Sun Communities, Inc. (SUI) Q2 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities Second Quarter 2014 Earnings Conference Call on the 24th of July, 2014. 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 advise or update any forward-looking statements to reflect events or circumstances after the date of this release. Having said that, I'd like to introduce management with us today, Gary Shiffman, Chairman and Chief Executive Officer; Karen Dearing, Chief Financial Officer; and Jeff Jorissen, Director of Corporate Development. [Operator Instructions] I would now like to turn the conference over to Gary Shiffman. Please go ahead, sir.

Thank you, operator, and good morning. Today, we reported funds from operations of $34.7 million or $0.78 per share for the second quarter of 2014 compared to $27 million or $0.69 per share in the second quarter of 2013. For the 6 months ended 2014, funds from operations were $72.9 million or $1.73 per share compared to $58.7 million or $1.62 per share, and these results exclude transaction costs related to acquisition activities in all periods. Revenues for the 6 months increased to $226.6 million from $203.1 million in the similar 2013 period. As an overview, positive trends in occupancy, RV performance, revenue growth and new home sales are all contributing to the strong results. Highlights of the performance of our RV portfolio include occupancy gains of 231 annual sites over the year-to-date budget and a same-site NOI performance exceeding 10% in the second quarter. In addition, the RV portfolio we acquired in early 2013 experienced net operating income growth of over 20% for the quarter when compared to the same quarter in 2013. We're also pleased to report that subsequent to the quarter end, we experienced continued strength, as transient RV revenue from the 2014 4th of July weekend grew by nearly 30% from the 2013 holiday weekend for properties owned in both periods. And now, turning to a portfolio overview. During the first 6 months of 2014, revenue-producing sites increased by 987 as compared to an increase of 1,115 sites in the first 6 months of 2013. Michigan occupancy exceeded 90% for the first time since 2003, joining our other 90%-plus markets in Colorado, Florida and Texas. Total portfolio occupancy increased to 91% at June 30, 2014, compared to 89.2% at June 30, '13. We expect that occupancy will gradually slow -- or occupancy growth will gradually slow as an increasing number of our communities experiencing -- experience occupancy in the 94% to 98% range. Traditionally, such occupancy levels have created the opportunity for increasing the amount of the annual rental increase. We would also note that our rental program declined in 32 of our fully-stabilized communities. We expect this trend to continue as our portfolio continues to achieve full or nearly full occupancy. In the same-site portfolio of 169 properties, revenues grew by 6.6%, while expenses increased by 4.3%, resulting in an increase of NOI of 7.6% for the 6 months ended June 30, 2014. Growth was even stronger in the second quarter, with increases in revenues of 6.2%, expenses of 1.5% and an NOI increase of 8.5%. Same-site occupancy increased to 91.3% at June 30, 2014, compared to 90% as of the prior year June 30. Home sales continued to recover from the impact of the weather and new regulatory requirements in the first quarter. Sales in the second quarter were 521 compared to 480 in the second quarter of 2013. For the 6 months, current year home sales were 890 compared to 946 months (sic) [homes] for the first 6 months of '13. For the 54 new homes and 836 pre-owned homes sold during the first 6 months of this year, the average selling price was $84,730 and $24,350, respectively. Applications to live in our communities continue to grow, increasing by over 9% to 16,500 in the first half of 2014. Year-to-date, we have acquired 6 RV communities for a total of $140 million. Cap rates average in the 6 to 8 range, and we continue to have a solid pipeline of opportunities to acquire existing manufactured housing and RV communities, as well as some ground for potential expansions. Also, we sold 4 properties in the second quarter, and 1 additional community sale has taken place subsequent to quarter end. We expect to sell 7 additional properties in the third quarter, and we'll continue to review the portfolio for additional candidates for disposition. Turning to our expansions. We have completed 260 expansion sites in Colorado and Texas during the first 6 months of the year. And we expect to complete an additional 290 sites in Ohio and Texas near year end. A 300-site expansion just out of Austin, Texas, originally planned for 2014, will now be completed in mid-2015 as a result of delayed approval processes, which are now in place. In addition to these 300 delayed sites, an additional 400 expansion sites are anticipated to be completed in 2015 in 4 communities with full occupancy and continued strong demand. And now turning to our updated guidance. FFO per fully diluted share, excluding transaction-related costs, is expected to approximate $3.42 to $3.48 per share for the year and $0.93 to $0.96 per share for the third quarter. Other highlights for the revised guidance include an increase in same-site NOI from 7.1% to 7.8%, an increase in NOI from our acquisition portfolio from $17 million to $18.7 million, and an increase in RV transient revenue from $28.9 million to $31.6 million. No prospective acquisitions or prospective transactions or their related costs are included in this guidance. Today's press release contains additional detailed information regarding guidance assumptions that have been revised from those provided in April of this year. And now, operator, I would ask you to turn it over for questions.

[Operator Instructions] And our first question will come from Paul Adornato from BMO Capital Markets.

Gary, you mentioned that in some communities, you're approaching essentially full occupancy and that you would be able to potentially push rental rates a little bit. I was wondering if you could let us know what your experience has been in pushing rents. I don't know if I have much experience of significant rent increases with you guys.

Yes. I think that this year, average rental increases are about 3.2%.

That's correct.

And generally, what we found in looking forward when we have occupancy of 94% or greater on average, we will expect to get revenue increases closer to an average of 4% in the overall portfolio.

Okay. And what type of turnover or what other effects does rental increases of that magnitude have on your operations?

I think that it's just a mix of a healthy tension of demand and the occupancy being around that 94%, 95% level. And we're able to adjust when we reach that level and feel that we have strong demand. So once we are stabilized at that level, we don't expect there to be much differentiation. We get the normal turnover for normal reasons, but we have never been in a position where we've pressed rents to the point that it has drastically impacted occupancy. So we wouldn't expect to see much change.

Okay. And looking at the 11-property RV portfolio that you bought last year, you got a very nice revenue increase. I was wondering if you could translate that into cap rate, that is what the cap rate was at acquisition and where it is today, and maybe some comment on additional upside from here?

Well, I think that I would state that the portfolio in particular that we acquired, that we referenced in the remarks today, was a portfolio that had a tremendous amount of deferred maintenance, as well as lack of management direction. And I think the improvement that was put into place was the $13 million CapEx investment by the company in 11 properties, and obviously, stepping up the management of those communities to a level at which we do at some communities and had generated quite significant growth for the period that we discussed, as well as what we're seeing for the holiday weekend, which we shared with you. And I think the comment with regard to what it does to cap rate, Paul, could best be answered in that our expectation in acquiring properties that we're repositioning is that we can grow the NOI of those types of communities by 15% to 20% in a 2-year period of time. So in doing so, you'd be able to see the increase that a cap rate from one period to another would generate in value, depending upon what cap rate you used.

Okay. And just one more. I was wondering if you could comment on the Green Court portfolio that is supposedly about to do something. I was wondering if any properties have been shown to the market and if you might have an interest in some piece of that portfolio.

Sure. I think that the best response I can give, which was what I mentioned in my initial remarks, we are always out there looking for attractive opportunities. We do have a strong pipeline right now, as I've shared in the previous quarters. But generally, as a matter of policy, we don't discuss the specifics of anything like that publicly on the call, so we're outside the gulf [ph] .

[Operator Instructions] And we'll take our next question from Jana Galan from Bank of America Merrill Lynch.

You had very impressive expense savings in the quarter. I was wondering if you can maybe talk to the line items, and as you took down your expense growth guidance, maybe, again, which line items are driving that. Was it more favorable lower real estate taxes or payroll?

You're right, Jana, we did have some expense savings in our same-site portfolio. Primarily, they were related to better-than-expected claims in -- claims experience on our self-insured medical plan, so payroll and benefits were less than expected. That created a quarter-over-quarter expense decline rather than the anticipated increase. And we also had a lower-than-expected supply and repair cost. Those are primarily related to lawn maintenance, landscaping and general repairs in the community.

And then I just wanted to clarify on dispositions. Did you add a community there or when you say 7, you're including the one that's already sold?

I think we might have reported earlier that we had 11 on dispositions, and we actually did add a community into that group.

And then I know that assets targeted for disposition, the ones that you completed in Q2, had a slightly lower occupancies. Are you able to share with us kind of cap rates or the range?

I think that, especially with dispositions, we don't like to talk about cap rates because we are in the middle of transacting those, and it would not be something that we would want to discuss openly with regard to the people that we're negotiating with and closing with.

And our next question will come from Ryan Burke with Green Street Advisors.

A follow-up from Paul's earlier question, just on acquisitions. Curious, hypothetically, if you were to pursue a large portfolio base similar in size to Green Court, how would you go about financing that transaction?

I think that we have shared with the marketplace generally that we've taken a lot of steps to reposition our balance sheet over the last 3 years and have comfortably brought leverage down significantly and have shared previously that our outlook for all acquisitions would be that we have a view of staying debt-neutral. So acquisitions would always be funded by a similar [ph] combination of debt and equity or whatever other instruments are available to us in the marketplace at that time. But we would expect, over a period of time, to have the balance sheet reflect similar metrics and ratios as it does today.

And then a question just on the financing market in general. Can you just speak to what you're seeing sort of across the board and particularly, are you seeing any impact from the entrance of Fannie to lending at the community level?

I think, generally, we disclosed that we did a transaction and refinanced a couple of properties in the 4.5 range. And since then, the 10-year has come down quite a bit, as well as the fact that there is an enormous appetite out there that we're experiencing right now, and we're sure that our peers are as well, for financing both manufactured housing. And we're really pleased to be able to share the interest by the lenders in financing RV communities. And I think, in large part, they're becoming a more and more interested lender. So we are seeing financing opportunities that we are examining very closely right now that are probably 10-year closer to the 4% all-in fixed pricing.

4% all-in, is that on manufactured home or would that include RV? And if it does include RV, what's the general spread between the 2?

Interestingly enough, the general spread is just about on top of each other. However, you will find that the resort age-restricted communities will be about 25 basis points, we're finding, underneath where the RV communities are coming out right now.

Okay. And then separate and last question, just in regards to the amendments to your executive employment agreements that were announced last week. If you could speak to the language changes in terms of the change in control, why now, why the specific changes and what exactly does it mean for shareholders?

Well, I can only speak on behalf of the board and the discussions that I had with them. I should say, I don't want to speak on behalf of the board, but the discussion took place. The disclosure that was in our proxy did not sufficiently reflect the basis on which the comp committee had considered historical grants and the triggers in our...

Change of control.

Change of control in our executive agreements, employment agreements. And in reviewing it further, and thinking best practices, the company and the board wants to be as transparent and as close to best practices [ph] as anyone can be. And so the request was made to senior management to amend their contracts to provide for a second trigger related to a change of control or something that would cause the balance of one of our contracts to be paid out. Management had no objective to it, but the primary second trigger was that we had to be terminated in addition to there being a change in control. And that is best practice. It was something that was acceptable for all of us. So therefore, we need to make that change.

And our next question will come from Nick Joseph with Citi.

Just going back to the dispositions. Last quarter, you had targeted 11 properties and expected total proceeds of roughly $70 million. So far, you've sold 5 for 16s. Do you still expect those 11, and I recognize you've added 1, but those 11 to generate the $70 million?

Yes we do, Nick.

Can you talk about maybe what the difference is between the first 5 that you've sold and the remaining 6?

I can. One of the properties we sold for $500,000 and it had 16 homes on it. So that definitely took the average down and the rest is just coincidence of when the timing of the smaller assets and larger assets sold.

And when do you expect the timing for the remaining assets to actually sell?

They're expected to sell in the third quarter.

Okay. And then in terms of the expansion, obviously, the occupancy has been increasing across the portfolio. Can you talk about the economics behind your decision to actually expand at sites? What kind of yield do you target?

The expansion sites are very profitable. Since all of the in-place infrastructure is really at the communities already, you're really just adding roads and utilities and some driveways and things like that. So when we look at an average 100-site expansion property, we're looking at returns of around 12.5%.

And our next question will come from Todd Stender from Wells Fargo.

I just wanted to see what your current comments on how home sales are trending at this point in the selling season just compared to your current expectations, and just in general, your success in converting renters to homeowners?

I think that everything is pretty much in line with our budgets. And really, our historical performance for the last 3 to 5 years, conversions have been in the 10% to 11% range consistently, that's converting the renters into homeowners, adjusting for the weather of the so-called polar vortex and the fact that so much of our staff were diverted to taking care of snow and other issues in their communities, fewer people traveling the first quarter where we were, I think, down about 165 homes recently.

Over 100...

Over 100 homes.

116, um–hum.

Everything second quarter is pretty much on budget. There's an adjustment in overall sales for the total year in our guidance, and that reflects the loss of what took place in the first quarter, and also primarily the dispositions, where we will no longer have those conversions or home sales in the overall number. So pretty much right where we would have expected. We are seeing the ability to increase our prices, as I shared the new home price is right around $85,000 now, which is significantly above where it was last year. There's stronger demand for more features in the house, and interest and ability to pay more for those homes. So we see that as a positive trend. And again, as we're looking forward to share with the marketplace over the next, I would say, 2 to 4 quarters, that as we reach this full occupancy in the greater portion of our portfolio, we'll continue to see the decline in the rentals, and we'll be able to reuse the money from the sale of those rentals to enhance the growth in acquisitions and expansions, where we use the rentals to increase absorption greater than what would normally be available in the marketplace.

And do you have any price points at your fingertips to what the new homes are going for if the amenities are up and there's more of a demand for higher end versus a rental home sale and what those price points are?

Sure. I think that the rental home sale is going to be closer to that $25,000 average, especially when we're talking about a used home. And if we were talking about a new home, it would be much closer to that $85,000 rate for a new home. But the vast majority of our conversions are from the repossessed portfolio that we acquired primarily from 2000 to 2007.

Okay. And I don't know if I missed this. Did you give any cap rates or occupancies or if you assumed any debt on the Maine and Indiana acquisitions?

The Indiana acquisition was bought for all cash about $30 million, and the Indiana property -- Karen, do you recall if that had debt on it?

The Indiana property? No. No, there were no debt on either of these.

And how about occupancies or any of the fundamentals?

The fundamentals are they're both RVs, they both have a very, very large transient component. The Indiana community is very much related to one of the largest and oldest amusement parks. And it will be our goal to continue what operations is doing in RV, which is converting a good portion of the transient into annual and seasonal for a good stable base. But the history on the transient in these 2 properties has been very, very strong and steady for 10-plus years before we bought them, so good fundamentals. And we will convert some from transient to seasonal and annual.

And how about cap rates? Can you guys share kind of what the markets -- what the market is and what they were on those?

Yes, I did comment -- for us, these particular communities were all in the 7 to 8 cap rate range. But the general range for what we've acquired this year has been a 6 to 8 cap rate. I share as an aside because we're often asked what's going on in the marketplace, there remains some cap rate pressure from some of the new equity funds that have shown interest in acquiring this asset class, mainly due to the understanding of really the great cash stability and especially the cash flows during very challenging economic times have been very reliable. But most of that interest seems to be in what we would consider, perhaps, assets that are just focused on generating cash-on-cash return and not so focused on overall long-term appreciation. And I think a lot of that comes from high leverage and the ability to put that cheap debt on right now. So that compression in cap rate that's taking place out there has not been something that, as of yet, we've had to deal with in the acquisitions that we've made. But definitely, we'll keep an eye on what does happen with cap rates and if there's continued interest out there and competition out there.

It appears that there are no further questions at this time. Mr. Shiffman, I'd like to turn the conference back to you for any additional or closing remarks.

Well, I'd just close in saying that obviously, we're very pleased to be able to announce what's taken place through the first 2 quarters of this year. Both Karen and I are available for any additional or follow-up questions. And we look forward to third quarter's call, when we can share with you the performance of the portfolio at that time. And I would close, and thank you all for participating.

This concludes the Sun Communities 2014 Second Quarter Conference Call. Thank you.