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Sun Communities (NYSE:SUI)

Q2 2012 Earnings Call

July 26, 2012 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

Analysts

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

Andrew McCulloch - Green Street Advisors, Inc., Research Division

Todd Stender - Wells Fargo Securities, LLC, Research Division

Jeffrey Lau - Sidoti & Company, LLC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities Second Quarter 2012 Earnings Conference Call, on July 26, 2012.

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 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

Good morning. Today we reported funds from operations of $23.1 million or $0.78 per share for the second quarter of 2012, compared to $17.5 million or $0.74 in the second quarter of 2011. For the 6 months of 2012, FFO was $49 million or $1.68 per share, compared to $36.5 million or $1.67 per share in the first half of '11. These results exclude transaction costs related to acquisition activity in all periods. Revenues for the first 6 months increased by 20% from $138 million in 2011 to $165.5 million in 2012.

And now we'll turn to the portfolio. During the first 6 months of 2012, revenue producing sites increased by 704, of which 433 are in our same site portfolio and 271 are in acquired communities. The occupancy in the same site portfolio has increased from 84.5% to 86.6% in the last year. We will discuss the performance of our Kentland portfolio acquisition later in our comments.

Home sales had a record of 885 in the 6 months of 2012 compared to 719 last year, for an increase of 19%. While applications continue to drive leasing and home sales as they are at an annual rate of over 26,000 or 500 per week. Comparing to the same 6-month period year-over-year, applications have increased 16%. In the same site portfolio, revenues grew by 5% in the first 6 months while expenses increased by 1.1%, and NOI growth hit 6.6%.

Now I'd like to turn to our expansions. And as of June 30, we have a 4,846 sites in Texas. There are 40 vacant sites in the entire state and the communities are now 99.2% occupied. We will be opening 3 expansions in the third quarter, and one in October, adding 452 sites available for occupancy in Texas. These newly constructed expansions will provide us with a supply of homes -- or supply of home sites to meet the strong demand while we proceed to prepare additional expansions to bring on stream in 2013.

And turning to our Kentland portfolio and Michigan, the Kentland portfolio of over 5,000 sites located on the west side of the state closed at the end of June 2011. And since that time, we have added 408 revenue producing sites, increasing occupancy from 82.2% at acquisition to just under 90% at June 30, 2012. We expect occupancy to approach 95% by the end of 2012. This performance is stronger and has taken place more rapidly than our pro forma and budgets forecast.

In the first 6 months of 2012, Michigan added 457 sites of occupancy, with 231 being in the Kentland portfolio and 43 sites in the Cider Mill Crossings community acquisition, which we acquired in October 2011. The remaining growth in occupancy of 183 sites compares to an increase of 142 occupied sites in the first half of 2011. Demand is strong throughout the state, as Michigan is currently ranked sixth amongst all states in terms of economic growth according to the recently published U.S. Bureau of Economic Analysis. In addition, unemployment, which was 14.2% in 2009, has shrunk to 8.4% currently. The business and economic climate has improved dramatically and really, is reflected in the strong continued demand for affordable housing in Michigan.

And I'd like to review acquisitions. We currently have a large pipeline, they're in various stages of negotiation and due diligence. And it is the largest pipeline that we've seen in the last 20 years. We're focused on expanding our geographic footprint, taking advantage of opportunities to lever management strength, and increasing our extent in expanding the scope of our RV business platform.

To that end, the company acquired Blazing Star, a 260-site RV community in San Antonio located next to a Six Flags resort for approximately $7.1 million. In place NOI was approximately $570,000.

Additionally this morning, we announced 2 executed letters of intent related to a high-quality portfolio of 7 manufactured housing communities with 4,350 sites, an approximate occupancy of 87%. These assets are extremely well-located in and around Oakland, Macomb and Wayne counties and are actually within a 10 to 15-mile radius of our home office. Five communities will be acquired outright and 2 communities, where Sun will provide mezzanine financing and will assume management and operations on behalf of the owners of those communities.

At this time I'll turn it over to Karen to provide an update on the balance sheet.

Karen J. Dearing

Good morning. As noted in some of Gary's comments, we are very pleased with our current performance, the improvements we've made to our balance sheet and the positive long-term growth our recent acquisitions and anticipated transactions are expected to provide.

When comparing our current balance sheet to recent periods, we've reduced debt to total capitalization to 50% from 60%, and proved our debt to EBITDA ratio, from debt of 9.9x EBITDA to a projected 7.8x EBITDA by year-end, reduced our line of credit balance by approximately $100 million and improved our payout ratio from 90% in 2011 to an estimated 85% in 2012.

We have proactively managed our debt maturities, increasing our weighted average maturity from 4.9 years in June of 2011 to 6.9 years currently. Our most significant upcoming debt maturity is $175 million due in 2014. And the NOI of these properties has increased by over 16.5% since they were originally financed.

In addition to the above, we've successfully completed a $163 million equity offering of 4.6 million shares. Our strong year-to-date performance has absorbed all of the dilution from this offering. And all prospective growth from our acquisitions and core portfolio will add to bottom line FFO growth. Through the long-term growth potential provided by our recently closed and shortly anticipated transactions, we foresee excellent opportunities for strong future FFO accretion.

In our press release, we updated FFO guidance to $3.20 to $3.27 per share. Guidance does not include the effect of any potential transactions. Our business has a seasonal component for RV revenue and certain summertime expenses, which generally cause revenues to be the highest in first and fourth quarters, and expenses to be the highest in second and third quarters. We expect third quarter FFO to be our lowest quarter of the year and fourth quarter FFO to be slightly higher than the $0.81 achieved in Q4 of 2011.

And now, Gary, Jeff and I would be happy to take your comments and questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Paul Adornato from BMO.

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

Karen, with respect to your guidance in the $3.20 to $3.27 range, are there any acquisition costs included?

Karen J. Dearing

Not for any future transactions, Paul.

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

Not for future transactions. And so there's none at all in that number?

Karen J. Dearing

Correct.

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

Okay. I was wondering if you could then tell us what kind of assumptions would get us to the low-end and to the high end of that range?

Karen J. Dearing

Well, let's see, what can I tell you? Our guidance -- the guidance that we put out at the original -- beginning of the year is substantially unchanged, and we're still expecting site rent increases to be about 3%. Our occupancy revenue-producing site expectations are just a bit higher than what we originally anticipated. Same-site portfolio will be a little bit stronger, NOI growth, than what we had originally anticipated. Home sales are expected to be about the same. G&A? G&A, we are -- our forecast is running a little bit higher than the $19.1 million G&A guidance we previously provided. And that's partially due to about $450,000 of onetime expenses related to severance costs, and also some legal expense associated with contracts that we had with a cable provider that went bankrupt. And the other increases are primarily related to performance-based compensation due to our strong operating performance, so right now, we're projecting G&A costs for the year to approximate about $20 million.

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

Okay. That's helpful. And with respect to the acquisitions, I was wondering if you could comment on the potential economics. What sort of cap rates might we expect?

Gary A. Shiffman

I think, obviously, a good question, Paul. I think that we are, in fact, quite long in the process of the acquisitions that we shared this morning. And because we're still far along, we expect to be in a position very shortly where we can share that specific data. But that will be in the very near term.

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

Okay, and maybe just perhaps a little bit more color on the portfolio. Are they -- are the 7 properties coming all from a single entity?

Gary A. Shiffman

They're coming from 2 different entities. One of them is a family-related entity where they were built and developed by the family. And in fact as I indicated, all 7 of the properties are properties that I have watched my entire career, and they are what I would consider the premier properties in the metro Detroit area. And one of the properties is, in fact, from a different third party.

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

Okay. And in the release, you've mentioned that the high occupancies are reflective of the fact that there’s been very few rent increases. I was wondering what the plan would be. Would you expect to potentially implement some rent increases and then see a dip in occupancy or...

Gary A. Shiffman

I think that they are substantially below market, anywhere from $50 to $70, whereby, we think that we can increase the rents substantially and slightly above our average increases in the portfolio, and not impact occupancy at all. The key to these assets, obviously, is their location, like with all real estate. It's also of the overall quality of how they were constructed and the makeup in the credit profiles, the residents there, and the fact that the rents haven't been touched, most of them in 4 years.

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

Okay. And are there expansion possibilities at any of the properties?

Gary A. Shiffman

There are no expansion possibilities, but one of the communities is a more recent, all double-section community and has 150 new sites that have not been sold out and that's in the vacancies that we gave you.

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

And do you -- just one last question. Do you think that you'll implement a rent-to-own program in these properties?

Gary A. Shiffman

Yes, I think that there is a very limited to no rent-to-own in these properties, and probably about 7, 8 [ph] occupancy points to be gained. So we will mostly focus on sales and we will have some limited rent to own, probably. If we look at how well we did in Kentland, we're actually not only -- and as a good example, we're able to get it above market rental increases in the Kentland portfolio and increase the occupancy almost 10 points in an 18-month period of time. So I think we will bring these up to a very, very high occupancy, mostly with sales, but with some limited rental program.

Operator

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

Unknown Analyst

This is Jane for Jana. I apologize if I missed this, but did you provide the cap rates for the acquisitions that you announced?

Gary A. Shiffman

We didn't. What I said is that we are, in fact, very far along in these transactions. And I expect to be able to provide that specific information very near-term.

Unknown Analyst

Okay, great. Then can you provide maybe some color generally along what kind of cap rate trends you've been seeing in terms of the properties that are out there?

Gary A. Shiffman

Sure. I think that what I've shared for most of the time while I've held this position in the company is that in our industry we have not seen a great deal of fluctuation and cap rates over the years, in large part due to the stability of cash flow in our industry. Obviously, we did have a very difficult period of time from ’90 to about -- 2000 to 2006 in our industry with the competition that's placed on housing and lack of financing. But even through that period of time, you see a range of a low of around 6 cap rate and a high of around 9 cap rate in our industry, depending upon the fact if it is age-restricted community, and the sun belt you will most typically will see at the low-end of that range, and obviously, nonage-restricted at the high-end, depending upon the quality and the location of the community. And I would expect that everything that we're looking is right in the middle of that range.

Unknown Analyst

Great, thank you. And for the potential acquisition opportunity that you're also looking at, what regions of the country are you seeing more opportunities? And are there any specific regions that you're targeting?

Gary A. Shiffman

Yes, I think that while we're obviously not shying away from the areas that we have operations in, such as the Midwest, Southeast and the Texas Colorado area, we are looking at both the West Coast and the East Coast and looking to expand our geographic footprint. And we are finding additional opportunity, mostly in the small portfolio range of what we saw today, which is anywhere from 3 to 9 communities. And we are definitely focused on both manufactured housings, and looking to expand the footprint of our RV business

.

Operator

Our next question comes from Andy McCulloch from Green Street Advisors.

Unknown Analyst

This is Ryan Burke along with Andy McCulloch. A few questions from our end, just first couple continuing with the acquisitions. Regarding the 5 acquisition assets in Michigan, in particular, can you give us a feel for how many of those homes are currently rentals?

Gary A. Shiffman

Yes. There are no rentals in those communities .

Unknown Analyst

No rentals currently. And you mentioned obviously that rents in those communities are below market. Can you give us sort of a side-by-side comparison of how the rents in those communities currently are versus your current other Michigan assets?

Gary A. Shiffman

No, can -- we have -- I think Ryan, we'd have to get back to you on that.

Unknown Analyst

Yes, understood. Moving over to just a couple quick questions on the home sales throughout the quarter. Can you give us a feel for what percentage perhaps of those homes were bought using financing? And of this number, how many were financed by Sun either directly or indirectly?

Karen J. Dearing

Generally, our home sales is about 90% of the home sales are financed by third parties or ourselves. Another portion of it is cash. There's certain cash sales that go on.

Unknown Analyst

Okay. Is there any breakup possible, just between third-party financing and Sun financing of those 90%?

Karen J. Dearing

It's predominantly third-party financing.

Gary A. Shiffman

Yes, third-party financing with Sun does have liability...

Karen J. Dearing

With our -- and with some recourse.

Unknown Analyst

Great. Can you give us a feel for what sort of financing terms you're seeing in general?

Gary A. Shiffman

With regard to the channel [ph] loan?

Andrew McCulloch - Green Street Advisors, Inc., Research Division

With regard to -- yes.

Gary A. Shiffman

I think things have actually improved -- continued to improve slightly. We are seeing basically 15 to 20 year amortization with about 10% down. And depending upon credit quality, I'd say about a 8 3/4 to 9 3/4 range right now.

Operator

Our next question comes from Todd Stender from Wells Fargo Securities.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Just looking at the San Antonio RV ommunity. It sounded like you're around an 8 cap rate going in. Is that fair?

Gary A. Shiffman

I think if you do that math, yes.

Todd Stender - Wells Fargo Securities, LLC, Research Division

And in a dedicated community like that, is there any opportunity to add MH [ph] to that?

Gary A. Shiffman

I think in fact, it's not something we have looked at, but we are looking at the potential of expanding the RV Community itself because of the close proximity to the attraction there.

Todd Stender - Wells Fargo Securities, LLC, Research Division

And what kind of expansion would you have there?

Gary A. Shiffman

It depends on the availability of the landing and zoning that we could get, and I think it's just too premature for me to really know that because I know the guys that like to have operations there.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Sure. And just going into the mezzanine loan. It may be too premature, but do you have any pricing around that or duration of the loan for us?

Gary A. Shiffman

Yes, I think our intention is to share that very near-term with everybody. So it is a little bit early on that, but I hope it will be very shortly.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Okay. Does it sound more like you'll lend the money for a very short term and then the present owners try to refinance?

Gary A. Shiffman

I don't think that that's the intention. I think it's part of the overall package to be able to acquire these properties. And we have done it in the past. The principal owners are elderly and retiring. And when we've provided this type of lending in the past, it frequently has led to us to have the inside track on acquiring the properties. That would be our eventual goal.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Okay. Anything in place like a purchase option or right of first refusal?

Gary A. Shiffman

No, nothing.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Okay. And just last piece, how are you looking at your capital allocation for the second half and viewing where the CapEx stands right now and also address the dividend?

Karen J. Dearing

CapEx was projected to be about 8.4% for recurring capital expenditures, and we anticipate that to be right in line.

Todd Stender - Wells Fargo Securities, LLC, Research Division

Thanks, and any input on where the dividend stands?

Karen J. Dearing

I'm sorry, Todd. Gary just corrected me. I said 8.4%. It's $8.4 million, sorry.

Gary A. Shiffman

Todd, what was your question on the dividend?

Todd Stender - Wells Fargo Securities, LLC, Research Division

And on the dividend, just seeing where your allocation stands at midyear here. You're making acquisitions, probably a pretty good clarity on when stuff is going to close. How are you thinking about the dividend right now?

Gary A. Shiffman

Obviously, it's a frequently asked question of -- to us and to other companies, but I think we continue to pretty much review it on a quarterly basis obviously with the board. As I shared before, we're looking towards the 80% payout ratio to be kind of a historical figure for us to begin to talk about increasing the dividend, so we are nearing that level. But I would also suggest the acquisition activity, as such that the overall desire is for us to see the size and the magnitude of these acquisitions over the early third quarter and perhaps into the beginning of the fourth quarter, and we should be in a position to again review that.

Operator

Our next question comes from Jeff Lau from Sidoti & Company.

Jeffrey Lau - Sidoti & Company, LLC

Just a follow-up question on the acquisitions. You guys think it's in all likelihood you'll be doing another, I guess, offering this year or will those acquisitions be funded by current lines in cash?

Gary A. Shiffman

Well, I've said a few comments that the magnitude of the acquisitions are such that we have entered discussions for a facility to allow us to move forward if we saw a let down on the pipeline of acquisitions. But our desire is first and foremost, to acquire properties and acquisitions that will be accretive even at a debt-neutral basis, which is how we want to look at them going forward.

Operator

[Operator Instructions] We have a follow-up question from Paul Adornato.

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

Gary, given your extensive experience over the years and kind of pioneering the rent-to-own program, I have kind of a question coming out of left field, and that is looking at the single-family market, obviously, there's been some activity among those that are looking to capitalize on that opportunity, buying single-family homes and renting them to individuals. I was wondering if you had thought about that business, not -- either within or without the company, but if you have any ideas on the viability of rent-to-own in the single-family market?

Gary A. Shiffman

Well, that's a good question, Paul. I think that if you go back to 4 or 5 years at the height of the meltdown of single-family residential and subprime and everyone was very concerned on how that overhang of foreclosures might manifest itself in competitive rental units entering the market and competing with our manufactured housing. They've never materialized. I think mostly because there's still a vast difference between a $45,000 manufactured home in the Midwest and $120,000 FICO home. So we do see that competition. With regard to fast forwarding now, I think that type of business is more suited to a individual entrepreneur. There's just no economies of scale and too much fragmentation when you don't have a fully concentrated consolidated geographic area. And we've got to run around, whether it be repairs and maintenance or rent collections and all the issues you would have with that type of fragmentation. So it's not something I think that we have considered at this point.

Operator

[Operator Instructions] I think we have no further questions at this time. Please continue with any further points you wish to raise.

Gary A. Shiffman

Thank you operator, and I like to just conclude by saying that things are very positive with regard to leasing sales, operating budgets, recurring capital improvements to maintain the asset quality, as well as our systems are smoothly functioning, integrated with the management personnel, and we definitely look forward to a strong finish of 2012 and speaking to everybody near-term or next quarter. Thank you.

Operator

Thank you, Ladies and gentlemen. That concludes today's Sun Communities second quarter 2012 conference call. Thanks for your participation. You may now disconnect.

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