you are well aware, Sun purchased Carefree in the beginning of June for roughly $1.7 billion, enhancing Sun's irreplaceable portfolio with additional high-quality RV assets, retirement communities, and exposure to the western states. The RV winter season is in full swing, and operations at Carefree are proceeding smoothly. As Gary has discussed in the past, integrating acquisitions is one of Sun's core competencies.

Having added approximately $4.3 billion of assets over the past five years, we have developed a very efficient and effective process of integrating large acquisitions onto Sun's platform. With respect to Carefree, whose integration we now consider to be substantially complete, we successfully onboarded over 1,300 team members and restructured our asset and property management teams to ensure that our former Carefree team members had the appropriate support. We view culture as one of the key risk factors in making an acquisition successful, so we gave a great deal of consideration to blending the Carefree and Sun cultures to ensure the team members felt empowered, invested, and secure during the integration process. Our team's sense of ownership and empowerment raises the quality of service provided to our residents, which ultimately serves to strengthen our brand by building what we refer to as our resident sales force.

Culture is everything here at Sun. We treasure what we have collaboratively built. In addition to culture, we seamlessly merged all of our marketing programs, operating procedures, and financials to ensure continued smooth operations. This is clearly evidenced with first six months' results that exceeded our initial performance expectations for Carefree. Finally, we refined our capital improvement process, more clearly focusing on needs and timing of deployment. During the due diligence process for each of our acquisitions, we perform a thorough preliminary analysis of expected capital improvement projects, which focus on capturing unique repositioning opportunities and enhancing the community to Sun's quality standards. After closing, as we learn more about the asset and its residents, we perform another comprehensive review of budgeted projects to be sure we deliver the right improvements at the right time to create the greatest value per dollar spent.

As a part of the reevaluation process with the Carefree portfolio, we determined that continuing the planned three-year redevelopment of Ocean Breeze in Jensen Beach, Florida, or OBJ, which includes the improvement of existing sites, the addition of expansion sites, and providing for significant new amenities. We instead would take advantage of the high demand for this waterfront location and complete the entire project in 2017. Although requiring additional planning upfront and delaying the originally expected completion of a smaller number of sites, we believe accelerating the entire project is the right decision to maximize value. As a result of the change, OBJ will not contribute as much in 2017 as originally estimated, impacting accretion by approximately $0.02. So now let's turn to our operational results. Our team turned in another excellent quarter.

Total revenues increased by 30% over fourth quarter 2015 and 24% for the year, as all of our businesses and various growth initiatives across the platform contributed to top-line growth. We added 301 revenue-producing sites in the quarter, bringing total portfolio occupancy to 96.2% as of year-end, up 120 basis points on a year-over-year basis. Additionally, during 2016, we converted nearly 1,100 former renter households into owners. Our total number of occupied rentals was flat year-over-year and declined to 10.6% as a percentage of our total developed sites from 13.5% at the beginning of the year. Turning to our same-community results, our same-community performance for the quarter and the year continued to deliver solid gains. Same-community revenue growth for the quarter and the year was 6.2% and 6.1%, respectively. Same-community occupancy increased by 190 basis points to 96.6% year-over-year.

The occupancy increase includes the conversion of approximately 470 RV sites from transient to annual seasonal and filling 304 expansion sites during the year. Manufactured housing revenue for the same communities increased by 5.4% for the quarter and 5.6% for the year, while RV revenues for our same communities delivered strong growth of 9.3% for the quarter and 7.5% for the year. The RV revenue gains were comprised of 9.4% growth in annual seasonal revenues and 9.1% gains in transient revenue for the fourth quarter as compared to the fourth quarter 2015. For 2016, annual seasonal revenue gains were 9.4%, while transient revenues grew by 5.0%. As Karen shared with you over the first three quarters of 2016, operating expenses were running slightly above budget, primarily due to higher-than-expected real estate taxes, which resulted in a 3.7% same-community expense increase for the year.

However, for the quarter, same-community expenses improved 0.9%, resulting in very strong same-community NOI growth of 9.1% over the fourth quarter 2015. For the year, same-community NOI growth was 7.1%. Turning now to home sales, Sun had a record year for home sales, which we believe is a testament to the high quality of our communities and the value our properties deliver to our residents. Annual home sales revenues increased by 38.6% over 2015 and 13.3% over fourth quarter 2015. 10% of total homes sold in the year were new, with an average sales price of $94,000. In fact, in the fourth quarter, our average new home selling price was above $100,000 for the first time in the company's history. Of the total homes sold in the year, 34.3% were purchased by former Sun renters.

Our rental program continues to prove to be an effective tool in absorbing expansion inventory and a way to showcase our communities and offer prospective buyers an opportunity to test drive before making a meaningful financial commitment. At the end of 2016, our rental program was comprised of 10,733 sites with a weighted average rent of $882. All in all, we had a great year operationally, and we look forward to another successful year. With that, I will turn the call over to Karen.

Karen Dearing (CFO)

Thanks, John. For the fourth quarter ended December 31, 2016, Sun delivered funds from operations of $0.91 per diluted share, an increase of 12.3% from the prior year's fourth quarter. For the year, FFO was $3.79 per diluted share, a 4.4% year-over-year increase. As John discussed, these results were driven by strong performance across our platform, including solid same-community performance, increases in revenue-producing sites, the contribution from Carefree and other acquisitions, and ongoing momentum in home sales. And now I'd like to turn to our transaction activity and balance sheet. During the quarter, we completed a $58.5 million secured borrowing with an attractive fixed interest rate of 3.3% and a seven-year term. We also repaid $79.1 million of mortgage loans in the fourth quarter and $28.9 million of mortgages in 2017. These repayments substantially address our 2017 maturities and a small portion of 2018 maturities.

As of December 31, 2016, Sun had approximately $3.1 billion of debt outstanding, with a weighted average interest rate of 4.48% and a weighted average maturity of 8.5 years. At year-end 2016, we had $8.2 million of cash on hand and a net debt-to-trailing 12-month EBITDA ratio of 7.5 times, which shows ongoing progress towards our anticipated leverage in the mid-6 times by mid-2017, as a full 12 months of Carefree EBITDA recognized. During the fourth quarter of 2016 and in January 2017, we sold 300,000 shares of common stock through our At the Market Equity Sales program at a weighted average price of $76.43 per share. Net proceeds from the sales were $22.6 million. Now turning to guidance.

In 2017, we expect our FFO for the year to be in a range of $4.16-$4.24 per diluted share and FFO for the first quarter of 2017 to be in the range of $1.06-$1.08 per diluted share. Our FFO guidance does not include any potential capital market activities or prospective acquisitions. There is seasonality in revenue generation within the portfolio, and today's press release contains additional details on the estimated percentage of FFO per share to be earned in each quarter. There are a number of additional items that I would like to review that should assist you in developing your earnings models for the coming year. Our 2017 same-community portfolio has increased to 231 communities from 219 in 2016, and we anticipate full-year same-community NOI growth to be in a range of 6.4%-6.8%.

Our total portfolio weighted average rental rate increase is expected to be 3.6%, and revenue-producing sites are budgeted to increase by 2,600-2,800 sites. This includes converting just over 700 transient RV sites to annual seasonal and filling approximately 700 expansion sites. During the year, we expect to complete the construction of approximately 1,800 manufactured housing expansion sites in 18 communities and 400 RV sites across six communities. Total sales of approximately 3,600 new and pre-owned homes includes expected renter conversion sales of approximately 1,200 homes. Please refer to today's press release for additional detail regarding guidance for 2017. With that, I would like to turn the call back to the operator to begin the question and answer session.

Operator (participant)

Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press Star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the Star keys. One moment, please, while we pull for questions. Our first question comes from a line of Nick Joseph with Citigroup. Please state your question.

Michael Bilerman (Managing Director)

Hey, it's Michael Bilerman here with Nick Joseph. Gary, or Karen, maybe you can walk through a little bit and talk about sort of G&A growth and coming up this year of about 13% growth, up to $73 million. That's after a 35% growth last year. And you've sort of been in this range of 14%-16% of NOI, upwards of 90 basis points and above of GAV. You're almost a ten-billion-dollar company. I guess at what point should we start thinking about efficiencies on the G&A front? Have you guys gone through a process of trying to reduce G&A in any way so that incremental investments could have a bigger effect on the bottom line? Maybe just help us understand and bridge the gap a little bit why we continue to see I mean, G&A has doubled in three years.

I think just better understanding of what's going on would be helpful.

Karen Dearing (CFO)

Sure. I have a few things to say about G&A. So we have had very, very significant growth in the company in the past couple of years. And yes, G&A has grown. If we're looking from 2016 to 2017, the primary reasons for the increases are really a full-year of salary additions for Carefree personnel we brought on in comparison with a partial year in 2016. That, plus an increased deferred compensation amortization, are really the two reasons for it. And as we've discussed previously, we've hired and we've incentivized our people to assure the performance and the integration of all of those acquired properties. So when we look at it, absent those two factors, G&A would be increasing about 2% over last year. And we do our G&A as a percentage of revenue. So we are making good progress to reducing G&A as a percentage of revenue.

It's down to 7.4% from 7.7% last year. We have a goal of reaching 7% at the end of 2018. At that level, I think we'd be right in line with REIT averages. We think we're very, very scalable at this time if opportunities should arise. The other thing I want to say about G&A is just a reminder that we do not perform a property management allocation. If we were to allocate, let's say, a 4% property management fee, our G&A would approximate 4.7% of revenues for 2017, which we think is very well in line with REIT averages.

Michael Bilerman (Managing Director)

I think Nick had a question too.

Nick Joseph (Head of US Real Estate and Lodging Research Team)

Thanks. Yeah, this is Nick. I just want to touch on leverage. You mentioned 7.5% on trailing and trending to the mid-sixes by mid-2017. I think in past calls, you've talked about being comfortable under 7times. I just want to make sure that's still the fact, and if there's any kind of additional deleveraging that you expect this year or just the earn-in from Carefree.

Karen Dearing (CFO)

The 6.5 times that I noted in my comments are really a reflection of the Carefree EBITDA coming in through a full-year's Carefree EBITDA coming in through June of 2017.

Nick Joseph (Head of US Real Estate and Lodging Research Team)

Is your target still below 7 times?

Karen Dearing (CFO)

Our target is below 7 times. We're comfortable where we're at now. With the way the properties are growing, you'd have some natural deleveraging, but it does give us a little bit of room as far as acquisitions.

Nick Joseph (Head of US Real Estate and Lodging Research Team)

Okay. And then just last question on acquisitions. You've been active the last two years in terms of one-off properties as well as larger portfolio deals. Can you talk about the pipeline today and expectations for 2017, if you think there'll be more one-off deals or if there are any larger portfolios on the market?

Gary Shiffman (Chairman and CEO)

Hey, Nick. It's Gary. I think we look to continue what we would view as normalized acquisitions, onesies and twosies. I've shared before that there are a handful of high-quality portfolios out there that us and others tend to track, but there is nothing, I think, in the foreseeable future that right now we're aware of. So it would be acquisition activity that's a normalized year. And as I shared in my comments on the last call, we're also looking to leverage operations scalability to create opportunistic value by acquiring maybe some functionally obsolete-type communities that are well located and have the ability to benefit from Sun's management. And we bought four of them, as I shared by the third quarter call. And they'll be a part of what we're doing, but just a part of the onesies and twosies we will be acquiring throughout the year.

Nick Joseph (Head of US Real Estate and Lodging Research Team)

Thanks.

Operator (participant)

Thank you. Our next question comes from the line of Ryan Burke with Green Street Advisors. Please state your question.

Ryan Burke (Analyst)

Thank you. Karen, I wanted to make sure I understand your comments on G&A. So you have a target of 7% of revenue by when was it?

Karen Dearing (CFO)

The end of 2018, Ryan.

Ryan Burke (Analyst)

The end of 2018. Can you talk us through just how you get there? I mean, how much of this is the assumption of increasing revenues versus the assumption of actually reducing G&A line items or pieces of the line item?

Karen Dearing (CFO)

I think it definitely is a combination of both. We do have pretty strong growth inherent in the portfolio, but we are continuing to work on automating our processes. I've talked about it in prior calls. We're doing several projects to improve our efficiencies and to take some of our manual processes into automated processes. So we would expect it to be a combination of both.

Ryan Burke (Analyst)

Okay. And then perhaps a question for John. Your peak rent growth back in the early 2000s was 5%. I think you're guiding to something in the mid-3% range for 2017. What would keep Sun in the sector more broadly from getting back up to that 5% rent growth number?

John McLaren (President and COO)

So this is John. Historically, we have been sort of in the world of 2%-4% increases, even in the toughest of economic times. And frankly, this is one of the reasons why we've always referred to our industry as somewhat recession-resistant. And I think if you look at sort of our occupancy growth over these years, I think you would find that we've gone from a rent increase level of about a 2.5% range up to what we're guiding to in 2017 of 3.6%.

Ryan Burke (Analyst)

Okay. So I mean, it sounds like we shouldn't necessarily expect that rent growth is going to get back up to that 5%, perhaps even though this is a sort of very recession-resistant revenue stream. Perhaps that was just different times.

John McLaren (President and COO)

Yeah. I mean, I think we could expect it to be in the fours.

Ryan Burke (Analyst)

Okay. Okay. And then last question. Just I think this is my annual check-in on Fannie and Freddie. The FHFA at the end of 2016 started to give a little bit of a nudge to Fannie and Freddie to try and figure out how to support chattel lending. A lot has to happen for that to actually play out. But Gary, what are the implications for your portfolio if and when that happens?

Gary Shiffman (Chairman and CEO)

It's a great question, Ryan. I'll give you my annual response, which is after 30 years of being in this industry and hearing the federal government make requests and Fannie and Freddie respond occasionally, we just really haven't seen it, and we don't see anything at this time that we would expect to change. Of course, we would welcome additional opportunities to fund homes for our residents, but really not aware of any change actually taking place in the foreseeable future.

Ryan Burke (Analyst)

Okay. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Drew Babin with Robert W. Baird. Please state your question.

Drew Babin (Senior Research Analyst)

Morning.

Karen Dearing (CFO)

Morning, Drew.

Gary Shiffman (Chairman and CEO)

Morning, Drew.

Drew Babin (Senior Research Analyst)

I was hoping you could walk through kind of the quarter-by-quarter cadence of the new sites being added throughout the year. Could that be more back-end loaded or kind of spread evenly throughout the year, the expansion sites?

Karen Dearing (CFO)

Yeah. Drew, we're going to add 1,800 MH sites in 18 communities, primarily Michigan, some Texas, and some Texas and some other one-off states. But they are primarily loaded to the second half of the year.

Drew Babin (Senior Research Analyst)

Okay. And then can you talk about the process of converting some of the Carefree transient sites to seasonal and annual? Anything that's challenging about that or anything that you've learned throughout that process?

John McLaren (President and COO)

So Drew, this is John. I mean, the conversion of transient sites to annual seasonal sites is really one of our sort of key drivers for occupancy. And it's a process that we have refined over the course of many, many years. And so for us, as we found through many of these acquisitions, it's really because of the refinement in that process, it's pretty easy to kind of bolt it on with the acquisitions that we've had, and we get pretty good success right out of the gate. Some of what contributes to that is just the level of effort that we put into the communities. And as we've talked before about how important our relationship with our residents is.

When you build that and they see you hitting the ground running with the kind of improvements that we do and the relationship that we establish, it bodes well to driving more of our customers that direction. We're pretty excited about it.

Drew Babin (Senior Research Analyst)

Lastly, if you could just talk about, I guess, directionally, the performance of your more Midwestern legacy-type communities versus some of the more recently added age-restricted product, more in the Sun Belt. Has operating performance been roughly similar between those two types of portfolios, or are you seeing any kind of bifurcation there?

John McLaren (President and COO)

Yeah. I'd say that really both types of communities performed exceedingly well in 2016. We don't really look at them differently. Certainly, our programs and what we do from a strategic standpoint from one to the next might differ a little bit, but it's all kind of put in there to make sure that we get the most out of the opportunity that's in front of us, regardless of whether it's age-restricted or a family community.

Drew Babin (Senior Research Analyst)

All right. Great. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Gwen Clark with Evercore ISI. Please state your question.

Gwen Clark (Analyst)

Hi. Good morning. On the age-restricted versus all ages, is it possible to break out the rent growth between the different asset classes?

John McLaren (President and COO)

Well, as far as rent increases, Gwen, this is John. We really don't break them apart, but generally speaking, the all-age communities tend to get a little higher rent increase in all economic cycles and experience about a point of increased turnover during more challenging economic cycles.

Gwen Clark (Analyst)

Is it possible to say what that delta was like this year? Was it 50 basis points?

Gary Shiffman (Chairman and CEO)

I don't think we have it, Gwen, but if you want to get back in touch with John or Karen, we can probably discuss it a little bit more.

Gwen Clark (Analyst)

Okay. Great. And then just one other one. On external growth, can you talk about just what you're seeing on the acquisition side and whether you guys are contemplating more dispositions?

Gary Shiffman (Chairman and CEO)

It's Gary. And John, you can fill in anything that you want. But I think our disposition plan was wrapped up in 2014, and we sold about 30 communities. And obviously, we've been growing since. We identified some communities in the Carefree portfolio that were under consideration for disposition, but we were not able to actually execute on those properties. And since then, under John's oversight in the operations department, we've seen very healthy and significant growth in those actual properties. And he has been a proponent of continuing to manage those properties for continued growth and review at some future time. And on the acquisition side, we expect to—we do have a very good pipeline, very similar to what we've had in each of the previous years. But as I indicated, they're all single or double community acquisitions.

So it will be much like previous years where we didn't have platform acquisitions like American Land Lease and Carefree.

Gwen Clark (Analyst)

Okay. That's helpful. Thank you.

Operator (participant)

Thank you. There are no further questions at this time. That does conclude our question-and-answer session. I will now turn the conference back over to Mr. Gary Shiffman for closing remarks.

Gary Shiffman (Chairman and CEO)

As always, I want to thank everybody for participating. Myself, Karen, and John are available for any follow-up discussion. We certainly look forward to speaking to everybody after first quarter is completed. Thanks.

Operator (participant)

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.