Sun Communities, Inc. Q1 2008 Earnings Call Transcript

May.12.08 | About: Sun Communities (SUI)

Sun Communities, Inc. (NYSE:SUI)

Q1 2008 Earnings Call Transcript

May 12, 2008 11:00 am ET

Executives

Gary Shiffman – Chairman and CEO

Karen Dearing – EVP, CFO, Treasurer and Secretary

Analysts

Craig Nelcher – Citigroup

Paul Adornato – BMO Capital Markets

Dan Fisher – Wachovia Securities.

Cathy Chasm [ph] – State of New Jersey

Andy McCullock – Green Street Advisors

Operator

Greetings, ladies and gentlemen, and welcome to the Sun Communities, Inc. first quarter 2008 earnings results conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder this conference is being recorded.

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 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 would like to introduce management with us today, Mr. Gary Shiffman, Chairman and Chief Executive Officer, Ms. Karen Dearing, Chief Financial Officer, and Mr. Jeff Jorissen, former Chief Financial Officer. It is now my pleasure to introduce you host, Mr. Gary Shiffman. Thank you. Mr. Shiffman, you may begin.

Gary Shiffman

Thank you and good morning, and I apologize for any delay. We were on hold like many of you were until the operator came on. This morning, we reported funds from operations of $15.9 million, or $0.78 per share before a $0.24 of losses related to Origen. This compares to FFO of $15.5 million, or $0.76 in 2007. Net loss was $3.1 million, or $0.17 per share, compared to net income of $50,000 in the prior year.

Revenues increased from $61.4 million in the first quarter of 2007 to $65 million in the current quarter. We have discussed our portfolio’s gradual evolution from the perfect storm of undisciplined lending practices resulting in tens of thousands of repossessions by financial institutions, collapsing shipments of new homes, and the dissemination or the decimation of the dealer network. It is now beginning to look like many of those topics are substantially related to the past.

There are clear signs that the characteristics of our portfolio of communities has returned to levels experienced prior to the advent of the storm. Internally, we reference 2000 as the pivotal year this storm began and at quarter-end there were 220 repossessed homes in our portfolio, which represents about 64 basis points of our occupied sites. This is better than the 252 repossessed homes in our portfolio back in 1999, which represented about 78 basis points of our occupied sites.

There were 174 repossessions in the first quarter, which is a 19% reduction from the first quarter of 2007. We expect some continued improvements, but as an annual rate of 696 it is down 51% from the levels of 2003 through 2005, and repossessions are down 35% from 2006 and 15% from 2007.

Likewise, our average monthly delinquency for the first quarter was $920,000, down from averages of $1.2 million to $1.4 million experienced in recent years. It is in fact nearly the same percentage of income from property as were the delinquencies in 1999.

Applications to live in our communities exceeded 4100 in the first quarter, running about 20% ahead of 2007's first quarter. Approximately 46% of all the rental applications were approved, which is similar to recent prior periods; however, approximately 54% of the approvals actually moved towards closing where the customer moved into a rental unit, which is almost about 5% to 10% higher than recent prior periods. And as the general economy remains challenged and site of homes are not an option, we may continue to see a benefit from the affordability and value offered in our rental and sales programs.

As we have also previously noted, our rental program developed from the opportunity to acquire homes repossessed by lenders at what we believe were opportunistic prices, which equated to $15 per square foot, or an average price of about $20,000 per home. This price represents from 40% to 50% of the cost of a new home including setup costs. We undertook this strategy because of the opportunity to purchase value at a discount while retaining the homes in the community and generating a cash flow stream.

The rental program has allowed us to sustain much of our occupancy at the same time the repossessions drained occupancy. We now have a portfolio of approximately 5900 rental homes, which we are selling at an increased rate in excess of the original cost of the homes. With the large overhanging repossession inventory clearly burned off, our rental homes now actually represent an opportunity to create real value for both the company and third party purchases.

In the absence of a rental program, we would have lost an average of 341 sites of occupancy each quarter for the last five years. In the first quarter of 2008, our portfolio, exclusive of the rental program, would have lost only 108 sites, a significant improvement from the five-year average of 341. This seems to affirm that the portfolio is nearly in equilibrium on occupancy without the rental program.

The portfolio characteristics continue to show signs of improvement. Another indicator is that our net purchases of new and pre-owned homes have declined to an annual rate of 372 from 573 and 851 in '07 and '06. This represents substantial progress and reflect the declining growth of the rental program, counterbalanced by increasing sales of homes. Affordability of housing remains the key to our business. The economics of our housing offers an opportunity to prospective homeowners with credit, but who are now currently shut out of the site-built market due to the restoration or appropriate underwriting standards caused by the current subprime market conditions. And after the experience of the last six to eight years, management is encouraged by developments and seeing reason for some modest optimism.

And at this time, I'd open it up to questions of both myself, Karen and Jeff who are joining me in this call.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from the line of Michael Bilerman with Citigroup. Please go ahead with your question.

Craig Nelcher – Citigroup

Hi, it’s Craig Nelcher here with Michael. My first question is just on the home sales business. How – it seems like the gross profit continues to be quite strong, but I am just curious to get a little more color on the – your pricing strategies and how the broader housing market weakness is impacting the way you are going about this business.

Gary Shiffman

Well, it is Gary. I will take – answer from the standpoint of strategically and then if Karen or Jeff want to add anything, but I think that coming off of the seven-year challenge that we've had, that we've shared with all of you throughout that period on the conference call, our single primary goal is to convert the rental or the renters into owners. So, we are above our original cost on the homes, but we have not marked anything up in the cost of commissions and other expenses related to the sale. I think that's pretty much the case with all of our used inventory.

With regard to our new inventory, we are starting from margins of 15% to 17%. From that we will deduct any kind of marketing but again we are still selling all homes averaging at or above the invoice price. What we are not seeing right now, Craig, clearly is substantial mark-ups. It’s something that we would look to in the future as we jumpstart if you will or begin to create a more effective demand for the new housing and the used housing product that we have in the manufactured housing. Step one strategically, as I have discussed before, is to earn the respect and the interest of the customer, again, which we lost over the last five to seven years, both from the bad credit that took place, bad underwriting in the 90s, and also from the competition of site-built housing and low interest rates. And after we have achieved our modest goals, which are for example, 80 homes in budget for the signature program this year, we will eventually look to continue to put pressure on our rental rates and therefore drive more and more of the prospective customers into ownership as opposed to rental of the homes.

Craig Nelcher – Citigroup

Okay. And on your FFO guidance, I didn't see an update on that. Is the – how has that changed based on the 1Q results?

Gary Shiffman

I think that today we would confirm the existing guidance of 276 to 282 and very comfortable in doing so.

Craig Nelcher – Citigroup

So, adjusting for the Origen – does that assume – not assuming or adding back that charge from Origen in the first quarter the loss.

Gary Shiffman

That's correct.

Craig Nelcher – Citigroup

And does that assume just flat for the rest of the year on Origen or is there a positive income contribution from Origen in that range?

Gary Shiffman

I think that we look and compare the potential for income from Origen of perhaps the value of the sale of Origen or its components as it is going forward and expect it to be fairly neutral in offsetting any income we would expect to see.

Craig Nelcher – Citigroup

Okay. Last question is just on the bad debt. If you could talk about how that is looking on the rental portfolio and as well as just the traditional site rent.

Karen Dearing

Well, bad debt for the MH portfolio generally runs between 60 and 70 basis points of income from properties. The LTP program, that one runs about, I think about 2.5% to 3% of total revenues from that program inclusive of site rent.

Craig Nelcher – Citigroup

And have those been pretty steady the last couple of quarters?

Karen Dearing

Yes, those are fairly steady.

Craig Nelcher – Citigroup

All right. Thank you.

Operator

(Operator instructions) Our next question comes from the line of Paul Adornato with BMO Capital Markets. Please proceed with your question.

Paul Adornato – BMO Capital Markets

Thanks. Good morning. Could you talk about conditions in some of your tougher markets, Michigan and Ohio?

Gary Shiffman

Sure, Paul. I think that we have shared with everyone before that we do definitely suffer more of an 80/20 scenario where 80% of our challenges come from less than 20, actually as few as 15% of our actual properties in our portfolio, those areas being hardest hit, would be the flint, Michigan, South Bend, Indiana and similar Midwestern areas that are impacted certainly by the (inaudible) automotive and reduction of job force. I don't think there has been very much change. The only thing that we have seen that is worth noting is that our LPP program continues to be occupied at the highest levels that we have seen. In fact, we were 20 over budget at quarter end in actual occupancy. And so the best answer I can give you to the question is that very little has changed. We don't see significant continuation of the repossession. In fact, it has slowed down to more normalized terms. So as we shared with you, we think that most of the bad underwriting has already blown out of the portfolio. But when you compare Michigan, Indiana, Ohio with other parts of the portfolio, the south, southeast, Texas, while we continue to see normalized repossessions, the repossessions and the losses in that part of the portfolio are the same as they have been historically. So not much change from what we have been seeing these last few quarters, but not much deterioration either. So it is for us a manageable scenario right now and not a deteriorating scenario.

Paul Adornato – BMO Capital Markets

Okay. And as the single family crisis continues to play out, I was wondering if you could comment on those customers. Are you seeing them come to you as potential renters or buyers of homes?

Gary Shiffman

Well, I think what we are seeing is we are seeing a little bit improvement of the overall credit that is coming to us, which indicates some of these buyers are crossing over. And we are right solidly in the middle of all of our marketing programs and our strategy to target after that customer who had for the last five years been buying site-built homes with the introduction of our signature program and signature homes and the introduction of trying to establish our relationship with the normally the retail brokerage companies that cater to site-built housing and trying to educate them and get an interest with them crossing over, and bringing those customers into our communities and looking at some of this new product. So, it is too early to tell how substantial that difference is going to be, but we are certainly planning to market against that customer and the signature program this quarter again while small as opposed to what I shared at the end of the fourth quarter is the fact that we were actually two homes beyond budget being three to six months behind in the program where we thought we would be when we rolled it out third quarter in '07. So we are starting to see a little bit of a pick up there although it is small on a base of eight homes in the quarter and it doubles going into second and doubles again going into third quarter this year. So, it is an answer that needs to be addressed, but we are targeting that for the next couple of quarters.

Paul Adornato – BMO Capital Markets

Okay. And given the previous delays in the program, is there any reason to think that you won't be able to double the size of signature in each of the next couple of quarters?

Gary Shiffman

No, the fact we are above budget tells us we are better focused on it again. We shared with everyone weather conditions, harsh winter in particular in the Midwest was the biggest problem for setup taking anywhere from 6 to 12 weeks longer. And now, we are established firmly in about 27 of the 40 communities for the signature program where we had it targeted. And the first 20 of them, you may recall, were strictly Michigan and Indiana. So, we are coming into the stronger season for selling, which would be the spring summertime, getting out of the harsh wintertime. So we are cautiously optimistic that we will meet or exceed our budgets with regard to that.

Paul Adornato – BMO Capital Markets

Okay. Thank you.

Operator

Our next question comes from the line of Dan Fisher with Wachovia securities. Please go ahead with your question.

Dan Fisher – Wachovia Securities

Hi guys. I am sorry, I missed the beginning of the call, so if I duplicate anything you have mentioned before, I am sorry, but I was wondering in the – I know you guys have acquired quite a few independent parks and I was wondering how that pricing is right now in the market or are there bargains out there?

Gary Shiffman

The last – the answer is there are no bargains out there. From what we have seen, cap rates have been equal to or surprisingly even tighter than what we have been. We actually served letters of intent on three different communities over the last 30 days or so. And saw cap rates that were much more aggressive than we were prepared to follow through on. And prior to that there was a group of four communities and two RV parks in there, and they traded for some of the tightest cap rates I have seen in quite some time. And I just continue to be surprised at how strong the market has been for the properties.

Dan Fisher – Wachovia Securities

The next question I had for the – how substantial is your RV market exposure and talking about summer coming I mean are you a little nervous that with gas prices where they are that the RV business will be soft?

Gary Shiffman

That's really a good question, Dan. I think our greatest concern is always in the wintertime because that's where our snow birds come down to our communities, which are basically all in Florida or in south Texas. What we do have and what we do know is that we have 50% of about 5,000 or so sites or what we call permanent sites where the homes actually never leave the sites. The other 50% are seasonal. They come for a week, a month, or the whole season, but they drive down there. So certainly we do have some sensitivity to those gas prices. We have not seen any deterioration as of this point. Reservations are where they were or ahead of where they were at this particular time. But definitely as we all feel the impact of the price per gallon, we are watching very carefully and we have actually designed but not implemented a few marketing incentive programs where we will target the price per gallon for anyone who comes into a community for over a week or a month if we start to see any diminishment in reservations. But as of right now we haven’t seen anything. We are where we should be on reservations and one of the things that maybe we will see is maybe we will see more people choose to leave their homes down on a more permanent basis than the RV community and we will also gain a marketing concept to increase the permanence in the communities this winter when they all get down there. So we will have more to report on that, but we are definitely watching it very closely.

Dan Fisher – Wachovia Securities

And then my last question is, just in general, a new – not an RV but a new semi-permanent home, commodity prices, construction costs, I mean is there a favorable comparison to stick built right now or not?

Gary Shiffman

Well, I think on the RV side and in general–

Dan Fisher – Wachovia Securities

I see more about the – you are competing with the traditionally built home, you are talking more about that. I mean I just I know that it's – oil prices go up, railroads have an advantage over trucks. I mean does this, is there anything to that–-

Gary Shiffman

No, it is a good question. I think that what we have seen is that strategically, we are paying attention to the $30,000 to $60,000 market and where we do see slippage in – especially our Midwest markets, although now we all read the headlines that Vegas and California are leading the pack with declining home sales and pricing. 5 and 10 and 15% corrections that have taken place the site-built housing and a $175,000 and above is not enough to significantly impact the affordability advantage that we have on $30,000 to $60,000 housing. So, I think what we do more than anything is just shift a customer who can't afford and who shouldn't have been buying that site-built housing with a subprime back to our market and those who can affordably and comfortably buy the adjusted site-built housing will continue to do so. So, I think you will see more stratification between the markets, but not a loss of market share or opportunity for us. In fact the inverse. We should see an increase in the pool available for our type of housing.

Dan Fisher – Wachovia Securities

Right. Last question, sorry to take up all your time. As far as your capital and balance sheet and everything you don't see any need in the immediate future to do any capital raising or debt or anything like that?

Gary Shiffman

No, I think that we are good on our lines and Karen and Jeff have been working on refinancing of four or five properties that we think carry us very comfortably into the future.

Dan Fisher – Wachovia Securities

Thank you.

Operator

(Operator instructions) Our next question comes from the line of Cathy Chasm [ph] with State of New Jersey. Please go ahead with your question.

Cathy Chasm

What further deterioration or charges might we see from Origen?

Gary Shiffman

Cathy, that's a good question. I'm as anxious as you to kind of get to their – to hear their recorded analyst call and read their press release. As you know, they announced simultaneous to Sun, which provides for them not to have their market information known in advance with Sun reporting. So I think from what I can share that they have shared with the market that I am aware of without having heard their call, is they have sold all of their existing portfolio of new originated loans which they announced last quarter. They have paid down their credit facility and warehouse line to Citibank with those proceeds. They have entered into an arrangement with Green Tree to sell their servicing platform. And I think that was $30 million or in excess of $30 million. And they maintain their origination platform and all of the tranches of subordinated loans, which are pretty significant at this time and determining valuation for those and whether or not they will offer them to the market or continue to run those will be the next decisions they have to make there. So, that's as much as I know as of this point. And I think that the question is what is the valuation to Sun as a shareholder and other shareholders now and going forward And I'm anxious to get their read based on what they released today.

Cathy Chasm

Okay. Thank you.

Operator

Our next question comes from the line of Andy McCullock with Green Street Advisors. Please go ahead with your question.

Andy McCullock – Green Street Advisors

Hi, good morning. Karen, on the four to five communities that you are looking to refinance, is that Fannie debt and what kind of rates are you looking at?

Karen Dearing

We are looking at several different options, some with a secured revolver, some – of course, we have about four or five quotes. Rates are anywhere between 200 and 250 basis points over LIBOR.

Andy McCullock – Green Street Advisors

Okay. And then, what does the current market look like for counter-financing? What are the rates on those?

Gary Shiffman

That's an interesting question. Even with all the challenges that Origen is experiencing, one of the things that we are seeing is more continued interest by the small local banks, I think as they seek what seem to be appealing interest rates. And what we are seeing pretty much them pick up some of the missing pieces, but I think 9% to 11% currently out there in the market is the range of what we are seeing. And then as you get to a very highly qualified liquid retiree in the retirement market, you are seeing much more aggressive rates because you are seeing an interest by the financial institutions to maintain and manage (inaudible) if you would of those particular customers. So they're a little bit different and I have seen in Florida rates in the 6%, 6.5% range. But as a rule of thumb, 9% to 11% in our industry today.

Andy McCullock – Green Street Advisors

Great. Thank, guys.

Gary Shiffman

Thank you, Andy.

Operator

There are no further questions in the queue at this time. I'd like to hand the floor back over to management.

Gary Shiffman

At this time, I would like to thank everyone for participating on our first quarter comments. As you know, it’s early in the year. We expect to have much more to discuss with you as the year progresses, but as this hopefully reflected, we feel comfortable, we are on budget right now, we are seeing the trends of improvements in many different, metrics and we continue to hope to share with you those positive trends on the next call.

Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.

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