Flagship Communities Real Estate Investment Trust (MHCUN) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Flagship Communities REIT Third Quarter 2022 Earnings Call. [Operator Instructions]. I would like to remind everyone that today's call is being recorded. Today's presenters are Kurt Keeney, Flagship's President and Chief Executive Officer; Nathan Smith, Chief Investment Officer; and Eddie Carlisle, Chief Financial Officer. Please note that comments made on today's call may contain forward-looking information, and this information, by its nature, is subject to risks and uncertainties. Actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings on SEDAR. These documents are also available on Flagship's website at flagshipcommunities.com. Flagship has also prepared a corresponding PowerPoint presentation, which it encourages you to follow along with during this call. I would now like to turn the conference over to Kurt Keeney. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Thank you for joining us today. During the third quarter, we continued to demonstrate the solid fundamentals of the MHC industry while also further strengthening our portfolio with 2 acquisitions within our existing footprint. Our outlook for the MHC industry remains positive even in the current inflationary environment with rising mortgage rates in the United States. Over the past 25 years, the MHC industry has consistently outperformed all other real estate classes during similar economic conditions. As one of the Midwest region's largest MHC operators, we are well positioned for long-term growth for 3 main reasons. First, is the highly fragmented nature of the MHC industry, which has limited supply. The MHC industry is primarily comprised of local owner operators. The top 50 MHC investors are estimated to control approximately 17% of the 4.2 million manufactured housing lots in the United States. There is also a limited supply of new manufactured housing communities given the various layers of regulatory restrictions, competing land uses and scarcity of land zoned, which creates high barriers to entry for new market entrants. Second, we have a stable and growing resident base. The majority of our residents have steady jobs or they are retired in receiving social security or fixed income from the government. In fact, as of January 2023, the United States government has authorized an 8.7% increase in social security and disability payments, the largest increase in the past 40 years. As such, the residents in our communities are less affected by inflationary pressures as those with traditional stick-built homes who are more prone to fluctuations in their rents and their mortgage rates. And finally, we maintain a conservative low-cost debt profile with long-dated average maturity to maintain staggered maturities to lessen our risk exposure while allowing us to write out difficult economic cycles in the fullness of time. Eddie will provide more details of this during his remarks. The strong fundamentals of the MHC industry, coupled with our operating success translated into a solid and predictable financial performance for the quarter, which enabled us to announce a 5% increase to our monthly cash distribution to unitholders subsequent to year-end. We also continue to enhance our corporate governance with the appointment of Anne Rooney to our Board and has held a number of Board positions and has extensive experience within the MHC industry. We also want to acknowledge Ian Stewart, who has resigned his Board position seat. He was one of the original board members and was key in helping us establish a public REIT. He made many contributions to Flagship during his tenure, and we are grateful and thank him for all of his efforts. Now let's turn to the financial results for the quarter. Our revenues, net operating income and adjusted funds from operations all remained consistent and increased relative to the same period last year. This is mainly due to 3 factors: first, the acquisitions we have completed to date; second, both lot rent increases and occupancy increases across the portfolio and cost inferred cost containment initiatives we realized during the quarter. I will now turn it over to Nathan to provide more details on our operating regions and strategy. Nathan?

Thanks, Kurt. Good morning, everyone. We are focused on optimizing our current portfolio as well as adding external opportunities that adhere to our bolt-on strategy. And during the third quarter, we made progress on both fronts. In September, we acquired 2 MHCs in our existing footprint of Louisville, Kentucky and Bloomington, Illinois for approximately $32.3 million. Located just north of Springfield, the Bloomington community is located in the heart of Central Illinois within the tri-cities region and is with an easy access to veterans Parkway and Interstate 74 and 55. Bloomington is located in one of the most productive agricultural areas of the United States. In addition to major manufacturers and industries, it serves as the headquarters for State Farm Insurance and country financials. And recently, the electrical vehicle maker, Rivian, established a state-of-the-art manufacturing facility in the community. Turning to our Louisville acquisition. Flagship has been operating in Louisville, Kentucky for over 25 years. Louisville is home to Churchill Downs and UPS Worldport and is considered a health care hub for the entire United States. Louisville Metro area is a regional economic hub of 24 surrounding counties in Kentucky and Southern Indiana. It's also a strategic location for thousands of companies and is a day's drive of 2/3 of the U.S. population, which makes it highly conducive for logistics. These acquisitions and all the others we have made to date were made possible in part through our long-standing industry relationships. We have been in the MHC space for 27 years. And during that time, we have established ourselves as credible operators and have gained many relationships in the industry, both of which are necessary for growth. These acquisitions also adhere to our strict and disciplined criteria as follows: First, we're looking for opportunities that will be accretive to our adjusted funds from operation per unit. Second, we are seeking opportunities that will enable us to leverage management synergies and generate economies of scale. And finally, we're seeking acquisition targets within our current markets or adjacent U.S. states where we currently operate with similar regulatory frameworks and characteristics as the existing markets within our portfolio. This framework allows us to achieve measured growth while establishing a platform to acquire adjacent properties or enter new jurisdictions. We also have significant opportunities to optimize our organic portfolio. This quarter, we grew both our occupancy and our San community NOI, which speaks to the merits of MHC in the current economic environment. I'll now turn it over to Eddie, our CFO, to talk about our financial performance for the quarter. Eddie?

Thanks, Nathan. Good morning, everyone. We generated $15 million in revenue during the third quarter, which was $3.6 million higher than the same period last year, primarily due to acquisitions, lot rate increases and occupancy increases across the portfolio. Net operating income and NOI margin were $9.8 million and 65.5%, respectively, compared to $7.6 million and 66.6% during the third quarter of 2021. Same community NOI for the third quarter was $6.8 million, an increase of 9.7% compared to the third quarter of 2021. FFO and FFO per unit for the third quarter were $5.3 million and $0.27 per unit, a 21% and 5.8% increase, respectively, from the third quarter of 2021. Adjusted funds from operations and AFFO per unit were $4.6 million and approximately $0.24 per unit, respectively, at 23.1% and 7.8% increase, respectively, from the third quarter of 2021. Same community occupancy of 82.2% increased by 1.1% as of September 30 versus September 30, 2021. The -- as Nathan mentioned, we believe this increase speaks to the merits of MHCs in the current economic environment and our ability to optimize our existing portfolio. Rent collections for the third quarter were 98.2%, which demonstrates the strength and predictability of the MHC sector and was within our expectations. As at September 30, our total lot occupancy was 83.1% and our average monthly lot rent was $385. Both of these metrics were within our expectations. And we ended the quarter with total cash and cash equivalents of $4.8 million, with $4 million available on our operating line of credit. The REIT also has 20 unencumbered assets with a value of approximately $50 million. We remain committed to preserving a conservative debt profile. Our weighted average mortgage term to maturity is 11.7 years, with our first maturity due in 5.5 years, and our weighted average mortgage interest rate was 3.68% as at the end of the quarter. Both of these metrics are especially ran for companies that operate in the real estate sector. With that, I'll now turn it back over to Kurt for some final remarks. Kurt?

Thanks, Eddie. We just reached our 2-year anniversary as a public REIT, and we have been pleased with our operating and financial performance since that time. Our solid progress since going public gave us the confidence to announce 2 increases in our monthly cash distribution to unitholders. These decisions were also indicative of our position -- positive outlook on the MHC industry. We believe we will continue to be poised for growth as housing prices, high monthly rental rates and mortgage rate increases have potential to lead more people toward manufactured housing, which is a very cost-effective pathway to homeownership. Manufactured homes offer a better living experience compared to other options. These homes are detached structures, they do not share walls, utilities, air conditioning or heating with any other homes. Our customers typically enjoy 2-, 3- and 4-bedroom homes, typically with 2 bathrooms. These homes also have a deck, a yard, a driveway, in-home laundry facilities, all for less of cost of renting an apartment. Our MHCs also typically include recreational amenities and common areas, including club houses, green spaces, playgrounds, basketball courts, soccer fields, fishing lakes and after-school programming. We are one of the Midwest region's largest MHC operators, and we are the only pure-play manufactured housing investment in the Canadian capital markets. Our REIT offers investors an opportunity to participate in a niche and stable market with significant growth potential. We certainly thank you for your time today, and now I'll open the line for questions.

[Operator Instructions]. Your first question will come from Brad Sturges of Raymond James.

Just wanted to touch on what you're seeing in the acquisition market right now. You do have a little bit of balance sheet capacity. I guess if you wanted to do some smaller transactions. Just curious to see how you're thinking about using that capacity today and what the opportunities might be?

Nathan, do you want to grab this?

Sure, sure. We are seeing opportunities in acquisitions. Obviously, we did two this past quarter. And we hope to do some coming forward. We do have some opportunities ahead of us. And so we feel very tenable. The cap rate has not -- everybody is asking when the cap rate is going to move. And right now, we're still seeing it stay pretty stable. And we'll see where it goes in the future.

Brad, just to follow up on the question about balance sheet capacity. As we talked, we do have still about $50 million of unencumbered assets that we have the ability to go out and do some leverage on to be able to do acquisitions. So we certainly have some balance sheet capacity without needing to come to the market at this point to do can do some acquisitions.

Is the current industry environment, is that shaking lose more opportunities than what you might have seen earlier in the year? Or has it been a pretty consistent deal flow?

I don't think that the current interest rate has taken hold in the MH sector where people -- my guess is it'll be next year before those have loans coming due. But there is a lot of people out there that have floating rate depth that they underwrote these properties at a 3% and a 4% interest rate and now they're at 7 or more. And so we'll see how long that will take them. That's one of the reasons why the 3 of us have been so diligent in trying to get our interest rate locked in over the past 2 years, which we have succeeded. So it makes us -- we're looking very good compared -- well, we're looking very good. Other people, I'm hearing that there will be some stresses in 2023.

And you would expect next year, you might see some -- maybe some larger portfolios hit the market available for...

I think you're more likely to see some of this private equity sell off certain markets. And they have one in, let's make it up little rock. They would just say, I'm getting out that one little rock and paying down my desk and taking my game and moving forward and trying to reposition their community where they have for the last probably 3 or 4 years, just been buying anywhere everywhere with no woman reason to it. And then that they will find that difficult to manage in this kind of environment that we're in. And so I think they'll turn around they'll start selling some of that to consolidate to those portfolios.

Your next question comes from Kyle Stanley of Desjardin.

Would you be able to disclose what same-property AMR was and maybe how that compared year-over-year and quarter-over-quarter if you have that on hand?

Yes. So the same property is going to be -- I don't have the exact number in front of me, but the percentage year-over-year is almost identical to the total portfolio. So look at comparative to the total portfolio, it's almost the same percentage increase year-over-year.

Okay. Great. There was a very small sequential decline in occupancy from the second quarter. Was that related to the acquisitions that were completed...

Yes, it was. So the acquisitions that we completed in the core market there in Northern Kentucky. Those acquisitions were -- it was a relatively large acquisition, 300-plus lots, and we had 70% to occupancy between the 2, and that's what really had the effect on the occupancy.

Okay. And then I think we've talked about this in the past, just some elements of seasonality in your business. But if we look at your NOI margin in the fourth quarter of last year, I believe that's when it peaked. I just wondering if you could just remind us of the seasonality and what should we expect maybe the strongest margin of the year in the fourth quarter again?

Yes. So the seasonality for us really comes around the -- obviously the summer months, right? The spring summer wind. The grass is growing the most, and we're bringing in temporary labor to cut the grass or bringing in folks who -- contractors to do the work to help at the graph. This year, additionally, we kind of had a little additional stress, which was some significant storm damage to some of the trees in the communities. And those are very expensive to have those trees cut down and removed. That was actually a relatively large number in the third quarter. Most of it's going to be around those maintenance-type items, whether it be grass-cutting, tree maintenance and even just general outside maintenance in the community. Those are the summer months or when we're able to get that work done, spring and summer. And so you would expect to see Q2, Q3 finish a little lower. Q4 will all depend on the weather events really. So as we think about Q4 in our markets, most of the time, we don't see snow. And when we have to start doing now kind of street maintenance for snow, that can hurt margins a little bit. But to the extent that we have weather with us in the fourth quarter that would -- traditionally, I would think is where you see the higher margins.

Okay. Perfect. And just one last one for me. There was some mention in disclosure about a small dip in rent collections. Is there anything to read into there? Is that reflected the economy or just transitional?

I'll take that one. At the end of the day, it's really just some COVID programs ending. And that was the -- it wasn't significant. But what's interesting is in some of our markets, COVID support has absolutely ended, which is actually a healthy thing, not a bad thing. And then, for example, in the state of Indiana, the COVID programs actually stopped and then restarted again. So it's a little sporadic, but it's -- I don't -- we don't consider it a big risk factor. It's just return to some normalization.

Ladies and gentlemen, once again, if you would like to ask a question, please press star at this time. Your next question will come from Himanshu Gupta of Scotiabank.

So just on the distribution increase, so 5% distribution increase announced. So just wondering, do you have a target AFFO payout ratio in mind? Or is that a reflection of your expectation of AFFO growth next year?

[indiscernible] we have a target in mind at this point, Himanshu. I think our entire commitment is that we think we can have a distribution increase annually. We're going to be very conservative about that. The number may fluctuate on a payout ratio perspective. But I'm comfortable with the 5% range. We did it last year about the same time. And it's when the coast is clear, and you can see the short-term foreseeable future.

Fair enough. And then continuing with the kind of outlook question there. So same store -- same community NOI growth was very strong this year. And how should we think about like 2023, like in the same kind of indication like 4% to 5% rent growth and some occupancy against it?

Yes. I think our guidance really hasn't changed, which is 2% to 3% occupancy growth. It's coming in a little tighter in the occupancy, and we're getting a little more on lot rent, those moments are going to happen from time to time. But Nathan and I have lived through these types of recessionary periods before. Typically, we're having customers because the alternative housing sources are having such inflationary pressures. First, it was the price of the home. Now it's mortgage rates going up and apartment rents have gone up as well. And while some of those have come down a little bit, we haven't actually seen it come down in the apartments that are coming to us. We -- those are still up 30% over the last 2 years. So at the end of the day, we look at it and we know more customers are coming our way. And I think that's what we see in the foreseeable future. So I think we'll be in a really good spot. And that's historically where we've been during these negative cycles, more people come towards this.

Got it. So continued consistent rent growth and occupancy gains with outer restructure next year Okay. And then obviously, Kurt you mentioned you and Nathan have gone through recessionary periods there. I mean you have gone through bed cycles also. So how the availability of that today are expected next year? Do you think any cutback from retail banks or even Freddie or Fannie making less debt available for the asset class? Anything you are hearing or expecting?

No. I think what's fascinating about it again, and I said before, that all recessions are not equal, right? They all act a little differently. Back during the financial crisis, the problem was you couldn't get a loan, right? I mean at one point, the CMBS market was tied down. So right now, the debt markets are fully open. You may not like the interest rate, but they're open. So at the end of the day, we haven't seen any restriction on availability of debt, but what we have seen is spreads move out. And we're just real thankful that we locked our interest rates in. We've got a lot of 20-year and even some 30-year fixed rate debt. So we're really pleased with where we're at. And we kind of hope that it's an opportunity for us. If you've got debt maturing at 4%, you might be trying to renew that at 6%, you might just make the decision that those one-off operators might make a decision to actually sell.

Got it. And you actually made a good point that that market is fully open, although the cost of that has moved out. Is that the reason why Nathan said that cap as haven't moved because the debt market is open and market is still able to absorb higher cost of debt. I mean is that why the value thing so far?

It's certainly a factor. Again, if the debt markets weren't open, then you're going to have a little bit of chaos. But the truth of it is our segment of real estate has got very little supply. So we spend our time trying to source and then spend a lot of the time sourcing. It takes years to actually source a deal. So I think what you may see is that there's a bifurcation in the market where these institutional-grade assets or the stable assets, no, we're not seeing any cap rate expansion there. Matter of fact, we actually have data that actually shows that portfolios are trading basically the same when it comes to institutional portfolio. You may see some bifurcation when the smaller destabilized assets are hitting the market. Those might have cap rate expansion. And again, it's kind of -- I'll kind of say that isn't that a return than normal they shouldn't have been priced at the same cap rate as some of the other ones, which is what we've seen in the last couple of years. So I think you're going to see that bifurcation and I think it's kind of healthy when you see it. But at the end of the day, we don't think institutional moments have actually come down or gone up.

All right. That's a good point there. And my last question is around some commentary around private equity and they might react to variable cost of debt. So just wondering, is private equity even active in your Midwest. Or do you think private equity has been more aggressive and active on the coastal, the Floridas and Californias of the world? Or do you use [indiscernible] equity a lot in Midwest as well?

Nathan, do you want to tackle that one?

Yes. So I would say now after Hurricane Ian that they're thinking about the Florida and the coastal properties much different. The ability to buy insurance, especially loss of rent income insurance, it's going to vary to stabilize those assets on the coast if you're a private equity and you need those kind of things. And quite frankly, if you're going to CMBS market or Fannie Freddie or life, they're going to ask you to have a loss of rent income. And right now, it's just simply not available. I'm hearing that a lot. Private equity, there are definitely, as we would say, pulled their jet they have been out there for a while. And I think there's lot looking at just going, "Oh, this isn't as easy as we thought it was," because the thing -- the problem they have is they refused to do any long-term debt, like we've locked in with life cos or CMBS, they won't do that. I mean they do almost always balance sheet debt. So that's really taken a hit to them.

Your next question comes from David Chrystal of Echelon Capital Markets.

Eddie, a quick clarification on the unencumbered asset base. Did you say $50 million or $15 million?

$50 million, 5-0.

50. Okay, thought so. How comfortable are you taking up leverage from here in terms of -- I think you've articulated the 45% to 55% debt to GBV. At the moment, you're well below the lower bound of that. For the right opportunity, how high would you go? Would you stretch to that 55?

I don't think so, David. I mean our -- we've stuck with the mantra that when that comes, it's certainly less debt is more. So 45% to 55% is the range that we've given. And our -- I think our position at this point is we want to keep a 4 handle. -- on our leverage. So you may see us stretch it up some. If you remember, we were at 49.8% at IPO. I don't foresee us going any higher than that really. I mean it would have to be an absolute perfect deal that would drive anything beyond that.

And in that vein of kind of finding that perfect deal, I think you're kind of stuck with the same debt -- same new debt terms as any of your peers would be on refinancing. So what kind of investment spread are you looking for, would you really be looking for a very distressed counterparty where you might get below market price and on the asset acquisition and in terms of timing, like you -- I think you mentioned that 2023 would likely be surface better opportunities. But how should we look at modeling future acquisitions? Well...

At the end of the day, I'll jump on this one, Eddie. At the end of the day, we take the opportunities that the market gives us, and we're real mindful to not take on too much value add simultaneously. And we're also very mindful to not take on what I would call deep value add too much of that as well because that -- again, that could -- too much value add is just like development. So you have to be mindful not to do that. So I think you'll see us see some modest value add at a decent cap rate. Like I said, I think there's going to be a bifurcation there. And then I think you'll still see those really stable assets pretty much in the same wheelhouse we've got before we were buying in the basically 5, 6, 7 caps, and you'll see that, and they'll be nice stable assets. There's still going to be people that need to trade, and it's not going to have to do anything to do with the recession or debt maturity. There's still somebody that wants to retire. There's still somebody that their kids don't want to hold the asset anymore. And those deals, while they are few and far between, they still happen.

Fair. And then just quickly on the chattel lending. I know I think in previous quarters, rates hadn't really moved up. Has there been any change on financing costs for these homes?

Yes, they've gone up. So the interesting moment is that our rates have moved up from the 9% to basically 10 on chattel, so about 1 point. Now you say, "Oh my gosh, that's the end of the world Well, it's actually something to be mindful of. But at the end of the day, the mortgage rates on the competing projects competing housing product, they moved from basically 3 to 7. So you just look at say, what does that mean? Again, more people are being pushed towards this is what it means. I do think you might sell and Nathan could chime in. I think you might see more single wide sales in or multi-section. Nathan, I mean, you want to take...

Yes. Yes. Yes. I think that's what normally happens here in this, right? But what we have seen is, so from pre-COVID to the peak of COVID, the price of the house escalated quite a bit. And we're starting to see it starts come down. And as I had talked about last year that when they were talking about the supply chain of how to get a home that we won't have enough problem because there really wasn't that big of a problem. What was really happening is people were in the manufactured housing industry buying too many homes that they didn't need and or they couldn't sale, they wouldn't turn them quick enough, and they might have overbought. So you're going to see some pressures on those people to finally flush that inventory out in the fourth quarter and the first quarter of 2023. So the houses are going to have to come down some because we're going to need to match what the people can afford. And we're doing that every day right now.

There are no other questions at this time. So I will turn the conference back to Kurt Keeney for any closing remarks.

Thank you, operator, and thank you, everyone, for participating. Please feel free to reach out to our investor relations for further questions.

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.