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Sun Communities (NYSE:SUI)

Q4 2012 Earnings Call

February 21, 2013 11:00 am ET

Executives

Gary A. Shiffman - Executive Chairman, Chief Executive Officer, President, Member of Executive Committee, President of Sun Home Services Inc and Director of Sun Home Services Inc

Karen J. Dearing - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Secretary and Treasurer

Jeffrey P. Jorissen - Former Senior Advisor

John Bandini McLaren - Chief Operating Officer and Executive Vice President

Analysts

Paul E. Adornato - BMO Capital Markets U.S.

Stephen Mead - Anchor Capital Advisors, LLC

Ryan Burke

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Sun Communities Fourth Quarter 2012 Earnings Conference Call on the 21st of February 2013. 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.

Gary A. Shiffman

Thank you, operator, and good morning. Today, we reported funds from operations of $26.2 million or $0.80 per share for the fourth quarter of 2012, compared to $18.8 million or $0.81 in the fourth quarter of 2011. For the year, FFO was $96.7 million or $3.19 per share compared to $73.9 million or $3.13 per share for 2011. These results exclude transaction costs primarily related to acquisition costs in all periods. Revenues for 2012 increased by 17% from $289.2 million in '11 to $339.6 million in 2012.

During 2012, as we look at the portfolio, revenue-producing sites increased by 1,069 compared to 892 in 2011. This marks the first time that we have added more than 1,000 sites to occupancy in a single year and the fourth consecutive year of steady occupancy increases. Guidance for 2013 includes the addition of a total of approximately 1,500 revenue-producing sites. In 2008, the year in which the Great Recession commenced, we lost 47 sites, which demonstrates the recession-resistant nature of manufactured housing.

In the same property portfolio, revenues grew by 4.5% in 2012 while expense increased by 2.2% and NOI growth was 5.5% for the year. This growth occurred across the entire portfolio as 17 states experienced same property NOI growth. Only one state with one community did not grow and its decline in NOI was only $26,000. Guidance for 2013 includes projected NOI growth of 5.6% to 5.9%. During 2012, 1,742 homes were sold, including 953 homes which were formerly rented. Guidance for 2013 projects the sale of over 2,000 homes, half of which are the conversion of rentals. The sale of rental homes frees up capital to be recycled into further building occupancy. And demand for homes is so strong that in the last 5 years, we have sold nearly 6,600 homes, enough to completely fill, on average, 18 communities.

Applications, which of course drive occupancy and home sales, increased 12% in 2012 to 26,100. Applications have grown at a compounded annual rate of over 11% during the last 4 years which reflects strong and continuing demand for affordable housing, as competition from housing alternatives has had little effect on our customers and residents. Expansions had a build-out of zoned sites that are adjacent to our existing communities and this allows us to control when we bring these sites onstream as well as the opportunity to select the market for our expansions.

In 2012, we added 354 sites. Over 1,100 new expansion sites are scheduled in 2013 with absorption expected to come towards the later part of this coming year. An additional 3,300 expansion sites are projected in our 5-year plan. These expansion sites are zoned and entitled and are a part of trend of Sun's existing inventory. We generally expand communities when occupancy rises above 95% and strong demand continues in the marketplace. The projected fill rates range from 4 to 10 sites per month with an average of 6 to 7. Unlevered return on investment, when the expansion is occupied, which usually takes about 18 months, is expected to approximate 13%.

In 2012, 2.5% of our residents moved their homes out of our communities while an additional 4.9% sold their homes which then remained in the community. Extrapolating that data indicates that than on average, homeowners remain in our communities for 14 years while the homes produced revenue for over 40 years. In 2007, home move-outs were 3.2% while resales were 6.5%, extrapolated to average residency of 10 years and an average home in the community of 31 years. So both the length of residency and the revenue life of homes not only remain sticky, but has increased significantly.

We focused on reducing leverage over the last 18 months with the results that all related metrics are showing improvement. EBITDA over interest has improved from 2.4 at 12/31/11 to 2.8 at 12/31/12. Debt over total capitalization has improved from 62% at the end of '11 to 53% at 12/31/12. And debt over gross assets has similarly declined from 71% to 60%. We have discussed that we intend to grow on a leverage-neutral basis and project our debt over EBITDA multiple to be in a range of 7.6x to 7.8x by year-end.

We expect 2013 FFO per share on a fully-diluted basis to be in the range of $3.45 to $3.55. After considering recurring capital improvements of about $0.29 per share, the payout ratio should approximate 79%. An FFO guidance for the first quarter of 2013 is $0.97 to $0.98 per fully diluted share, an increase of 6.7% to 8.9% over first quarter, 2012.

Now, I'd like to turn to acquisitions for a moment which has, in the last 2 years, including our recently announced acquisition, we have purchased nearly $600 million of communities, growing our site count by approximately 40%. We continue to see a robust acquisition market and we are reviewing additional opportunities to broaden the company's geographic footprint, as well as building critical mass in our existing markets. While guidance includes no prospective acquisitions, we are optimistic that we will be able to continue to add quality profits to our portfolio.

Our acquisition strategy has had 3 principal objectives. First, is to buy the property rights over those initially accretive to earnings. Then, we focus our property management team to improve the appearance and operating efficiency of the property. Additionally, where necessary, we invest capital on upgrading and repositioning the properties that have been mismanaged or neglected. And finally, our sales and rental teams accelerate the occupancy growth to maximize the properties' profitability over the short term. The result is an attractive, fully-occupied community with significant enhancements to the initial accretion.

As previously noted, we are strategically increasing our commitment to the recreational vehicle marketplace. We expect this segment of our portfolio to increase from 11% of income from property in 2012 to 17% in 2013. In addition, we have expanded the geographic footprint of our RV business so that nearly 30% of our transient sites are now in the northeast and Midwest. Previously, with all of our transient RV sites in the south, our effective season was less than 6 months.

So the effect of the foregoing is to materially increase importance of this segment to the company while also developing it into a year-round business, the north complementing the south with regard to seasonality. This allows us to vote more resources to promote growth as we bring to bear the systems and management team that has effectively grown the MH business, as well as our Southern RV holdings to increase the profitability and sophistication of RV community management.

To cite an example, we have utilized dynamic pricing in our manufactured housing rental systems and sales business for years -- for the last few years as the economic returns from renting or selling are constantly weighted on the management process. Applying this concept to the RV business, we have empowered our personnel through software and systems to dynamically price reservations and extensions in our RV Communities, depending upon the specific occupancy status of the particular community. This practice mirrors the pricing strategy of the airline industry. We have also borrowed an accountability measure from the lodging industry which uses RevPAR and we have instituted RevPAR reporting to measure the historical and competitive performance of each of our RV Communities on a per site basis.

And I think at this time, both myself, Karen and Jeff would make ourselves available for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Paul Adornato.

Paul E. Adornato - BMO Capital Markets U.S.

You disclosed investment in occupied rental homes in your supplemental and it increased 21% this year. Was wondering what we can expect in terms of capital allocation to rental homes.

Gary A. Shiffman

Paul, I think that the vast majority of the increase in rental homes is a result of expansions and acquisitions. I think we're just in the process of forecasting the increase and we expected to be in a $30 million to $45 million range. I think it's important to also discuss that for the first time, when we look at -- pick 10 communities randomly and look at what's taken place for the rental program in those 10 communities. From the high point of rentals, we are finding that with a 12% rough average of selling the rentals in the program each year now, we're seeing declines from the peak period as we convert to stabilize communities from rental to owner-occupied. So I think the vast majority will be a function of existing acquisitions, future acquisitions and expansions and for the rest of the portfolio, we'll see a decline. Now Indiana, where we've been a little bit slow to recover occupancy, will probably increase in rentals as a percent of occupancy, while we see the vast majority of the portfolio, especially Texas and Colorado, steadily decline.

Paul E. Adornato - BMO Capital Markets U.S.

Okay. And related to that, at one time, you were able to buy a lot of homes for pennies on the dollar from the lenders. Has that supply dried up? Are you buying brand-new homes at this point?

Karen J. Dearing

Paul, we still continue to have opportunities to buy repossessed homes from lenders. The mix right now is about 60% new homes and 40% repossessions.

Paul E. Adornato - BMO Capital Markets U.S.

Okay. And switching to your most recent RV acquisitions, I was wondering if you could talk about the going-in cap rate and what's the near-term plan with respect to boosting that yield?

Gary A. Shiffman

Sure. I think that it's probably, of all our acquisitions, the toughest to allocate a cap rate to, just because of the mismanagement or lack of investment or repositioning that's going to take place in those 10 properties. I think that what we've done is purchase it accretive from day 1 and we would look to enhance NOI growth on a low double-digit basis, 12 to 18 months after we made the investment in that community to reposition it and turn it around. And these communities were acquired because of their Class A locations and the opportunity that Sun has to really lever an underutilized RV management team and our systems in the north part of the country where the season is basically May to September, as opposed to the southern season where our other holdings are, which is more December to March. So we have complementary seasons and now our staff can be working year-round in the RV area. And I think that we have continued to state the cap rate have been very consistent and I mentioned RV land. They have remained in the 6 to 8.5 to 9 range, depending upon the quality, the location of the asset. And all of our acquisitions tend to be bought in that range. So we wouldn't expect any difference going forward.

Operator

Our next question comes from the line of Stephen Mead.

Stephen Mead - Anchor Capital Advisors, LLC

I got to ask a question about sort of what happens next in terms of your thoughts on the dividend?

Gary A. Shiffman

Sure, that's a great question. I think that we continue to share with everyone that the board, on a quarterly and annual basis, carefully reviews that. So far, as I've shared on the previous calls, the board has weighed the strategy of really strengthening the balance sheet and has chose to reduce the debt to mostly absorption of growth that might have otherwise been used to increase the dividend. And I think the policy will continue for the board to strategically think about that. It is definitely a topic of discussion and my expectation would be that we view that on an ongoing basis just as we've done in the past. And as soon as we have something to share with the marketplace with regard to the dividend, we will be out there sharing it.

Stephen Mead - Anchor Capital Advisors, LLC

I just was wondering whether you've looked at sort of other REIT valuations and as a cost of capital, whether that plays into your -- into the board's thinking?

Gary A. Shiffman

I think it's definitely one of the components. I think it's one of about 5 or 6 components that the board carefully monitors and that we carefully look at as relative value is compared to the metrics of premiums that are being applied to other REITs. But I also suggest that if you look at our dividend yield right now in comparison to other REITs, that we would fall out on the high side right now. So I'm not sure that dividend alone would enhance that multiple or the valuation.

Stephen Mead - Anchor Capital Advisors, LLC

Going back to the acquisitions, if I could, just in terms of the sort of, if you're going to look at progression of what cap rates were, say, a year ago or 2 years ago, what's happened in terms of the properties that you're looking at? And then also, are you seeing more competition for the same property? What do you bring to the table in terms of on the acquisition front to the seller?

Gary A. Shiffman

Sure. I guess I'd share with you how I've felt from a professional standpoint of being in this industry for quite a few years. We really have never seen much compression or change to cap rates. There are not a lot of consolidators. There are a few -- there's ourselves and obviously, our competition, ELS, as public companies. I think the current marketplace plays very strong to the public companies with regard to aggregating and consolidating holdings in the MAC arena and the RV arena. I think that, obviously, the capital marketplaces are favorable and I see a strong continued pipeline. I think what the public companies have is obvious rapid ability to close a transaction, the ability to issue tax-deferred structures through the use of OP Units and other securities that aren't available often to the private competition. And I see that same 6 to 8.5 range that I looked at 5 years ago, 10 years ago and 15-plus years ago today and not a lot has changed, nor have I ever seen a real compression or expansion. Debt markets and capital markets obviously have a role but I think when you point to the steady cash flows of this industry when compared to other asset classes, that's why there's been a consistency and not much elasticity, if you will, to the cap rates. So I don't see much change out there. On the point of what I see with regard to the pipeline, I think that there are a lot of reasons I could point to, some of which would be the lack of capital by current owners or needs to refinance, to buy back occupancy through things like the rental programs, estate planning and retirement going on, much stronger and more difficult underwriting when they refinance and the capital that's available to companies like ourselves to acquire right now. Kind of making a pretty robust acquisition environment.

Operator

And our next question comes from the line of Andrew McCulloch.

Ryan Burke

This is Ryan Burke here with Andy. Just sticking with acquisitions for a second, definitely appreciate the comments on RV portfolio and the fact that cap rates have sort of stayed in this band, in this range. Are you able to provide specific color on cap rates for each of the acquisitions besides the RV portfolio?

Gary A. Shiffman

Yes, I think we did in our Press Releases. We generally do when they're available. I don't know that we have anything in front of us right now, but if you want to call Karen or myself, we'll review anything that we published previous. But they're all in that range.

Ryan Burke

Okay. Understood. And then second question, just in regards to the guidance for 2,000 home sales for 2013, how do you expect those to breakout just in terms of homes that were financed versus cash purchases? Any change from the norm on that front?

Karen J. Dearing

No, but generally 95% of our homes are financed. So we would expect that to continue in 2013.

Ryan Burke

Okay, and the bucket that is financed, should we assume that they will continue to be financed primarily by what would technically be the third parties?

Karen J. Dearing

Yes.

Operator

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

Paul E. Adornato - BMO Capital Markets U.S.

Gary, you mentioned that the useful life of the manufactured homes has kind of increased over time. I was wondering if you could talk about the average age of the homes in your communities, if that had similarly increased or with the addition of new homes, if that has stayed the same or decreased over time.

Jeffrey P. Jorissen

Well, Paul, we have homes that have been in the communities for well over 40 years. I remember a HUD study some years ago that asserted a life of the average manufactured home at something like 54 years. In terms of our portfolio, the fact that something like 2.5% to 3.5% of the homes are actually removed from the community each year has the effect of creating a 30 to 35-year life, so that there's always new homes coming into the community to replace the -- what are usually the older homes that are moved out of the community. So it's kind of a gentrification, a re-gentrification process that takes place automatically in our communities.

Paul E. Adornato - BMO Capital Markets U.S.

Okay. Great. So that's not anything that -- I mean, that just happens. You can't really affect that except to the extent that you're putting in new homes into the rental program.

John Bandini McLaren

That's correct. That was Jeff, by the way, not Gary. But Paul, the only thing I would add too is I don't think it's a matter so much of their useful life ending, whether it's 31 years or 40 years. As Jeff, pointed out, the inventory just shifts out. So whether they go to private land, whether they're no -- some of them obviously don't have a useful life beyond that, but many of them do survive. They're just outside the community.

Operator

And gentlemen, it appears there are no further questions at this time. So I will turn it back to management for any closing remarks.

Gary A. Shiffman

I'd just like to thank everybody for participating on the call. Karen, myself and Jeff are available for any follow-up questions. And we certainly look forward to sharing additional news and any information on next quarter's results with everybody. Thank you.

Operator

Ladies and gentlemen, this does conclude your call for today. Thank you for your participation and you may now disconnect.

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