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

Hello, ladies and gentlemen, thank you for standing by. Welcome to the Flagship Communities REIT Second Quarter 2023 Earnings Call. [Operator Instructions] I would also like to remind everyone that this conference 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 the Flagship's website at flagship communities.com. Flagship has prepared a corresponding PowerPoint presentation, which it encourages you to follow along during this call. And now, I'll pass the call over to Kurt Keeney. Kurt?

Thank you, operator and thank you everyone for joining us today. Flagship continued to demonstrate the merits of its business model with another strong quarter of financial and operating results. Our rental revenue and same community metrics which demonstrate our ability to maximize operational efficiencies and increase economies of scale were both very strong. Rental revenue this quarter increased by 21% over the same period last year. Same community revenue was up over 9% over the same period last year. In addition to these increases, this is the second consecutive quarter where rental revenues increased by over 20% and same community revenue increased by over 9%, which speaks to the consistency of our business. Our positive results translated to strong net operating income metrics as well. Net operating income was up 22.4% over the same period last year and finally same community NOI was up 9.4% compared to Q2 of last year. After raising $3 million in the second quarter, we have now raised a total of $23 million through our at-the-market offering. Our ATM program has been an effective use of sourcing capital to help fund future acquisitions and for general business purposes, that's why we reestablished a $50 million ATM program towards the end of the second quarter. The ATM program is designed to provide us with additional financing flexibility as we continue to grow our portfolio. And the REIT has grown every year since we went public in October of 2020. The public REIT began with 45 MHCs comprising of 8,255 lots across 4 states. Today, the REIT owns 71 MHCs with over 13,000 lots across 7 U.S. states, as well as 2 RV Resort communities with 470 lots. Our ability to grow on an annual basis coupled with our strong financial results speak to the strength of our business model and the solid fundamentals of the MHC industry. The MHC industry has demonstrated a consistent track record of strong performance regardless of the economic cycle. The interest rates of our customers have not changed substantially and their credit underwriting remains available, which is why our manufactured homes are a very appealing and cost-effective option for many Americans. They also offer a better living experience compared with other options. Manufactured homes are detached structures that do not share walls, utilities, air conditioning or heating with any other homes. Our customers enjoy 2, 3 and 4 bedroom homes, typically with 2 bathrooms. These homes also have a deck, yard, driveway, in-home laundry facilities, all for less than the cost of renting an apartment. In addition to the same community metrics, a key measure of the success of our business model are occupancy rates and average monthly rents, both of which went up during the quarter and have steadily increased since 2019. We have a stable and growing resident base, which also speaks to the affordable nature of our homes. The majority of our residents have steady jobs or they are retired and receiving Social Security or disability or private or public pension. The residents in our communities are less affected by the inflationary environment as those in traditional stick-built homes or apartments who are more prone to fluctuations in their rent and mortgage rate. After being recognized by the Manufactured Housing Institute with the 3 highest National Awards for Excellence in manufactured housing, last month we received the Kentucky Manufactured Housing Institute's highest award for the Community of the Year for the second consecutive year. Our Mosby's Pointe community located in northern Kentucky was recognized for its considerable transformation. Mosby's Pointe is a 250-lot community and this past year we added an outdoor recreation center, which includes 2 state-of-the-art municipal-grade playgrounds and basketball courts, soccer field and a paved walking trail. When a community of our wins an award, it's a great honor, but more important, it's a recognition of our highly talented team that help serve the needs of every family within the community. Our staff makes it possible for us to run a successful business and for that I want to say thank you to everyone on our team for the important work they are doing on a day-to-day basis. With that, I will now turn it over to Nathan to provide more detail on our operating regions and growth strategies. Nathan?

Thanks, Kurt. Good morning, everyone. Acquisitions of new communities have always been a big part of Flagship's success. We are one of the Midwest region's largest MHC operators and have nearly 30-years of operating experience. When you see both top line and same-community growth, you're seeing the benefits of that experience. Our top line growth reflects the positive contributions from the acquisitions we completed last year, while our same-community growth shows our ability to optimize our existing portfolios. We have completed many acquisitions in our short time as a publicly traded REIT and we continue to see prominent deal flow in the MHC space that adheres to our strict acquisitions criteria, which is as follows. First, we're looking for opportunity that will be accretive to our adjusted funds from operation per unit. Second, we are seeking opportunity that will enable us to leverage management synergy and generate economies of scale. And finally, we're seeking acquisition targets within our current market or adjacent U.S. states where we currently operate with similar regulatory framework and characteristics as the existing markets within our portfolio. This framework allows us to achieve slow and measured growth, while establishing a platform to acquire adjacent properties within our existing market. During the quarter, we made 3 acquisitions in our existing markets, Indiana, Arkansas and Tennessee for approximately $21 million, using capital raised from our ATM program. This is our largest acquisition so far this year and adds to our existing footprint in 3 states. The Clarksville, Indiana community includes 334 lots, of which 47% are occupied. The Conway, Arkansas community includes 200 lots, in which 82% are occupied. And the Jackson, Tennessee community includes 126 lots, of which 97% are occupied. Our operating experience has helped us establish a longstanding industry relationship and these acquisitions were made possible in part through these relationships and our solid reputation as responsible and credible operators. The MHC industry is primarily composed of small, local owner operators. The top 50 MHC owners are established to control only approximately 17% of the 42 million manufactured housing lots in the United States. With that, I will now pass it on to Eddie.

Thanks, Nathan. Good morning, everyone. We generated revenue of $17.4 million during the second quarter, which was up 21% over the same period last year, primarily due to lot rate increases, occupancy growth, increases in utility revenue and economies of scale in existing markets. Same community revenues of $15.1 million grew by 9.1% over the comparable period last year, which was driven by higher monthly lot rent year-over-year, as well as growth in same community occupancy. Net operating income was $11.6 million during the quarter, an increase of 22.4% over the prior period as a result of our acquisitions, lot rate growth and cost containment efforts. NOI margin was 66.6%, compared to 65.9% last year for the same reasons. AFFO for the second quarter of 2023 was $5.5 million, an increase of 15.9% from last year. AFFO per unit was $0.26 per unit, an increase of 8.3% from the same period last year. Our same community occupancy increased to 84.9% versus 83.6% last year, which reflects our commitment to resident satisfaction and ensuring our communities are in desirable locations. Rent collections for the quarter were 98.9%, an increase over last year, which continues to demonstrate the strength and predictability of MHC sector. As at June 30, our total lot occupancy was 83.3% and our average monthly lot rent was $415. Both of these metrics were within our expectations. We ended the quarter with total cash and cash equivalents of approximately $5 million, with no near-term debt obligations. We also have 18 unencumbered assets with a value of approximately $40.3 million as at June 30, 2023. With that, I'll now turn it back over to Kurt for some final remarks. Kurt?

Thanks, Eddie. We are pleased by the progress we have made so far and we are poised for growth as we continue to integrate and maximize economies of scale from the acquisitions we have completed to date. We are also confident in our ability to source accretive acquisitions in the foreseeable future. We remain committed to preserving a conservative, low-cost debt profile with long-dated average maturities. Our weighted average mortgage term to maturity is 11.2 years, with our first maturity due in 2027 and our weighted average mortgage interest rate was 3.78% at the end of the quarter, which is entirely a fixed rate. Obtaining secured debt on a fixed rate basis is important to us to mitigate risk. We have no near-term debt obligations and no bank balance sheet mortgage debt. This strategy allows us to maintain staggered maturities to lessen our interest exposure, while allowing us to ride out difficult economic cycles in the fullness of time. In closing, our REIT offers investors an opportunity to participate in a niche and stable market with significant growth potential. In our 2 plus years as a publicly traded company, we've demonstrated the steady and predictive nature of the MHC industry and our ability as operators. We certainly thank you for your time today and we'll now open up the line for questions.

[Operator Instructions] And your first question will be from Mark Rothschild at Canaccord.

Looking at the improvement in occupancy, can you maybe just talk a little bit about what's driving that as much? Is it converting people who are renting homes from you to home ownership? Is it impacted by maybe the acquisitions? Or is it just leasing maybe vacant sites where there isn't even a home at all?

The answer is all of the above. We were absolutely successful converting people to rental home customers into owners. I think that number was 74 in the second quarter. But we've also -- the integration of the assets that we bought in the last 1.5 years, 2 years is coming to fruition. We've gotten our sales team focused and we've gotten our rental homes and I think you're just starting to see the synergies come together. It's certainly an environment where the affordable housing products in our market, the differential between us and multifamily apartments and every other housing form is still pretty substantial. So I think in our markets, we think the average differential is $300 to $500 more affordable for our communities. So I think it's pushing customers towards us as well for the vacant left.

Maybe just following-up on that, while I appreciate that it's relatively -- it's affordable relative to many other housing types, for the people who are now renting homes from you for that part of your portfolio, is it going to be more difficult to convert them to home ownership with the rise in interest rates? Or is that not as much a factor for your customer?

My customers rise in interest rate hasn't been that substantive, it's only gone up about 0.5 point. So I don't think that that's not a driving concern of ours at this time.

Maybe just one more small question. In regards to the G&A, how much of that going up is general inflationary or maybe other things going on at the company, they're just growth or other items?

Eddie, do you want to take that one?

Yes, absolutely. So there's some growth in the company with adding some headcount, that's not a significant portion of it. Really, we had some legal and consulting fees in Q2 around the AGM process and then some tax fees as we completed our 2022 year in taxes. So those were kind of the major drivers of the increase in G&A. There is a little bit of ongoing G&A, like I said, related to a couple of new positions, but for the most part, it was really related to some events that happened during Q2.

Next question will be from Brad Sturges at Raymond James.

Just a follow-on to Mark's question on occupancy. Just trying to, I guess, think through seasonal trends from that perspective and congrats on the occupancy growth that you've seen. Just curious, typically, from a seasonal perspective, would your occupancy growth typically be more first half of the year around the Spring season? Or how should we think about occupancy improvement for the back half of the year?

Historically, it was more cyclical in the first quarter, but as the years have marched on with home sales, it's gotten flattened out a little bit. But typically, when we see good strong occupancy in Q1 and Q2 like we've seen, that trend typically continues for the rest of the year. And again, wherever you're at in December is where you're at, right, nobody moves in December and that really starts and probably closer to October and Thanksgiving. So it looks the foreshadowing is good.

And in terms of maybe leasing trends that you're seeing or the conversion from rental and home ownership, is there particular markets or even communities that you're seeing, you're being positively surprised in terms of demand or the take up on that conversion at this point?

No, no, it's pretty much universal actually. Wherever we have some more rentals, again, most of our rentals that we picked up, not all, but most of them have been picked up through acquisition. So I think we've got plenty of opportunity to continue to decrease our rental home percentage of outstanding lots, but right now I think we're running just shy of 10%. And we'd like to drive that number down over time through homeowner ship, but that's a long strategy, not a short strategy, but it looks like it's pretty universal to answer your question in the marketplace.

Last question and I can appreciate it's probably early days with the Q2 acquisitions, but just any update on some of the early trends on occupancy or some of where you're at from a CapEx amenity package point of view?

I don't know if I fully under -- can you repeat the question one more time?

Just on the acquisitions, I guess, that you completed in Q2 for $21 million, just curious of what you're seeing early days on occupancy trends and leasing and then just your plans around the CapEx spend for the year right now?

On the occupancy and the trending on the 3 acquisitions, very pleased so far. We actually sold the first home, which is a great sign in -- down in Arkansas at the new acquisition. So that's a pretty -- that's some pretty quick takeoff to get our home inventory actually pulled in and actually turn around and get it sold in the first 90 days is great. So I think from an occupy perspective, we're right on plan on those acquisitions and we've been pretty successful getting our sub-metering installed as well, which is huge, again, that's how we have our NRI savings and drive the NOI from our business model. So I think that is actually being completed on the CapEx side at the 2 locations that needed it, the one in Clarksville and the one in Arkansas. So, now we're just focusing on getting our playground installed in our pickleball courts and I think we did have one pool closure of an old tired pool and we're replacing it with some year-round municipal-grade recreational amenity, which is great. So I look for all those to be completed this summer on the acquisition and then we'll continue to hopefully see some positive occupancy as we march forward.

Next question will be from Kyle Stanley at Desjardins.

Just looking at the transaction market, are you starting to see the bid-ask spread maybe start to tighten? Just love your kind of outlook for overall activity in the second half and into 2024?

Nathan, you want to jump in?

We're -- here's what I would say. I'm seeing lots and lots of deals, I'm not sure the cap rate has changed yet. It definitely has not changed for those deals that are 5-star deals, but I do start seeing a weakening of the 2 and the 3 and the 4 star deals, maybe not as much the fall at 4, but given the 2 and 3, the value-add deals are starting to come back in line. I think you're going to see -- it's going to take a while for people to come to reality that interest rates have risen and that everybody doesn't get a forecast now. And so I'm closely surprised with the things I'm seeing and I'm talking about lots of deals out there, but I don't think there's a lot of deals transactioning no matter what anybody says. Does that help?

Yes, definitely. So I guess, would you say you're sticking with kind of the $30 million or $50 million acquisition target for the year? Do you think that's still achievable, maybe?

I think it is, I think you -- I do think it is, I think you see a lot of people talking about deals that they won't have, but I feel very comfortable about where we're at because we're talking with mom and pops a lot and there are circumstances that change in those people's lives every day.

Maybe one for Eddie, I mean it's a small number, but there was a $2 million draw on the credit facility. I'm just curious for modeling purposes, maybe when this was drawn and when you might expect to repay it?

Yes, it was drawn at the kind of end of May, so we got the interest there for June. I would anticipate that to stay drawn for probably the rest of this quarter and we'll probably be paying it back toward the end of this quarter.

And then I mean, total CapEx was closer to $7 million in the quarter, a bit higher, I'm assuming obviously that's related to both seasonal factor but also the recent acquisition. But I'm just wondering, how are you thinking about your CapEx budget for the balance of the year?

Yes, I think we did a lot of the CapEx spending that was needing to be done in the first -- kind of the first half, whether it was installation some of the rental homes and then a lot of the work that's being done on the new -- the acquired acquisition as we fix streets and put in playgrounds and those kind of things. Q3 will be probably more similar to Q1. And then I would say that Q4 will fall off significantly as we -- the season to complete those capital projects is kind of runs out.

Next question will be from David Chrystal at Echelon Capital.

Just on the OpEx side, obviously, the year-over-year, we still saw the effects of inflation, but how should we look at margins for the balance of '23? And do you think the worst of OpEx inflation is behind you?

Eddie, [indiscernible].

Yes, absolutely. I do from an inflation standpoint. What we saw in Q1 was partly inflation related, but it was also kind of seasonal weather related. We had the real bad freeze where we saw a significant amount of water leaks and cost associated with just getting that back up and going -- getting folks back in water. Q2 kind of normalized a little bit more, our utility recapture was back over 90%, which is kind of where we would expect it to be. So I do think that the inflation related to wages has really leveled off for us in our markets. That was pretty significant at the end of last year, but that seems to have leveled off. The nice thing about what our model is, we're passing through the utility cost and frankly the property taxes through the residents, which is where we see big opportunities for inflation. So to the extent that those things do drive inflation, we'll be able to recapture the majority of that. So yes, thanks.

And then on the revenue side, have you started looking at 2024 rent increases and the kind of magnitude that those might be?

We haven't fully done that yet, David, because that's typically September, October conversation for our group, but we will go by line with each location to do that and what we do know inherently is that there's plenty of runway. We just need to be mindful of our rent increases so that our customers stay healthy.

Would you say that social security and the kind of magnitude of that increase would play a large part or is it community-specific?

The answer is yes and we always look for what we think CPI would come in at. Again, last year, I think CPI came at 8.7%, our rent increase was 7.8%, which was a little up from our guidance of 4% to 5%. Again, from a modeling perspective, I'd probably use 5%.

[Operator Instructions] And your next question will be from Tal Woolley at National Bank Financial.

Just wondering if you can give us your sort of latest and greatest view on the state of the actual for-sale MHC market. How are inventories pricing, financing availability, anything remarkable going on in that side of the business right now?

Are you talking about the home sales or...

Yes.

Community sales?

Home sales, yes.

It's home sales, Nathan, you want to jump in on that?

Home sales have been robust in the first 2 quarters. Actually, I was a little bit originally a little concerned, but I think there is a width of what a new home calls build home in the United States has gone up so much and between an apartment rent, it's just been really -- it's been very good. And we're seeing -- I have our actual new home sales have been way above what we expected. So we've been very pleased. And actually, July has been pretty good too. So we anticipate that, that it will continue as of right now and home availability is fine. And one of the things is when they had -- when Dodd Frank was passed, there was a lot of concern in the industry about what that would actually do. And it is actually kind of in the end, this is the first time we've seen a rising rate environment and it is kind of not rates of rise because of -- it triggers inside the regulatory framework for that. So we've been very pleased and [indiscernible] continue right now. And we've not seen this kind of affordability factor span for us in quite some time.

And then I guess one of the things I wanted to ask about too is just was leasing strategy. Like let's say you've acquired a community, you fixed it up to your liking and it's maybe like low sort of 80% range occupied. Given such low turnover on tenants, how do you think about filling that up over time? Is it -- do you try and think like, okay, we want to add a couple of 100 basis points a year or is it let's move as quickly as we can. I'm just wondering when you get these assets into ready for service into the condition you want, how aggressively you start to move -- try to move occupancy?

It's an interesting -- it's relevant to the individual location is what I would say to you is, again, we have a home ownership model. So if you were 80% rental home or of the 80% if you were 50% rental homes because we bought the community and it had a high rental home, we would be very focused on driving homeowner ship through new home sale and just converting those rental customers and driving that down so you get a more stable resident base. And so that -- again, at the mature locations, what we've guided is and what we truly believe is, again, we have some very large communities that have no rental homes at all in them and that are in the 80% to 85% to 95% range in occupancy. So we would guide about a 2% occupancy growth on average, kind of like the rental home or the average monthly rent increases, we guide about 5% on that. And when you get to the 95% occupancy in some of these communities that are older, you do have to be mindful that some of the housing stock is getting older and you've got to make sure that, that housing stock is being replaced with new modern homes. So I think for me to say that, oh, we're going to have 100% occupancy, we probably aren't -- I think from a modeling perspective, I'd probably hold it at 95% as we continue to make long-term decisions on the housing stock within that individual community.

And then just lastly, in terms of borrowing cost right now, where are you seeing mortgages these days and for what kind of term?

Eddie, you want...

Yes, absolutely. So yes, what I'll say is the debt markets are still kind of wide open for us, but certainly the rates have driven up. So as far as terms, I'm still quoting 20-year fixed rate deals that we can get done, those rates though, that were 4 or even sub 4 at one point are now closer 5.5, 5.75. And so the credit availability is there. What I'll tell you is the -- what we are seeing is the lenders they're hungry to new deals, they're not doing a lot of deals either. So we've seen folks get a little more aggressive on spreads maybe that we could come inside of that 5.75 or 5.50 rates. But the availability for the credit at this point has not changed. The lenders like our asset class, the stability that it comes with and so it's still there, just more expensive.

Thank you. And at this time, we have no further questions. I would like to turn the meeting back over to Kurt.

Thank you, operator and thank you, everyone for participating. Please feel free to reach out to our investment relations team at [email protected], if you have any further questions.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.