Equity LifeStyle Properties, Inc. (ELS) Q2 2012 Earnings Report, Transcript and Summary

Good day, everyone, and thank you, all for joining us to discuss Equity LifeStyle Properties Second Quarter 2012 Results. Our featured speakers today are Tom Heneghan, our CEO; and Marguerite Nader, our President and CFO. In advance of today's call, management released earnings. [Operator Instructions] As a reminder, this call is being recorded. Certain matters discussed during this conference call may contain forward-looking statements in the meanings of the federal securities laws. All forward-looking statements are subject to certain economic risk and uncertainty. The company assumes no obligation to update or supplement any statements that become untrue because of subsequent events. At this time, I would like to turn the call over to Tom Heneghan, our CEO.

Thanks. Good morning, everyone, and thank you for joining us. We are pleased with our results for the second quarter of 2012 and we expect solid performance for the remainder of 2012 and beyond. Our business plan has been straight long-term stable and predictable cash flows; I believe our results reflect this. To achieve this, our primary investment objective has been high-quality real estate locations in high barrier-to-entry markets near major metropolitan areas or in retirement and vacation destinations. In addition, we have consistently focused on serving the housing and lifestyle needs of retirees and baby boomers based on both the positive demographic trends of this segment and its generally higher credit quality. We couple this with a flexible balance sheet that has allowed us over time to take advantage of opportunities. This plan has served us well over the years with annual increases in net operating income every year going back to our initial public offering in 1993, and FFO per share that has quadrupled over that same period. For 2012, overall, we continue to see a healing process in the Manufactured Home Community business. Demand is strong in most of our markets, though strongly favoring rentals. Also, investor interest in single-family rental, the strong apartment markets and the overall low rate environment has generated new interest from investors in Manufactured Home chattel and/or rental financing. Although these programs are relatively small and in their infancy, the trend is positive for our industry. We also continue to see strong demand for our annual site usage in our RV footprint, a trend that has been consistent since we began making significant investments in these properties back in 2003. Although our transient revenue streams represent less than 5% of our total revenues, it does have the highest exposure to new customers in the marketplace. We had a very good second quarter, but activity has fallen somewhat during July. We think there are a number of factors impacting this, including the timing of the July 4 holiday, the extremely warm weather, less sites available for transient usage due to conversion to annual sites, and some softness in the economy. In any event, this slight decline is immaterial to our overall revenue streams, which are expected to increase in line with our expectations for the remainder of the year. In summary, our business continues to perform in line with our expectations, and I'm going to have Marguerite walk you through the numbers in a little bit more detail.

Thanks, Tom, and good morning. I'm going to give some details on our guidance for the full year, report results for the second quarter of the year, and finally, provide additional details on the remainder of the year. Our 2012 guidance range is $4.44 to $4.64. The supplemental package provides updated guidance on a line item basis. Core MH revenues came in as projected and approximately 3% higher than last year. The base rental income increase includes approximately 60 basis points related to occupancy gains and 2.4% in rate growth. We had core occupancy gains of 8 MH sites in the quarter. Within our RV business, we had core resort base rental income growth of 3.6%. Our annual growth rate was 3.7%, seasonal income was 3.6% and transient income increased 3.2% for the quarter. We experienced a positive impact to transient revenue expectations due mainly to the July 4 transient traffic having positively impacted the last week in June. Overall, the July 4 traffic was softer than expected. Membership dues came in at $12.2 million for the quarter. In the quarter, we sold almost 3,400 low-cost memberships, a 35% increase from the second quarter 2011. We expect to sell 9,000 low-cost products this year. However, we did see an increase in attrition causing our dues income to be 2.7% lower than 2011. For the quarter, the revenue from right-to-use contracts or membership upgrades was $2.9 million versus guidance of $2.8 million. The expenses came in at $2.6 million and net contribution was in line with guidance. One note about our reported revenues. In 2010, we entered into a contract for cable service at approximately 20 of our properties, which included an upfront payment of $2.8 million for access to our properties over the term of their related agreement. The contracts were terminated by the service provider before the end of the contract period. As a result, we accelerated $2.1 million of revenue that would have previously been amortized over the term. There is no interruption in service to our customers as another provider is in place. For the second quarter, core property operating revenues were up 2.5%, core property operating expenses were up 1.7%, resulting in a net increase in core NOI of 3.2%. The acquisition portfolio performed in line with our expectations contributing $25.2 million in property NOI. For quarters 3 and 4, we assume no change in our MH occupancy from the end of the second quarter and expect to show core community base rent revenues of almost $138 million, which is a growth rate of 2.7% for the remainder of the year. In our RV business for the rest of the year, we anticipate core RV revenues of $55.3 million with annuals continuing a strong performance of 4.1% growth. Our annual customer base has increased by 750 over the last year. Some of the gain we're getting in annuals is from selling our rental cottages that were in a rental pool and it's impacting transient revenue. The conversion from transient to annual can be seen on a full year basis in the annual revenue stream. Approximately 47% of the full year transient income is anticipated to come in the third quarter. Total core revenue from dues and membership sales are expected to be $32.5 million, in line with previous guidance. The associated sales and marketing expenses are $6 million. For the rest of the year, excluding upgrade contribution, property operating revenues are anticipated to be up 1.9% with expenses growing at 0.7%, resulting in a net increase in property NOI of 3%. We expect the Hometown properties will contribute about $50.8 million for the remainder of the year in income from property operations for a total of $101.3 million for the full year. Interest expense for 2012 is expected to be $124.6 million. We expect our average debt balance to be around $2.2 billion. Our interest coverage ratio is 2.8x and our preferred distribution is $16.1 million. Our 2012 FFO-per-share estimate at the midpoint is $4.54 and our share count is expected to average 45.4 million shares. As an update to the previously discussed financing, we closed on $85.5 million of financing on 2 RV resorts with a weighted average rate of 5.1% maturing in 2022. And we have a rate lock in effect related to the third property in Venice, Florida. The terms of that debt include a $74 million secured loan at 3.9% that we expect to close in the third quarter, which will generate proceeds of about $39 million. Once we close on this financing, over the next 3 years respectively, we have $34 million, $81 million and $134 million of debt maturing, and given our cash on hand and free cash flow, we are in a position to redirect all of this maturity. We have commitments from our line base to extend the maturity of our existing $380 million line to September 2016, and have also provided an additional 1 year extension option. We expect to finalize this by the end of July. Now, we would like to open it up for questions.

[Operator Instructions] And our first question comes from the line of Eric Wolfe with Citi.

For the program that you're piloting with the RV dealerships, I'm just wondering if you could tell us what the timeline is for scaling that program and whether you've made any changes based on the initial tests that you've done and the feedback from those dealerships?

It's still in its initial stages. I think a total of a few hundred zone park memberships have been issued under those dealership programs. We're primarily working with dealerships in Southeast Florida and we've recently started something up in the Northeast. We survey every customer coming through that and by and large, what we're getting from those surveys is making us feel very positive about the program. 90% of the customers indicate that they would refer customers to the dealer as a result of getting this product with their RV. The average amount of money that a customer thinks he's going to save as a result of getting this with this product is somewhere in the neighborhood of $800 to $900 a year. So there is some value that is going with this that the customer perceives. And we're also seeing the type of customer is a higher-quality customer on average coming through the RV dealership program than you would see typically with the volume coming through RV sales. There is about 40% to 50% of these customers are actually buying Class A RVs, which are the higher dollar ticket items. So the results to date make us feel positive about the program. We've recently started to negotiate with some of the dealers about the wholesale pricing relative to those products and we have strong interest from other dealers to participate in that program, but we have yet to enroll any other customers or dealerships into that program. I think we want to make sure we get the training down right so that if we implement it in a larger scale, we're servicing that customer correctly and we're servicing that RV dealership correctly.

Got you. And what sort of, I guess, training would be involved with something like that? You're saying training the dealerships and having them go through the programs?

There's 2 type of training. Training with dealership so he knows how to feature benefit the product, right? Describing the product, describing the properties, describing the experience that a customer could get using our facility, the Thousand Trails facilities. So there is some awareness that a RV dealer has to have in order to feature benefit the product to his advantage for his customer. And then there's just the knowledge of the product itself in terms of the restrictions that are contained within that product. It does have a free concept for the customer in terms of its usage in the properties, but there are some restrictions in terms of consecutive night stays and such.

Got you. And Tom, maybe you didn't mention it on this call, but on the prior calls, you sort of said that the acquisition environment just isn't that robust right now. So I'm curious, the last 2 quarters, you've taken out excess proceeds on, I think, 4 loans and you just mentioned that you're going to do another. Why are you trying to build liquidity if you don't really have much to put it towards other than, I guess, just paying off debt later on?

Yes, I mean, that's a great question. I mean, I wish I could plan my capital raising events based on my needs, but in what we achieve just generally, it's kind of a binary marketplace out there, it's kind of a risk on, risk off. There has been some choppiness with respect to our capital availability. But basically, through all the different facets that we look at, CMB has just been on again, off again, I would say, right now, it's pretty robust. The same has happened with respect to life companies and the same thing has happened with the GSEs as it relates to our sector, and we're mindful of that. So we have an opportunity given their strong demand for putting loans out to do some, what we believe, is pretty good executions. Our problem is that creates some additional cash in our balance sheet. We're extremely mindful of that. We've also said that we see some opportunities in the potential acquisition environment, but they generally -- the ones that you could probably get at an attractive price are in the all age sector and we've kind of, to date, have shied away from that. So I totally appreciate what you're saying, but I would generally say this company has always fashioned itself by having balance sheet flexibility and we're not always sure when those opportunities will arise, but being in a position to execute on those opportunities is always been something that we've been very mindful of. So I understand, we've got that very flexible balance sheet and the opportunities are not clear in terms of our pipeline, so to speak, but you never know what might pop up that we could take advantage of.

Our next question comes from the line of Andrew McCulloch with Green Street Advisors.

Tom, you mentioned an improvement in the financing market for both Chattel financing and rental Homes, can you just expand on that?

Sure, sure. There's a bunch of things going on. The first, I would say, there's traditional guys who have been in the business for a while. They will still do Chattel financing basically, with recourse to the community owner. In addition, there's a couple of new entrants in the marketplace that are providing a service to community owners because of some of the restrictions now imposed by the Safe Act on lending. So they're providing a lending service. And in connection with that lending service, that paper by and large goes back to the community owner. But they will buy some of that paper based on some criteria. It's essentially cherry picking with the loans, but you're seeing some activity where people are coming in and as a result of providing this origination service, they're looking at the flow of paper and they're saying, "Gee, some of this stuff I'd take." Again, I admit it's cherry picking and most of it goes back on to the communities' books or related entity, but it is happening. And then lastly, we're seeing some activity coming in, it's mostly balance sheet lending, where lenders will come and lend against a rental inventory of homes. Again, neither of these are very attractive to us given our cost of capital and the balance sheet recourse nature of the stuff, but we're seeing some movement in that direction. And one of the larger lending platforms in the business has recently started, I'd call it, a pilot program where they will, in essence, put homes into communities with the goal of selling those homes to customers and then dealing with the community owner in terms of potential site rent negotiation, as to making sure the monthly payments work for the customer buying the home when they look at both the housing payment and the land rent payment. So you're seeing a lot of people sniffing around. Some big institutional money has had conversations and some of the traditional guys are trying to figure out how they can participate in what is overall a pretty strongly improving demand for the manufactured housing product.

Interesting. Can you just expand on that a little bit? What does it meant for home sales, are you seeing a pick-up in demand?

We're not seeing much in terms of home sales, in terms of pick-up in demand. If you looked at our -- the resale activity that we control within our properties, 96% of that activity is cash, average price points of $20,000. If you look at the used activity, you're going to see a similar thing. If we bifurcated that activity between all age and age restricted, what you will see is related to pricing. As the pricing goes up in the all age community, the reliance on third-party financing increases. And as it goes closer to, say, $5,000 to $10,000, you'll see much more cash activity. But at a $20,000 price point or a $30,000 price point, you're going to see a lot more finance sales, whereas in the age restricted properties, it's cash all the way through the stream. You'll see $40,000, $50,000 resales that are all cash.

Just one more question. On the 2 RV loans, are those -- I think, there's 5.1% average rate, are those rates representative of what you can get in the market today or are those 2 forward rate locked as well?

Those rates were part of a blend and extend of an existing financing. In the market right now, in RVs, we see rates ranging from 4% to 4.5%.

Okay. What about for kind of core age qualified Manufactured Home Community?

Around 3% and 3.25% to 4% and 4.25%.

Our next question comes from the line of Gaurav Mehta with Cantor Fitzgerald.

Just a couple of questions on your rental housing program. I know in the past, you have mentioned that you're trying to expand that program outside your core market, especially Colorado and Michigan. So what are you seeing in those markets? How is the performance comparable to -- your core markets?

Actually, I would say some of the stronger markets for us in terms of rental demand are in some of those all age markets. Colorado has been a very strong market for us. I think we're getting rental rates close to $1,000 a month on the product we're putting into Colorado. Northern California, which is another area where we have some all age properties is also experiencing, and has consistently been experiencing some pretty strong demand. Michigan is, I would have to say, got a pep to the step. There's some activity that's very positive up in Michigan, there's demand for the housing and some rental rates that appear attractive, call it $800 a month. So there are some good things that are happening in those all age communities.

Second, I think in the past you mentioned that you don't necessarily have any plans to convert renters to owners in the future, but do you still hold that view? Or have you tried or tested at all to convert the renters to owners by giving them some kind of incentive?

We've been -- yes, we've been focused on converting renters to owners. I mean, I would say the demand is for rent, and it's clear it's for rent. I would also say, however, there are some areas in the country, again, primarily in areas where it's very strong demand and very tight housing market where we've been able to sell off a good portion of our rental and our used home sales have also been pretty robust. So an area like San Jose, we've been able to effectively liquidate our rental housing, reduce it significantly. But in some areas of the country, we're growing the rental housing. So there are some inklings of being able to liquidate some of the rental or used home, but I wouldn't say that, that's a strong flow.

Okay, that's helpful. And lastly, I want to go back to your comments on the financing for the rental program. I think in the past you have mentioned that you do see incremental financing for that program, but that's primarily with ELS as a backstop. So the financing that you initially mentioned on the call, is that without ELS being a backstop?

No, no. No, that's -- all those programs have some shape or form recourse back to the community owner. The rental financing that is available out there is effectively on the balance sheet with the community owner. The only instance where we're seeing no recourse back to the community owner in either a rental and/or a Chattel financing is those lenders who are cherry picking the highest quality loans, where there's strong FICO scores, 20% down, good customer credit, you'll see done -- some of those loans being done with very little or no recourse back to the community owner, but those are a trickle, those are a trickle.

Our next question comes from the line of Jana Galan with Bank of America Merrill Lynch.

Going back to the acquisitions market, are you anticipating any increase on sites being marketed for potential sale, perhaps due to the change -- potential change in tax rates?

No. I think what's driving the overall -- let me just make an overall comment. It's always been tight on the age restricted high-quality assets. We're seeing a lot more activity in the all age sector, primarily in the Midwest or the non-coastal markets. And I don't think that has anything to do with tax. I think it has to do with a number of factors. One, you've seen a lot of investor interest in the single-family rental housing space. In fact, that has put somewhat of a price war under single-family rental pricing, given the demand and the execution that's going on in that space. That has also attracted some people into the Manufactured Home Community space where effectively, you're in the single-family rental space, yet again, with arguably better returns. So you're seeing a lot of people get interested in that space more recently and a lot of it is very dependent upon what's going on in the financing markets. To the extent the financing markets stay robust, we would expect to see a number of transactions completed in the next 6 to 12 months at some pretty attractive execution, frankly.

And then maybe just a quick question on the Chattel loans portfolio. It looks like the default rate went up a tiny bit and it's above the guidance assumption. I was just wondering if you could give some detail there?

Yes, we have about 1,900 loans in our loan pool. We've operated this loan pool for about 8 months since we took over management of the properties. We have found that the default rate is a little bit higher than anticipated, but when we do have a home come back, we're able to rent it quickly and in some instance, actually sell the home. So based on that, it's kind of how we come up with our guidance numbers for $5.1 million of interest income for the year.

Yes, and then back to the acquisition, when we look at that portfolio, we always kind of looked at that loan portfolio as, I think I've used the term, a rental in drag. I mean a lot of those customers were subsidized with respect to the interest rates within the loan portfolio and we expected a good number of defaults and our ability to turn those around for rentals and that has in fact been the case.

Our next question comes from the line of Todd Stender from Wells Fargo Securities.

This is probably for Marguerite. Just with your 2012 guidance update, it would imply if you have included the $2.1 million of revenues, there's the one-time item. Is there some type of offset that we should be thinking about, maybe $0.02 of that?

The $2.1 million was the cable income and we're basically in line with guidance other than that.

Okay. I guess the income, it looks like about $0.045 from that one-time item and the guidance only went up by $0.03, just wondering if there's some type of offset.

I'm going to have to get back to you on that.

Okay, sure. I guess just switching gears back to how you're capitalizing the new homes you're bringing in, maybe just the budget that you're looking at for 2012. How much are you allocating for new homes and used homes to be bringing into the rental pool?

We have allocated -- our budget is about $30 million of new homes coming into the -- new and used coming in to the portfolio, I think it's roughly half and half.

Okay. And with the rentals, is half of that or a portion of that going to be included in the site rent, is that included in your core MH figures?

Yes. If you -- in the supplemental, you can see the breakdown and it shows the breakdown between base rent and home rent. But basically, you've got the -- the base rent component is inside of your MH revenues and then the home rent is broken out separately.

Okay. And then just going through acquisitions, has the rental model changed your underwriting assumptions? You guys were able to bring in a strong balance sheet and compete effectively against some private buyers. Has that changed your underwriting assumptions, maybe you were able to chase cap rates lower?

I don't think it's changed our view, but there are some participants in the industry who are looking at -- who have capital who are looking at all age properties that are -- have vacancy as opportunities to kind of fill given the demand for the housing. I think I made, on the last call, a comment about our view of whether or not we really wanted to make significant investments in the all age business. I think we shy away from that, primarily because we have long had a business plan that's been demographically focused in high-cost areas, housing focus. We got out of the Midwest in the late 90s, early 2000s, primarily because we couldn't compete against the single-family housing market. That has changed to the good now. I mean, there is some opportunity in those all age properties and you can gain occupancy. But over the long term, we're kind of mindful that while our senior communities remain stabilized at 90-some percent occupancy throughout the downturn, some of the all age properties in certain areas of the country went from 90% down to 70%. So although they may be on the upside on a long-term basis from an investment perspective, we know that there's maybe some more volatility in that income stream over time. So we've been shy to make an investment in a large way in that all age Midwest location.

[Operator Instructions] Our your next question is a follow-up question from the line of Eric Wolfe with Citi.

Yes, it's Michael Bilerman. Tom, I just want to come back to this idea of obviously maintaining a pretty flexible balance sheet, as well as coming from a company that had a pretty active share repurchase program back in the late 90s and in 2000, you obviously did the leverage recap in 2004. So I'm just curious as you sort of sit here today and obviously you have the cash in the balance sheet, doesn't sound like there's a significant amount of acquisitions on the pipe. Would you entertain a more aggressive use of the balance sheet from a capital structure perspective? So you have these $200 million of preferred that's sitting there at 8%, obviously not a comp but can go just 5.5% yesterday. So obviously, that's a pretty active market. Would you entertain stock buyback at this point? I'm just curious how you sort of think about all this excess capacity that you have knowing the company's history of being a pretty active manager of that cap structure?

Michael, one of the things, I know you know our preferred is currently callable and we know about the Kimco deal, we know there's a nice execution lately on the preferred and that the market is pretty robust. But kind of going to Tom's point earlier about our financial flexibility, it's always been a hallmark of ours on our balance sheet. Having said that, we are evaluating our best execution on the preferred.

And then I guess just more broadly in terms of being -- and I guess, you think about replacing the preferred with new preferred, that would be a direct savings, but then being a little bit more aggressive in terms of some sort of cap structure move, either special dividend, maybe raising leverage, maybe stock buyback. I'm just curious how you think about those things to drive shareholder value, Tom, I think you've been sort of open and honest about obviously the consistent and stable growth profile of the company and how FFO has grown yet the stock continues to trade at a discount in multiple and a discount in AV. So I'm just wondering whether there was more aggressive ways that you're thinking about to narrow that gap.

I totally appreciate the comment. What I would say is we are mindful of the issues that you raise. And in our history, you've seen us being very aggressive with respect to the balance sheet management when we saw the path forward pretty clearly. And we had no problem doing a massive recapitalization back in 2003 and sending out an $8 share dividend to our shareholders. That was something that we could get our arms around, frankly, because we saw that there was some pretty attractive and robust financing markets that were just in their infancy, frankly. Today, I don't think we have the same view of the financing markets. We see a very binary nature of the financing markets. One day, it's very robust and then something blows up and everybody gets shy again. So we would have some difficulty being as aggressive, but I totally understand your comment. It is a conversation that is going on with respect to Sam and the board and we appreciate what you're saying.

And we have no further audio questions at this time. I will now turn the call over back over to Tom Heneghan for any closing remarks.

Well, thank you, everyone for joining us on our call and we look forward updating you on our third quarter call. And if you have any questions, as always, feel free to call Marguerite Nader. Take care, everyone.

Thank you for your participation in today's conference. This concludes the presentation. Everyone may now disconnect, and have a great day.