Sun Communities, Inc. (SUI) Q4 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities' Fourth Quarter 2011 Earnings Conference Call on the 23rd of February, 2012. At this time, management would now 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 the SEC. The company undertakes no obligation to advise or update any forward-looking statements [indiscernible] 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. [Operator Instructions] I would now like to turn the conference over to Gary Shiffman. Please go ahead, sir.

Thank you, operator, and good morning, everyone. Today we reported funds from operations of $20.1 million or $0.81 per share for the fourth quarter of 2011, compared to $17.2 million or $0.78 per share for the fourth quarter of 2010. For the year 2011, FFO was $75.3 million or $3.13 per share compared to $63.6 million or $2.97 per share for 2010. These results exclude certain items as noted in the table in the press release. 2011 was a breakout year for Sun. Performance of our core portfolio rapidly leasing expansions and fully integrated acquisitions formed a trio of growth generators effectively executed by our experienced management team to produce results not seen in many cases in over a decade. Along with achieving FFO per share growth of 5.4%, the highest FFO growth achieved in a decade, we are pleased to report the following additional achievements of 2011 and projected information for 2012. Revenue producing sites in our core portfolio increased by 732 during the year, bringing same site occupancy to 85.8%, an increase of 130 basis points from 2010. Budgeted same site occupancy for 2012 approximates 87%. Additionally, our recent acquisitions exceeded our pro forma as an added 160 sites of occupancy, bringing the total gain in revenue producing sites to 892, or the largest gain in sites that we've seen in the portfolio since 1999. We note the current gains were achieved without the benefit of the robust dealer network, which existed back in 1999. We continue to see occupancy increases in our major markets including the Midwest, which gained nearly 50% of the reported 2011 gained sites and in Colorado and Texas, which added another 43% of the gained sites. In 2012, we expect to add 1,154 sites to occupancy, which would bring total portfolio occupancy to…

[Operator Instructions] And our first question comes from the line of Jana Galan.

Can you please -- can you let us know how you're thinking about expenses for the same property portfolio in 2012?

We normally don't split the NOI growth in 2012 between revenues and expenses. But in general, I would say that it's a slight reduction from where they ended up in 2011.

And then I was just curious if kind of year-to-date have you noticed any increased competition from site-built homes in any of your markets?

No, I think that much of what we shared over the industry's difficulties over the last 10 years is the competition that was generated from site built was primarily due to the sub-prime lending and the credit bubble that existed for such a period of time. Even the overhang of the foreclosures and repossessions in the site build world did not have much effect on our business and our portfolio, just because of the differentiation of an average home in our portfolio costing $45,000, $50,000 as compared to any discounted site-built housing. And that ongoing affordability differential, if you will, is probably what's fueling the demand that we've seen increasing over the last 3 years or so since the sub-prime and other financing hasn't been available in this site-built world. So it's really a positive thing for us, and we have not seen direct competition from it.

And our next question comes from the line of Paul Adornato with BMO Capital Markets.

I was wondering if you could tell us a little bit about the trend that you're seeing in terms of the credit quality of both the renters and those buying homes within the portfolio?

I think I'd comment, Paul, it pretty much mirrors a lot of the remarks I just made. The affordability factor of manufactured housing is kind of playing it strong right now into the lack of financing that previously existed in site-built housing. So I think that's creating a bigger universal pool, if you will, for the manufactured housing certainly as it relates to our portfolio and that we are seeing just really stronger demand pretty much the same if not slightly improving trends towards approval with slightly, and I underscore the word slightly, improved credit ratings. So I think that, that as a trend we'll continue to see. I think that we'll see with the return of a customer that never should have been in site-built housing, because they really didn't qualify for it under proper underwriting in today's underwriting standards. So that will probably continue to reflect in a slightly improved profile of credit that we see in our communities.

And Paul, if you look at it from like a delinquency standpoint, we've seen no measurable increase in delinquencies. They stayed stable across the year as has bad debt as a percentage of revenue. It's, in total, it's still about 130 basis points.

Okay, and so you're seeing that chattel financing is available to incoming residents? And is that in abundance from third-party sources?

Abundance would not be the correct statement. No, they are still quite limited. I think the vast majority of all of the sales that we're doing are financed internally by Sun and then sold off to third parties, or they are funded in white paper with third parties where we have arrangements. We estimate about 12% to 14% of the sales are actually financed by third parties and about another 7% or 10% are actually bought with cash.

Okay. And then switching to your comments on leverage. I appreciate all the color there and also the outlook for acquisitions that you've got at some -- in the due diligence pipeline. So at the end of the year, if you expect to be at a lower -- at lower leverage metrics, we should expect additional equity to come in conjunction with any additional acquisitions in 2012?

I think that that's a very good question. It's something that we are going to watch and weigh very, very carefully based on the acquisition pipeline that we have and balancing the acquisitions and the accretiveness to our shareholders against what we want to accomplish with the balance sheet. As everyone's aware, Sun has been a company that's been very, very patient. We believe that the balance sheet and the industry can handle stronger leverage. So we really took our time and rather than having to raise equity at times, we were able to wait until our share price improved and take advantage of that. So I think that how we look at that over the year, Paul, though we have intimated that we will continue to look at reducing leverage will depend a lot on what happens with acquisition and the timing of what's going on in the marketplace.

Okay, I appreciate that. And just one more item. You talked a little bit about providing additional sales support out to the -- out in the field. I was wondering if there are any G&A implications of providing, perhaps a little bit more or different type of sales support?

No, we basically re-purposed individuals around the organization to support that new initiative. And really what we're talking about, Paul, is we successfully implemented this type of main office support for rental home conversions, where we have individuals here who are focused on particular regions in the country. And we've kind of spread that successful model out to other sources of business, whether it's preowned home sales, new home sales, relocations and things like that.

And our next question comes from the line of Stephen Mead with Anchor Capital Advisors.

If I could just ask this question, if you look at how you started the year in terms of the relationship of whatever kind of number you look at in terms of cash flow available for the dividend, and then what you exited 2011 at in terms of that relationship. And a little bit of color as to where you have to get to, to become a company with a sort of predictable growing dividend stream?

I'm just missing the question at the end there. Is it where do we think we have to get to? Or whether...

I was just wondering, do you have a sense of kind of like how much of a cushion between the cash flow available for dividend and the dividend, the idea that once you start to increase your dividend, you have to have a business model that supports a continuation of that growth with the dividend?

Yes, I think we've shared with the market before, first of all, the board reviews the dividend periodically and certainly on a quarterly basis when the board gets together. And there has been a philosophy historically, although it changed when we restructured our balance sheet in 2004. Prior to that, there was a policy of payout ratio as it approached or dipped below 80%, there was typically a dividend increase that was pretty much comparable to CPI. So the board had been inclined to raise dividend such the fact that there'd be an increase similar to the CPI index and at the same time, retain enough internal -- retain enough of the earnings to fuel growth within the company at the same time. So I would suspect and I've shared with the market that the board will continue to look closer and closer to the dividend and that coming off a period of time from 2004 where we went from being an unsecured borrower to a secured borrower. We were ahead of our payout over 100% until 2 years ago, gradually bringing that down. And I think towards 80%, the policy will be looked at a lot harder.

You have -- can you provide kind of like where you began 2011 and where you exited 2011 in terms of that relationship?

In terms of payout ratio?

Yes.

Do you have that, Karen?

Just from a payout ratio percentage, we ended the year at 90%. And last year, I believe we were right around 94%.

And if I could ask, in terms of the initiatives that you took in 2011, in terms of expenses, are there some that were sort of one-time in nature that won't occur in 2012 or not?

I think one-time expenses that we see in G&A. We do see about $1 million of nonrecurring kind of one-time expenses that are in G&A for 2011. They're related to some software implementation costs and consulting costs that we had as well as some bonuses.

Are you talking about within the company or on a same site basis?

Overall.

Okay, I just wanted to make sure we answered the question for you right.

That was just -- that's helpful. As I look at the metrics in your guidance, if you achieved the metrics, I was wondering why the growth in FFO just wasn't a little bit higher than what is implied in the range today.

I think that there are no one-time...

Besides the ones that I talked about, no.

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

Can you talk about the cap rates on the 6 RV Communities you purchased in December and February? And maybe provide some color on how you value the permanent sites versus the seasonal ones?

Yes, I think that -- I think we shared with the marketplace, this was a particular situation where we were not talking a lot about cap rates because there was divisiveness between the ownership on the sellers' side and they didn't want to get into a situation where one group of owners was looking at cap rates of the other. But I think overall, we shared with the marketplace on this particular group as they're now all closed, all 6 of them, right around an 8 2 cap rate. And we're very, very pleased with those particular acquisitions, because it's tough to get things in the Florida marketplace. As we know, they really enhance the geographic footprint that we have and the existing sales entity that works for us, the telemarketing. And our existing communities there overlaps and then also allows us to feed into these communities from our existing communities. So we're very pleased that we were able to make that acquisition. I think we have good upside, the rents as they're slightly under market as compared to the rents in all the competition, both inside our portfolio and outside in that particular area. So we're excited about finally getting to close the last 3, which literally took place as we announced last week.

Any color on how you value the permanent versus seasonal sites? Or maybe just generally talk about how much income the permanent sites generate versus seasonal ones?

Yes, I don't think I have the breakdown of that. If you want to get back to Karen on that, I'm sure she can provide some color on that and we'll get it from our acquisitions group. But we just basically value the property as we would any other property, which is applying the cap rate or applying the cost of capital to the current NOI and then looking at growth by either improving or increasing occupancy or raising the rents or operating the communities more efficient. But we don't break it out between one site to the other, permanent or not.

And then I think on 3 of those RV properties, there was 7% debt. What rate do you think you could achieve if you were to refinance that today and knit kind of new 10-year money? And would that rate be materially different for what you could get on a core MH property?

I'm going to say that we're looking at that in the 5% to 5.5% range right now. And I don't have -- Karen, do you know where the debt -- where the debt was on those properties? Or what the rate is?

It's at 7.

You could give 5.5% on high-quality RV property and the core MH, assuming high occupancy, same rate?

In Florida.

In Florida, okay. How much would that change in some of your Midwest and that size?

Generally, RV Communities will have a higher debt or a higher interest rate than manufactured housing communities. We've been very, very fortunate through a lot of our banking relationships, to be able to keep it very tight. But that spread could range anywhere from 20 to 75 basis points.

Okay, and then on the guidance. Is it possible for you to tell us what you're seeing NOI growth would be for 2012, absent any gains from the rental program and expansion activities?

I'm sorry, could you repeat that question?

Yes, could you tell us -- you had 6.2% NOI growth for the same -- I think same property portfolio in 2012. What would that be if you weren't getting any site gains from the rental program or your expansion activities?

It's tough. I guess the way we look at it, I mean a rough rule of thumb if you're going to have -- we have revenue increase of 3%, expense increase 2%. It's going to yield 5 something. I don't think we're -- we have enough information to be able to give you that difference. But I think if you want to get back to Karen on that, you can take a look at factoring out expansions.

I think if we just look at occupancy as another point of reference, I think there's 452 expansion sites being added and there's 118 RPSs gained from those.

I don't think you're seeing a lot of growth...

I don't think it's big, not significant.

[indiscernible] majority of growth on same site increase in rental increase and control of expense factors. So it's not driven from expansions now. Any acquisitions that we're able to generate accretive in excess of what we've already closed in I think would have a dramatic impact.

And if you did 100 sites, it's generally about $500,000 of revenue. Expansions are almost all revenue. There's no additional expenses associated with them. So the 118 sites gained in the expansions would be a little over $500,000.

Okay, great. One last question on guidance. Sorry if I missed this. Did you give interest expense guidance? Or can you?

No, we did not give interest expense guidance, but included in the guidance is interest rate that was in place as of 1/1 with no variable rate increase.

[Operator Instructions] And we have a follow-up question from the line of Paul Adornato with BMO Capital Markets.

Gary, could you just tell us how you think about the mix of property types between RV, all age and age restricted?

Sure. I think that we shared it with the market before that certainly between all age and age restricted it seemed to run in cycles. During more difficult economic times, you've got more stability in the age restricted. You have a lot of retirees and fewer people moving out generally, especially when they're resort areas -- they're usually moving out because of health, not so much because of job or other regional economic circumstances. At the same time, when those communities are more tied to CPI and indexes that aren't increasing as fast as the growth. The rest of the economy, we tend to experience higher growth in our all-age communities where we can pass on larger rental increases and we're not restricted to CPI. So we believe a good balance is good over the long period of time for our shareholders. Secondly, with regard to RVs, RVs have been, I think, very strong generators of growth throughout the period of time that we've owned them, which has been about last 12 years or so. I think that the RV owner-operator tends to be a bit younger in profile and more active than the age-restricted resident. And therefore, it's a nice step to market to the RV home buyer to move into a manufactured housing community. Right now, RVs represent about somewhere between 15% and 20% of the portfolio, and I will back that to probably not change too dramatically.

And just maybe one more item with respect to the overall industry. When you guys have been very successful in the rent to own program, I was wondering how just the smaller operators are dealing with the lack of a dealer network? Are they participating in any sort of rent-to-own? Have they -- how are they filling their communities in this kind of new age of the industry?

Sure. I think it's a great question, Paul. I think it really underscores the opportunity that Sun has right now. I think I shared in a lot of the discussion around our recent equity offering. The cost to regain occupancy today is just far too expensive. It just takes more capital than the small owner-operators have. I think even the regional syndicators that have medium-sized portfolios, they've entered into the lease-to-own programs but without access to public capital and other forms of capital, it's very, very difficult for them to run the program as long as it takes to buy the homes, to increase the occupancy and then to turn around and sell the homes after carrying the paper on their balance sheets. And I think quite frankly, that's what's driving a lot of the acquisition opportunity to Sun. It's those portfolios. It's those owners and operators that have been in the lease-to-own business a little bit, but can't regain the occupancy that they're looking for because they don't have the capital. So whether it be something like Kentland or a smaller one-off or a couple of communities, I think those are the types of things that we're looking at. And then we also have developed just basically a machine to be able to process, underwrite, rent and then sell these homes. And a lot of investment and a lot of experience goes into that form. It's for us, buying and having those opportunities of getting a solid community that's accretive right upfront on cash flow and having the vacancies as our upside kind of plays right into the sweet spot of what we're looking for.

And our next question comes from the line of Taylor Schimkat with KBW.

Just thinking about converting the renters to owners. What proportion of your home sales are coming from homes that Sun has acquired as new versus used? I guess sort of another way, are you seeing similar demand to acquire new rental homes versus used rental homes?

New rentals, new rental or do you mean new homes versus new or used rentals? Or do you mean new versus used within the rental program?

Within the rental program, the homes that Sun acquired as new homes and put into the rental program. How are you seeing interest in acquiring those newer homes versus the ones that were acquired and I think it's generally out of foreclosure court?

Yes -- no, I think it's strictly a case of price point and value. I think there's no differentiation. I shared with you that probably high residents and all of us would prefer new over used, but it really comes down to credit and value. I think oftentimes, the value that's greatest is on those homes that we've been able to buy deeply discounted as repos and I don't think there's a difference, and I don't think we track that difference specifically...

I don't have it in front of me.

Versus yields.

Has there been any change in repo volume lately?

We've been rock steady for 3 years now, dropping down to the same levels it was pre-2000, Karen?

Repos on homes, or repos that are in our portfolio?

Repos that are pulled into the rental program.

Oh, it's been about the same for the past several years and down to kind of pre-distressed time period maybe 600 to 700 a year.

Yes, it's been the same for 3, 4 years now. It hasn't varied very much.

And then, could you talk a bit more about the geographies where you're seeing attractive acquisition opportunities today?

I think we're seeing it across the spectrum of the country. Sun does not and is not looking deeply into the West Coast, but just about everywhere else across the country. I think that we continue to see a lot of opportunities in the Midwest. The fact of the matter is because of the rental program and the interest in buying communities that have solid base of occupancy to work from good NOI, an accretive opportunity and the ability to fill the vacant sites. We can create the greatest returns for our shareholders, both short and long term by filling and buying communities with vacancy. That will tend to take place more in the Midwest areas of Texas. We are looking at areas of Florida where there has been a retreat of occupancy or more vacancy over the last 10 years or new communities that didn't have the third-party dealerships to fill up. But there is no particular area. And I think as I said before, we'll focus on really solid fundamentals within the community for our shareholders and the growth more than we will going outside a region we're comfortable in.

Okay. And given your outlook on slightly lower year-over-year expenses, I think that's what I heard, if that was correct. What line items are you sort of seeing the most savings in?

I am looking for that at the moment, Taylor. I don't know if I have that in front of me. We don't -- generally, as I said, we don't generally give out that information. My guess would be, we would be seeing it in utilities based on kind of increased revenue on water and sewer, increased recoveries.

Okay. And then lastly, I'm not sure if I missed this. But did you talk about the $1.4 million impairment charge, what drove that in the quarter?

The $1.4 million impairment charge is on one community in North Carolina. It's in a difficult economic area. And unfortunately, we are being unallowed -- not allowed to bring rental homes into that community to support occupancy.

Is that driven by some state regulation or local regulation, is that...

It's a local, it's a local municipality issue.

And you think that's a one-off issue there?

Yes.

[Operator Instructions] And we have a follow-up question from the line of Stephen Mead with Anchor Capital Advisors.

I was just wondering, and you've touched on it, but the increase in occupancy in 2012 in terms of what you were guiding towards was a pretty -- I mean, that's a good increase. And I just was wondering in terms of the issue of, say, retention of existing people in the homes versus what you're seeing in terms of new applications and just a little bit of sort of what contributes to that increase in occupancy?

The increase in occupancy from a total portfolio basis is strongly -- in the same site, about 55% of it is in the same site portfolio. Another 34% of it is in acquisitions and about 10% of it is in expansions.

I think it's strictly driven by demand.

Okay, but I mean, are you seeing a better retention in terms of holding on to the base and thus, sort of lowered turnover that you're dealing with or...

I think the answer to your question -- I think we're seeing no change whatsoever. It's not a matter of better retention. The retention's the same. The repos have been the same and the portfolio for the last 4 years, as I indicated. So demand is stronger. Applications have been increasing significantly year after year. I think it's driven a lot by the affordability factor, the lack of the ability to get into site-built housing for much of this population. And I would tend to suggest in the Midwest in particular as we see, I think, greater stabilization, greater -- I won't say job growth, but job security. Certainly in automotive area, there is a move from the sidelines of not wanting to commit or not wanting to buy or make a change. That is fueling the growth of -- I think it's a situation where demand is up and all other metrics are pretty equal.

And I'm showing no further questions. Please continue with any closing remarks.

Well, at this time, on behalf of the company, Karen and I would like to thank all of you for participating on this call. We certainly look forward to 2012. As the metrics continue to indicate, we should have continued growth. And we're both available for any questions that anyone might have separately from this phone call. Thank you.

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation. You may now disconnect.