Seeking Alpha

Sun Communities: Residential REIT With Strong FFO And Cash Flow Growth

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About: Sun Communities, Inc. (SUI), Includes: ELS, UMH
by: David Zanoni
Summary

As a residential REIT, Sun Communities is thriving while many commercial REITs are struggling.

Sun's strong FFO and cash flow growth led to above-average price appreciation for many years.

The strong growth may pause in 2020, but the long term still looks positive.

While many commercial-based REITs are struggling due to COVID-19 related business shutdowns, most residential REITs are thriving. One of these residential REITs is Sun Communities (SUI), an owner and operator of manufactured home [MH] and recreational vehicle [RV] communities.

Many investors fall into the trap of chasing high-yield REITs. However, many of these investors may not look at the underlying fundamentals of the business. If a REIT is struggling to grow revenue and FFO, then the underlying price is likely to also suffer, and the payment distributions to shareholders could be reduced. Many commercial REITs have been struggling even before COVID-19 made things worse.

Sun Communities has been thriving before COVID-19, and the REIT is still holding up well during the pandemic. Although Sun has a modest yield of about 2%, the price appreciation has been stellar over many years. Sun's underlying price increased 412% over the last 10 years. Sun's outperformance has a good chance of thriving going forward due to the affordability of manufactured homes and the well-maintained communities that they are a part of.

The other positive catalyst for Sun is the recent strength in RV sales. RV dealers in the United States experienced significant increases in sales during the pandemic. Some dealers reported as much as a 170% sales increase. This is a result of consumers re-evaluating how they wish to travel. Air travel may not be as attractive during the pandemic. So, consumers might be shifting more towards RV travel, which allows them to spend time with family while reducing the risk of catching COVID-19.

Sun Communities Geographic Portfolio

Source

The graphic above shows the total amount of homes and RVs per region that are a part of Sun's various communities. Sun acquires communities on a regular basis for ongoing growth. The REIT acquired a total of 13 communities with a total of 10,390 homes and RVs in 2019.

High FFO and Cash Flow Growth

Sun's high growth is a result of the REIT's ability to increase revenue over the long-term. Sun makes most of its money (about 77% of total revenue) by leasing the site that the MHs and RVs sit on. So, the REIT is primarily responsible for the land containing the homes and RVs. The home and RV owners are mostly responsible for maintaining their homes and RVs.

Sun does make some money on home sales (about 13% of total revenue) and home rentals (about 5% of total revenue). Sometimes, opportunities present themselves for Sun to buy, rehab, resell, or rent the homes. However, the main function of the REIT is to manage and maintain the land for the MH and RV communities.

FFO (funds from operations) is the key growth measure for REITs (as an alternative to net income). FFO adds in depreciation and amortization to net income and then subtracts gains from property sales.

Sun Communities increased FFO by 20% in 2018 and 14% in 2019. This is not a fluke. Sun increased FFO by strong double-digit rates for the past 9 years. This is one reason why the REIT's trading price increased at a strong above-average pace over this time period.

Here's Sun's FFO growth:

Sun Communities FFO Growth

Source

And here is Sun's stock price growth:

Sun Communities 10 year stock chart

Source: stockcharts.com

You don't need a high yielding REIT when you have one like Sun Communities that appreciates in price like this. If you want a higher regular payout, sell some puts when the stock is oversold or sell some shares or sell covered calls when the stock is overbought. Sun's price was driven by strong consistent fundamental growth, not risky speculation. So, while some investors are holding high yielding REITs with declining fundamentals and declining underlying stock prices, Sun can be a good alternative backed by long-term growth.

Sun's price is well correlated with cash flow growth as shown in the chart below:

Sun Communities Stock vs. Cash Flow chart

Source: YCharts

The interesting thing about the chart above is that the price is now lagging the cash flow growth. This might indicate that the price has room to move higher to close that gap. Sun increased operating cash flow by 31% in 2019. The REIT has a solid track record of increasing cash flow at a strong pace over the long term. That helps drive the underlying stock price higher.

Sun might experience a slight decline in FFO of about 1% (consensus) for 2020 due to the uncertain economic situation this year. However, that is expected to be temporary with growth resuming in 2021. Sun is holding up much better than the commercial REITs that have exposure to malls that have been temporarily shut down. I would be more comfortable owning residential REITs like Sun Communities.

Everyone needs an affordable place to live, but many malls and commercial complexes may struggle due to online shopping and growing trends such as working from home. The trend in working from home is not only due to COVID-19. Growth in remote work increased 159% over the past 12 years. So, commercial REITs are not as attractive as they once were. COVID-19 might accelerate this trend.

Valuation

The residential REITs like Sun Communities tend to trade with high valuations. The reason for that is because investors are willing to pay a higher price for the growing fundamentals.

Here's how Sun stacks up to the competition:

SUI

UMH Properties

(UMH)

Equity LifeStyle Properties

(ELS)

Forward Price/FFO 28 18.5 29.8
Forward Price/AFFO 30.1 20.3 33.4

Source: Seeking Alpha

Sun is valued in the middle of its peers. UMH is probably valued lower because the REIT experienced a decline of about 9% in 2019. UMH missed FFO estimates for 3 out of 4 quarters in 2019. Sun exceeded estimates in every quarter in 2019. ELS missed FFO estimates for 2 quarters and exceeded estimates for 2 quarters in 2019. Sun has the best track record with the highest and most consistent FFO growth over the past decade.

As long as Sun's fundamentals remain strong, the REIT's valuation will probably remain high. So, investors may want to wait for an oversold condition in the stock to get a good entry point.

Sun Stock Chart

Source: stockcharts

The weekly chart above shows that the stock is in the middle of oversold and overbought with the RSI at 48.41. The MACD is indicating that momentum changed from negative to positive. That is a buy indication for the stock on the MACD indicator with the green line crossing above the red signal line.

Sun Communities' Long-Term Investment Outlook

There is always a market for affordable housing. First-time or low-budget buyers who want to own a home instead of renting can consider manufactured homes, which can be 25% to 30% less than site-built homes. Manufactured homes also tend to last just as long as site-built homes. The market for MHs is expected to grow at a pace of about 7% annually through 2025. That should provide a nice tailwind for Sun Communities to continue its long-term growth.

The recent surge in RV sales is also positive for Sun Communities. The RV market is projected to grow at about 6% annually through 2025.

Sun Communities has a good track record of acquiring new communities for ongoing growth. This strategy can be repeated so that the REIT continues to increase FFO at a strong pace over multiple years. The REIT's strong FFO and cash flow growth has been driving the stock price to grow at an above-average pace. Investors should keep an eye on Sun's community acquisition progress to gauge future growth.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: The article was written by David Zanoni for Kirk Spano's Margin of Safety Investing service [MoSI].

Additional disclosure: The article is for informational purposes only (not a solicitation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.