Sun Communities, Inc. (SUI) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Sun Communities Third Quarter 2013 Earnings Conference Call on the 29th of October 2013. At this time, management would like 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 statement 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 $32.1 million, or $0.82 per share, for the third quarter of 2013, compared to $21.5 million, or $0.71 per share, in the third quarter of 2012. For the 9 months of 2013, FFO was $90.9 million, or $2.44 per share, compared with $70.5 million or $2.39 per share in the 9 months of 2012. All these results exclude transaction costs related to acquisition activity in all periods. Revenues for the 9 months increased by 25% from $248 million in 2012 to $310 million in 2013. And at this time, I'd like to review the portfolio. During the first 9 months of 2013, revenue-producing sites increased by 1,312, as compared to an increase of 975 sites in the 9 months in 2012. Of that occupancy gain -- or of the occupancy gain of 1,312 residents, 983 were on our same-site portfolio, while 329 were in our recent acquisitions. The occupancy improvement of recently acquired properties reflects the success of our strategy to acquire high-quality, well-located communities based on in-place NOI that include vacancies or other market attributes that the company can take further advantage of, such as below-market rents and the absence of capital by sellers to maintain or improve the community. By joining these vacancies and investing capital to reposition them, we're able to accelerate the growth in net operating income in many of our acquired communities. Portfolio occupancy is at 89.6% at September 30 and is expected to exceed 90% by year-end and approach 93% by the end of 2014. At that time, the existing portfolio will have effectively achieved full occupancy. As occupancy growth requires the investment in new homes in our communities, the activity will subside to a level necessary to sustain portfolio occupancy at around 93%. It's expected that the sales of the rental homes will significantly exceed rental new home purchases at that time, and the proceeds from sales will exceed the capital needed for any home purchases. The only prospective need for significant new home purchases for these rental programs would be due to expansions or the purchase of what we refer to as free vacant sites and community acquisitions, both of which represent sources of strong earnings growth. Now we turn to the same-site portfolio of 159 communities. Revenues increased by 4.9% in the first 9 months, while expenses increased by 3.6%, resulting in a 5.4% increase in NOI. The same-site occupancy increased from 87.2% to 88.8% from September 2012 to 2013. Home sales for the first 9 months were 1,433, an all-time high at Sun Communities. This compares to 1,253 homes sold during the 9 months ended September 2012. Applications to buy or rent homes in our communities exceeded 23,000 for the 9 months, an increase of over 15% from 2012. Nearly 100 potential residents are applying for occupancy or purchase of a home across the portfolio every single day. Reviewing our expansions of existing communities, they continue on plan. We currently have 1,230 sites under development in 8 communities, with 470 to be opened in the fourth quarter and the remaining 760 opening in 2014. Expansions are always scheduled in our communities with strong demand profile and nearly full occupancies. While expansions are concentrated in the extremely strong Texas markets, nearly 1/3 of the sites will open in Ohio, North Carolina and Colorado, where demand remains exceedingly strong. Due to the strength of these markets, rental homes placed in these communities we expect to command premium pricing. Turning to our acquisitions. The company currently has approximately $160 million of manufactured housing and RV communities under various stages of agreement and in advanced due diligence. Approximately 135 million of these communities will increase the company's footprint on the East and West Coast as we shared as our focus strategic growth areas. Closing is expected on several of the communities late fourth quarter and early in 2014. On a separate note, the company recently settled all claims arising out of the litigation that it commenced against the affiliate of Equity Lifestyle Properties with respect to our recently acquired Morgan RV Properties. And in connection with that settlement, the company and ELS completely and fully released each other from any and all claims associated with the Morgan RV acquisition. With this behind us, we will continue to move forward with the repositioning and capital investment required for the success of these acquired properties. Although 2013 results were impacted by a slight delay in beginning the capital improvement projects, we're gaining traction in seasonal business and expect that this increase in seasonal contracts, along with currently booked future reservations and the positive response expressed by returning guests, will create mid-teen revenue growth in this portfolio in 2014. We are currently in the process of refinancing our July 1, 2014, debt maturity of approximately $170 million. The window for prepayment without cost begins at January 1, 2014, and we expect to pay out this maturing debt at that time with financing transactions of 10 and 12 years. With indicative pricing based on current rates, it's approximately 50 to 85 basis points below the in-place interest rate on this debt. The completion of these transactions will extend the weighted average maturity of our debt from 6.5 years to 10 years. We tightened our 2013 FFO guidance to $3.19 to $3.23 per diluted share and expect fourth quarter to approximate $0.75 to $0.79 per diluted share, excluding acquisition-related expenses and subsequently closed acquisitions. We expect to provide 2014 guidance before the end of this year. And at this time, operator, we will turn it back over for question and answers.

[Operator Instructions] Our first question is from the line of Jana Galan from Bank of America Merrill Lynch.

I was curious with your $160 million potential acquisition pipeline. If you can give us some detail on what percent is RV versus MH and how you plan to fund it?

Yes, the approximate breakdown is a 40% MH, 60% RV. We're very pleased that the RV communities that are currently under acquisition contain anywhere from 60% to 90% seasonal RVs. So very, very stable, established RV revenue should be in place at the time that we take them over. I think that we've intended, for the most part, to fund these with a combination of their existing debt and a draw off of our credit facility or directly through our credit facility if there is no debt in place.

And then maybe more broadly, if you could comment on what you're seeing on the market in terms of cap rates?

Sure. When that question comes up, certainly, I've shared with the market and many others in this industry is that there doesn't seem to be much change in the cap rates through long periods of time in manufactured housing. We've seen some compression in the RV world of maybe about 100 basis points, compression in cap rates from where it was a few years ago. Everything that we're looking at acquiring that I mentioned and that we put in our press release is between a 7% and 8% cap rate.

And then maybe just following up on the timing of the 2014 guidance. Are you just waiting to get more clarity on the closing of the deals and maybe the terms for your debt refi? Or is there something else that you're waiting to see how it plays out?

Yes, we're in the middle of doing our budget process right now. So still kind of looking at that, and then we'll have a little bit more clarity on those acquisitions as time goes by.

Our next question is from the line of Michael Bilerman with Citigroup.

It's actually Nick Joseph here with Michael. Sticking with the acquisition pipeline, how large of a shadow pipeline is there behind the current acquisition pipeline?

I think that we're quite specific to only indicate the pipeline that we have actually, either under letter of intent or purchase agreement. And the pipeline probably beyond that is about 100% equal to that amount.

Okay. And then in terms of refinancing next year's debt, could you talk about the demand that you've seen so far from lenders? And how much all-in rates have moved since you've began discussions, given the increase in the tenure?

I think that -- and Karen can add to this if she wishes. We have seen a very strong appetite, both on a securitized basis from bank balance sheet and from Life Company. And so the bidding and competitive process has been very aggressive, and we're very pleased at how tight the pricing has come in. And then more recently, we've seen after a little bit of a rise in the tenure over the last 5, 6 days, a reduction of those rates. And I think we're looking to take advantage of that, knowing what we're trying to accomplish for the first quarter refinancing of the debt that we discussed.

Yes, Nick, just more specifically. That is at a 5.05% rate right now. A piece of that refinancing is locked in at 4.2%, and indicative pricing on the other transaction is around 4.55%.

[Operator Instructions] Our next question is from the line of David Harris with Imperial Capital.

Maybe I missed this, but it looked like expense property operating expenses took quite a jump in the quarter. Was this something seasonal? Or is this reflecting rather more the change in the composition of the portfolio over recent years?

Well, if you -- I mean on a same-site basis, David, we were in line with guidance on our top line revenue. On our expenses, we missed guidance on expenses by about $270,000 for the quarter and about $550,000 we're up for the year. And those misses in same-site are primarily related to additional payroll costs and additional cost of some health benefits. It's a tough claim year this year. We've had 3 years of very strong claim years on our self-insured plan, and this year, we just had a few larger claims, so we don't expect those to continue.

But the payroll is going to be more of a permanent feature, isn't it?

Yes, payroll will likely continue.

Okay. And then CapEx took a big jump up this quarter. Again, is that seasonal? Because I'm looking at your third quarter last year, which you very helpfully provide for us, and it was at a much lower level. I mean, is that more related to activity in the quarter and we can expect it to tail off? Or again, is that reflecting a rather more higher run rate than we've had in previous years?

That's reflecting a onetime project that we put into place this year. We allocated between $3.5 million and $4.5 million for significant road improvements in some of our communities.

Speaking of the Midwest, while we have a solid CapEx program, it had been probably 10, 15 years before we really did anything significant with our Midwest roads. And I think that it was kind of the desire to put them back into position for the next 10 or 15 years. So...

Okay, again I'll ask a question, then. Is that -- should we assume a higher run rate than you've been running at in the past? I mean, obviously, well, these are very low levels, but it does rather impact one's thinking about, perhaps, the dividend.

No, I wouldn't expect -- it is a onetime event that we're talking about, and we've been running, probably, $150 to $165 a site, and we'll continue to do that.

Okay. Then looping it back and just repeating that question for you, perhaps, Gary. This doesn't impact in any way on your thoughts around dividend?

No, it doesn't. What I've shared with the marketplace is the board anticipates, right after the first free year after -- at our next board meeting, to review the dividend policy. And historically, at around an 80% payout ratio, we have looked to increase the dividend. I think that would be the discussion that will take place. And based on where the payout ratio is, we'll share that information right after the next quarter meeting.

Okay, and that would be what, with your fourth quarter earnings, most likely?

Yes.

[Operator Instructions] Our next question is from the line of Paula Poskon with Robert W. Baird. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: I see the trends in Michigan are quite improving: occupancy up significantly year-over-year and the pre-owned home sales particularly strong. What are you seeing, just anecdotally, there in the regional economy? And what gives you the belief that, that's going to continue?

I think, anecdotally, for those of us living in the Midwest, in particular in metropolitan Detroit, we're seeing this secret resurgence that the rest of the country isn't quite experiencing we're seeing. We've attributed a lot of it to the restructuring of the automotive world, taking away the uncertainty over the last few years and the hesitancy. And to stand on the sidelines, we're seeing the increase in all aspects, from -- it was difficult for us to get additional office space. Multifamily is in high occupancy again; retail's in demand; light industrial, there are cranes out here again. So we're seeing a strong resurgence in Michigan. I think if you tie it a little bit further to what we're looking at in Indiana, which is slow, steady growth, we're starting to see a little bit more activity in manufactured housing, manufacturing and RV manufacturing took a tick up. And some of the mothballed factories, they're now talking about opening this year. So as we continue to concentrate our efforts in Indiana, I think we'll -- which has been the one area that's lagged the most for us, we expect to see slow, steady growth. Site-built housing, I think I've shared a few articles on Michigan that have been in the Wall Street Journal where the inventory of quality used site-built homes doesn't -- that overhang is gone. The average home is staying on less than 7 days today on the multi-list in the desirable locations. And we're seeing prices bid up above the asking price. So I'm just -- it's very, very good timing in Michigan right now. And I think, you couple that with the fact that there has been no development in any asset class over the last 5, 6 years, we anticipate seeing strong demand for less affordable housing.

Our next question is from the line of Dave Bragg with Green Street Advisors.

As it relates to the announced acquisition plans, can you talk about the decision process to fund them with debt as opposed to equity?

Sure. I think we've shared generally with the marketplace that long-term, we look to be debt neutral on our balance sheet. Since 2011, we had raised $635 million in both common equity and preferred stock. And it's our goal to be less leveraged, just going forward than we were historically. So I think we'll certainly look to take advantage of the low interest rates right now. And when we talk about keeping the same leverage, if we can demonstrate to the marketplace the right accretiveness from the acquisitions that we funded by a combination long-term of what we hope will be a low-cost debt and future equity in the marketplace.

There are no further questions at this time. I'd now like to turn the call back over to Mr. Shiffman for closing remarks.

I think that we're very pleased with the progress that we've been making so far. We're very pleased with, strategically, what we've been able to accomplish in repositioning the portfolio. And we look forward to sharing both results of fourth quarter and 2014 guidance on our next call or sooner. Thank you.

Ladies and gentlemen, that does conclude the Sun Communities Third Quarter 2013 Earnings Conference Call. Thank you for your participation. You may now disconnect.