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's Third Quarter 2023 Earnings Call. [Operator Instructions]. I would 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 press 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 websites at flagshipcommunities.com. Flagship has also prepared a corresponding PowerPoint presentation, which encourages you to follow along with during the call. And now I'll pass the call over to Kurt Keeney. Kurt?

Thank you, operator. Good morning, everyone. Thank you for joining us today. Anyone who has followed the Flagship store for a while, has heard us talk about the strength of the MHC industry and its track record of outperformance relative to all other real estate classes. This continues to be true and was especially prevalent in the third quarter, a quarter where we saw strong growth relative to other real estate classes, which struggled due to the recent rise of the Government of Canada yields. We saw year-over-year improvements in rental revenue, NOI and FFO, which are all positive trends for our business. Rental revenue increased by nearly 21% compared to last year, FFO increased by nearly 15% and NOI grew by just over 20% compared to the same period last year. Year-to-date, we have seen rental revenues increase by over 20% with same community revenue growing by over 9% each quarter, and that trend continued this quarter. This remarkable achievement speaks to the consistency of our business and our strong and experienced operating teams. Our management team is especially focused on same community metrics because they provide a better depiction of the growth and the overall stability of our business. And those metrics saw notable increases during the quarter. Same community revenue was up over 10% over the same period last year. Same community NOI was up nearly 11% over 2022 levels and same community NOI margin was up over last year. Our positive financial results enabled us to announce a 5% increase in our monthly cash distribution. This is the third consecutive year that we have raised distribution which speaks to both the strong fundamentals of our business and the MHC industry. Another key measure of success for our business and our occupancy rates and average monthly rents. Similar to the growth we have seen with the rental revenues and same community revenue, these metrics have gone up per quarter and have steadily increased since 2019. We have demonstrated our ability to maintain a stable and growing resident base, this 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 pension. The residents and our communities are less affected by inflationary environments as those in traditional stick built homes or apartments who are more prone to fluctuation in their rent and mortgage rates. Earlier in the call, I spoke about our industry amidst the other real estate asset classes. Interest rates, particularly in Canada, are near all-time highs, which has led to higher financing costs, higher cap rates and less transactions amongst the Canadian multifamily industrial retail and office sectors of real estate. However, our ability to grow during the same period speaks to the strength and the solid fundamentals of the MHC industry. The interest rates for our customers have not changed substantially and their credit underwriting remains available which is why our manufactured homes are very appealing in a cost-effective option for many Americans. They also offer a better living experience compared to other options. Manufactured homes are detached structures that do not share walls, utilities, air conditioning or heating with any other home. Our customers enjoy 2-, 3- and 4-bedroom homes, typically with 2 bathrooms. These homes also have a deck driveway and home laundry facilities, all for less than the cost of renting an apartment. We have also made 2 significant acquisitions during the quarter, and Nathan will provide more detail on his remarks right now. Nathan?

Thanks, Kurt. Good morning, everyone. Acquisitions have always been a big part of our history, and this past quarter has no exception. In August, we acquired an MHC in Evansville, Indiana for approximately $23 million funded with cash on the balance sheet and additional leverage. Opportunities like this don't come around very often. This is a top-tier asset. It is one of the nicest assets in the state of Indiana and arguably one of the best assets in the U.S. Midwest. We have included a few photos of the community on Slide 8 of this presentation. Evansville is also a strategic component of our portfolio. This is our 11th purchase in Evansville market and we have been operating there since 2015. The community has 309 lots, of which approximately 95% are occupied. This acquisition provides Flagship with the opportunity for stable and continued loan growth for the Evansville market while adding growth occupancy at all of our communities in the area. During the quarter, we also added to our resort style communities, completing a $3 million acquisition at Indian Lake in Lakeview, Ohio. Over the past few years, we have been adding resort style communities to our portfolio, and this acquisition is close to one of our other resorts, which will enable us to leverage our management capacity and achieve economies of scale. This resort style community is a popular outdoor and boating recreation area that features a loyal following of visitors. It essentially located in Lakeview, Ohio on historic Indian Lake in Logan County, Western Ohio. We remain disciplined in our approach when it comes to acquisitions. If an opportunity does not adhere to our strict acquisition criteria, we won't pursue it. These criteria are as follows: First, we're looking for opportunities that will be accretive to 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 existing markets within our portfolio. This framework allows us to achieve steady and measured growth while continuing our bolt-on strategy to acquire adjacent properties within our markets. Our operating experience has helped us establish long-standing industry relationships. These acquisitions and others we have made to date were made possible in part through our long term relationships and solid reputation as responsible and credible operators. The MHC industry is primarily comprised of local owner operators, the top 50 MHC owners are estimated to control only approximately 17% of the 4.2 million manufactured housing lots in the United States. With that, I will pass it off to Eddie, our CFO.

Thanks, Nathan. Good morning, everyone. We generated revenue of $18.2 million during the third quarter, which was up 20.7% over the same period last year, primarily due to lot rate increases, occupancy increases across the portfolio as well as acquisitions. Same community revenues of $15.7 million grew by 10.3% over the comparable period last year, which was driven by higher monthly lot rent year-over-year growth in same-community occupancy and increased utility revenues. Net operating income was $11.8 million during the quarter, an increase of 20.1% over the prior period as a result of lot rate increases implemented during the year. Occupancy growth, increases in utility revenues and economies of scale from operating in existing markets. NOI margin was 65.2% compared to 65.5% while same community NOI margin was 66% compared to 65.7%. AFFO for the third quarter of 2023 was $5.5 million, an increase of 18.9% from last year. AFFO per unit was $0.26 per unit, an increase of 10.6% from the same period last year. Our same community occupancy increased to 85% versus 83.6% last year which reflects our ability to drive occupancy growth utilizing the homeownership model and our commitment to resident satisfaction ensuring our communities are in desirable locations. Rent collections for the quarter were 99.3%, an increase over last year, which continues to demonstrate the strength and predictability of the MHC sector. As of September 30, our total lot occupancy was 83.5%, 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 $5.9 million. We also have 16 unencumbered assets with a value of approximately $28.1 million as of September 30, 2023. With that, I'll now turn it back over to Kurt for some final remarks. Kurt?

Thanks, Eddie. While we are proud of what we achieved to date, we are always striving to do better. Many Midwestern Americans rely on us for an affordable living experience, and that provides us with the motivation to continue to improve and always strive to provide exceptional residential living experiences. To that end, we are always looking for opportunities to provide better value for our residents, namely through our purchase power ability as the large operator that our residents could not get otherwise. Not only does this help our residents, but it helps us provide a better cost structure and enables us to potentially cascade that model across our portfolio to other markets. Our disciplined capital structure speaks to our conservative nature. We remain committed to maintaining low-cost debt profile with long-dated average maturities. Our weighted average mortgage term to maturity is 10.3 years, and our weighted average mortgage interest rate was 4.09% at the end of the quarter, which the majority is fixed rate. During the quarter, we secured a variable rate interest bridge loan so that we could position ourselves to quickly acquire the Evansville MHC, which we consider to be a best-in-class asset. We intend to refinance this bridge loan at a fixed rate, and that process is already underwent. Obtaining secured debt on a fixed rate basis is important to us to mitigate risk. We have no material near-term debt obligations and no bank balance sheet mortgage debt. This strategy allows us to maintain staggered maturities to lessen interest rate risk 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. Our performance this year continues to demonstrate the steady and predictive nature of the MHC industry and our ability as operators. We certainly thank you for your time today. And now I'll open up the line for questions.

[Operator Instructions] Our first question comes from the line of Mark Rothschild at Canaccord.

Maybe just -- can you give an update on how much you're pushing rents now if you're seeing maybe any moderation in rent growth? Or has there been any pushback from your residents on the amount that you're pushing rents?

I think that shows up in occupancy growth, Mark. Our occupancy growth is up year-over-year. I think we had advised that we were at 7.8% earlier this year back in Q1, and that's continued. Our leases are typically month-to-month. And we raised them typically in the first quarter, and I think we're probably going to see the same range of rent increase next year. But at the end of the day, the answer is no, we haven't seen any issues there.

Okay. Great. And then in regards to the Evansville acquisition, if you can just give a little more color on the thought process of buying what you consider prime assets in your core market. And I guess there have been some others over the past couple of years like that or maybe the going-in return is lower than some of your other acquisitions? And maybe it's not materially accretive, at least not going in. Is it just that you have to own the asset for protective reasons? Or you want to own in your core markets? Or is there a better opportunity for rent growth that you see that others might not see if you could just explain that.

Well, Nathan, do you want to take the first -- I have a quick answer, but Nathan you want to take the first?

Yes. I mean we -- the property is adjacent to one of our other properties. And like many adjacent shares actually a border of a property line. And this property is a top tier, and you want to own the best in market, and best in class, and we have the opportunity to own that but also it helps with home sales because many times, people will come there to purchase a home and our -- and while this community has very few home sites available that would come there to maybe shop for a manufactured home and they may end up living in one of our other properties.

Okay. Great. And maybe just one last question. There was a recent announcement of a portfolio, I think of maybe like 10,000 lots that sold or is trading. It seems to overlap with some of your markets. I don't know if you have any comments on that portfolio, the comparison to your portfolio and the valuation metrics. If there's anything we can infer from that?

We're absolutely aware of the transaction. There hasn't been a lot of transactions, and that is a substantive transaction. There's no doubt and it is in upper Midwest, although there's some Florida assets and some in Montana. But we don't comment on the valuation of that at this time. All we know is that because, again, it's not our company. But at the end of the day, there is absolutely a transaction that was large, about 10,000 lots and we absolutely can confirm that. And we think it was an openly market transaction.

Our next question comes from the line of Mike Markidis of BMO Capital Markets.

I wanted to circle back on comments on the rent increase you're expecting for 2024. I think in the past, you guys have always kind of guided to the 4% to 5% range. And then last year, we had an abnormally high increase in social security, which was the rationale for pushing through, I think, an 8-ish percent rent increase in Q1 of last year. And so I just wanted to circle back on that because I guess I see that the social security for the U.S. is the increase is 3.2% this year. So just trying to circle the square there in terms of how you're thinking about pushing rents this year based on the lower social security increase.

Well, you've always got to be good question. You've always got to be mindful of that moment. So again, in our industry, it's a homeownership model and we think about 75% of our customers don't have a load in their home, which is because of a long-term home ownership strategy. So the -- we think the average again, average rent may go up about $31 next year, which is higher than the 4% to 5% range, but not as high as last year. So that's kind of our -- that is what we think will happen. And inflation does play a little role in that over time. We were conservative for the years prior, if you remember. We were -- we've been around 5. When everybody else in multifamily was raising 10 and 15 more we were at 5. So again, we just want to be slow and steady.

Fair comment. Speaking of inflation, great same-property performance, although, I guess, a little bit of inflation on the cost side is as well. And I know some of that is a pass-through just on the utility side, but the stuff that you can't pass through, what are you guys -- what are you thinking for next year in terms of property staff and insurance and tax, et cetera, on a year-over-year basis?

Eddie, you want to jump in?

Yes, absolutely. So yes, Mike, that's a good observation. So what I'll tell you is on the staffing cost, that seems to -- for us, seems to has leveled out somewhat. Now for us, it's getting to full staffing. During some previous years, last year specifically, we had some times where we were running just lower staff because we didn't have the folks to hire the actual cost in regions, those seems to have leveled out and certainly employment in our market has become steady and finding tenant has been a little easier over the last 3 to 6 months. So I don't expect a big increase there. Certainly, taxes, I mean we feel pressured on the property taxes when things are being reassessed. Fortunately or unfortunately, that seems to be somewhat reluctant with the rise in interest rates as far as the municipalities increasing assessed values on the property taxes for. So we've seen a couple of those along the way, but we have implemented a strategy of property taxes where we can pass property tax increases along. I think the one that you brought up is on the top of everyone's mind is insurance. We are not unique in an insurance standpoint. And certainly, we've seen some pressures in insurance, nothing like some of the other bigger players that have talked about. And I don't know, I've heard 60% to 70% increases in insurance. That's not us. But the 10% to 12% range is reasonable. And we are actually implementing some strategies with our current carrier. We actually had a some meetings over the last couple of weeks that I think is going to help us basically shape and kind of use some strategy in our insurance program that I think we'll be able to get some savings. But certainly, we are seeing some pressures in the insurance market. Those are around property insurance, and we're working with our engineered providers to try to mitigate that, but we certainly will see some cost increases there.

Okay. So just on a combined basis, would you expect -- because I think you guys group it together, taxes and insurance would kind of be up sort of circa 10-percent ish again next year?

Yes, I would think -- I think that's reasonable.

Okay. Great. Last one for me, kind of stood here a little bit, and forgive me for not knowing the historical experience. I know it's been good, but your collections improved to 99% from 98%, I think, year-over-year. Maybe is 99% a high water point? Or is that typical for you guys? And I guess, maybe just some comments on now what the improvement -- I mean, it's a good news sign, but why you think you're seeing that?

Go ahead, Eddie.

Yes. So what I'll tell you is, Mike, is our assumption always has been that we see 1.5% so 98.5% collection. That's kind of been our rule of thumb. That really actually elevated during COVID and COVID because there's a lot of governmental type programs that helped. Around this time last year, we started seeing some of those programs go away. And so you started seeing that drop a little bit below the 99%, but 98.5% to 99% is a normal -- kind of a normal collections expectations for us. Our customers, our residents are healthy. In our market, if you want a job, there's work available. The benefit -- the people that got the benefit of the wage inflation over the last 2 to 3 years are residents so I spoke to the service sector and some of those jobs that the culture just -- that's our core resident working class and so our residents are generally very healthy. And so the collections between 98.5% and 99% is where I would normally expect to.

Our next question comes from the line of Brad Sturges at Raymond James.

Just on the -- Kurt, you talked about the bridge loan in process of putting in permanent financing on Evansville. Just curious where you are in that process? And could we see permanent financing in place by the end of the year? Also just wanted to get some guidance on expectations for where fixed interest rates would be today?

Eddie, you want to take this? That's what -- I know you're working on it.

Yes. So I won't give exact guidance on closing time, but yes, it will be for come shortly. I don't know if we'll get it done by the end of the year. Some folks are not -- the lenders aren't necessarily as motivated to finish things by the end of the year, they'd like to have it come in the first year. So -- but what I'll say is rates, we've actually seen some good signs from rates just in the last couple of weeks with the 10-year treasury moving. Those rates were closer to 7 a month ago. We're seeing in the mid-6s is probably where we would look at for long-term fixed rate financing 10, 12, 15 years for a deal like that.

Okay. That's helpful. In terms of the acquisition pipeline you're reviewing or looking at, I'm just curious if you're seeing any further cap rate expansion. I know you've talked about maybe value-add cap rates expanding a little bit more than core -- just seeing if there's any changes on that front in terms of yield expectations?

Nathan, can you jump in?

Sure, sure. What's interesting about this market is there's very few deals to even know if there is any expansion. I mean I'm hearing a very few deals changing hands other than the one big deal, which actually started, I think, quite a few months ago, there has been nothing, nothing traded hands. So you wouldn't know if it existed.

And no signs of distress by over-levered owners that are looking to may have been offside from like accounts structure?

I think you're starting to see stuff like that. But I don't think that it actually comes to the market yet. I said the other day, I said the first thing they're going to do is pay the bank. Then the next thing is going to happen to those distressed buyers is they're unable after paying the bank and the higher interest, they're unable to take care of the property and they're unable to pay the tax over the end of the year. So you normally probably wouldn't see that stress happening and probably until April or May in the number of pay for properties.

Our next question comes from the line of Kyle Stanley at Desjardins.

I just wanted to go back to the Silver Lake acquisition. Just curious if you could talk about how the integration of that and the stabilization is going? I know I think there was a number of home sales to be done over a period of time. So just wondering if we can get an update there.

Yes. So good question. Yes, Silver Lake was going extremely well. I look for some nice stabilization between now and the end of the year. When we closed on that property, I think we had 42 unoccupied rental homes in various stages of set up. I think we've got that number now down to about 14 and we'd look to try to lease those up between now and the end of the year. Again, we're a home ownership model, but sometimes you got to deal the hand that you're dealt. And so we're -- we got those 42 rental homes with it. I will note this -- so we've already got some of our new amenities in the roads are already, again doing very well from an integration perspective, but our rental home fleet went down quarter-over-quarter by about 40 units. So that's actually pretty exciting to me when we added actual units to it during the quarter 2. So we're pretty thrilled with Silver Lake at this point.

Okay. No, that's -- we've talked about it a couple of times just that sizable deal that bid price in some of your markets. Just curious, can you -- Nathan, you kind of mentioned that you don't expect or haven't seen the distress yet. Do you know what the motivation for the seller was? And then who the potential type of buyer was and maybe what the interest in the portfolio would have been?

I do know the buyer. It was a family shop exiting.

We'd be glad to talk to you offline, but we're just so sensitive to not being able to -- again, we don't want to report on here. It was a long standing member of the industry that was well known.

Our next question comes from the line of Himanshu Gupta at Scotiabank.

So just on the permanent financing for the bridge loan, so what options are you looking at? I mean, Lifecos or Fannie or banks? And like who's most aggressive? And who's -- is there any lending type which is pulling back from this market?

You certainly look at all options, we've looked at all options, agency debt, Fannie, Freddie, Lifeco as well. To answer your question, no, there seems to be no pullback in the market. As of right now, it looks like the agency has been -- we got a little more aggressive in the business, but we got quotes from multiple Lifecos, multiple agency quotes and they are open for business. Obviously, the rate is a little thicker than where we've locked in at the past, but they're over for business. And honestly, they love our asset class, right? The reliability and stability of the revenues, they really like that. And the thing that they like the most are assets with low rental home fleets, which is -- it's what we do. It becomes a lot more complicated to get these deals financed when you have a significant rental fleet. That becomes -- because of the volatility of that customer on a rental home customer, it's -- they act like a great apartment as far as turnover. And so when you have a community that is 90-plus percent homeowners. The lenders are very aggressive and interested in doing the business.

Okay. And I think you mentioned something closer to 7% rate. Like what term are we talking like 10 years? Or are you -- you were looking for a...

There's been -- basically, if you look from 10 to 20 years, rates are very similar. There are very little fluctuation in the term -- in the rate versus the terms. So we're looking at all of it, probably right now, looking 10 or 12 years right now. I think the rates are going to be closer to 6.5%, hopefully 6.5% to 6.75% don't really want to see with a 7% handle at this point. And I think we can avoid that. Like I said, we've seen some help from the 10-year treasury over the last couple of weeks. So I think we're going to be able to into a little bit better rate.

Got it. And I don't know, have you disclosed the cap rate on this Evansville acquisition? Can you remind the cap rate -- the going-in cap rate on this acquisition?

Yes, it was right around it.

Okay. And then sticking to this Evansville market, post this acquisition, like what market share do you have in that Evansville market now?

I'd probably have to go back and do the math to make sure that I don't misquote. But right now, we're having a pretty strong -- we're in a strong market player in Evansville. But it's not that we have all the lots. What I would say to you is we have the best community now. And again, the accretion, like we may have paid 5 cap on the best in asset class. We think it's best in asset in Indiana, by the way, not Evansville. And the accretion actually probably comes next door in our other location where we've got 100 vacant lots and it will push and drive customers there. So what I'm excited about is not that we have dominant market share in Evansville, I'm excited that we have the dominant quality assets in Evansville. And that's actually more important to us because we want to be the primary place people want to live and then everything else works out.

Got it. And maybe a follow-up again on Evansville. I mean your portfolio occupancy is more like 75% and the acquisition, what you have done in Evansville it's like 95%. Like why is the big gap between -- I mean, one is like fully unstabilized. I mean the existing portfolio is like would you say mostly unstabilized and this has stabilized. Is that the only cap? Or is it the quality difference is a big gap?

Well, we bought those portfolios from different operators. The first big one that we bought was the property that was next door, by the way, to this high-quality asset we just purchased, it had over 200 old home rentals in it when we showed up. And so we have been systematically removing them over time and selling new homes actually. So that's actually the reason the occupancy is a little bit lower is because we're high-grading, the housing stock and the community. So it's -- they're all stabilized from that perspective. But the high grading in the Evansville market will probably go on for another 4 or 5 years, just because, again, we've -- will grow incrementally, but we won't be into the 90s of these other ones. We'll grow 1.5%, 2% a year because we're pulling out some 1972 homes that need to go to the dump.

Got it. Okay. Last question is on same-store NOI growth for the next year. I mean, I think you already spoke about on the rental rate increase similar to this year. You spoke about the expense inflation as well. So if you put everything together, I mean, would you say like high single digit same store NOI growth? Or would you say mid-single digit same store NOI growth for next year?

I'd say we're going to see more mid- to high. I mean I wouldn't say that I would expect 3% every quarter or 11%. But yes, I don't think we can achieve high single digits.

[Operator Instructions] And the next question comes from the line of Tom Callaghan at RBC.

Just one on my end on the capital spending side. Just curious, I'm assuming given the quality of that Evansville acquisition is maybe not as much in terms of initial requirements for kind of the amenity initiatives that you guys usually do. Is that the case? And then just secondly, more broadly, where do you kind of see capital spending here trending over the next few quarters?

Well, I think when it comes to the Evansville acquisition, what's interesting is it had a massive clubhouse that was, again, best-in-class, I don't know, maybe 8,000 square feet, it's massive and beautiful. It did not actually have a municipal grade playground. And so we've actually are installing that in pickleball courts and shuffleboard. So again, we are upgrading the amenity package there. It's probably not as heavy of a lift as normal that we would see it's a little lighter than we would see, which was -- that's appealing to us. The streets were in good shape. The infrastructure was in excellent shape actually in the entire community. So -- and as far as the capital, again, Q4, Q1, the capital expenditures are not -- we're out of the construction season in our industry, that's really Q2, Q3. So I don't see anything crazy going on in the next -- other than just some continued maintenance CapEx over the winter. Eddie, I don't -- we'll speak to you, but you may jump in.

Yes. I think that's true. Tom, the -- a lot of the capital spend that you've seen over the last year to 1.5 years were the result of the heavy acquisition loan that we had kind of over the last couple of years and the work that we do when we acquire a community, whether it's paving streets or pickers point, playground, the basketball course, all the amenities we put in. A lot of those projects are nearing an end. They're not there yet, but they're nearing conclusion. So asset -- a bunch of large acquisitions. Again, I would expect to Kurt's point, to tail off a little bit in Q4 and Q1.

And as there are currently no further questions on the queue at this time, I'll hand the floor back to Kurt for the closing comments.

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

Thank you. This now concludes the conference. Thank you all very much for attending. You may now disconnect your lines.