Sun Communities, Inc. (SUI) Earnings Call Transcript & Summary

Good day, everyone. I'm honored to be here for the Sun Communities presentation featuring Gary Shiffman, Chairman and Chief Executive Officer. I'm Michael Goldsmith, the U.S. REITs analyst from UBS. Gary is going to kick it off with some opening remarks, and then we will jump into some Q&A.

Thanks, Michael, and good afternoon, everybody. Some of the faces I recognize, and I apologize because I'm going to share a little bit for those unfamiliar with the story and the business platform of Sun Communities, but then we'll get right into some Q&A. And if there's time at the end, we'll be glad to open it up to everybody. But as a brief introduction to Sun, we -- the company was founded about 40 years ago. We've been public for approximately 30 years. So there is obviously, a long operating history in the field of which we operate. We have done, and been really focused on becoming the premier owner-operator of manufactured housing communities, recreational vehicle resorts and marinas. I think it's safe to say with best-in-class assets and best-in-class management team and operations team that I think is best indicated by our performance year in and year out. Our portfolio is comprised of 646 properties with over 175,000 manufactured housing, RV and holiday park sites, in addition to over 45,000 marina wet slips and dry racks throughout the U.S., Canada and the U.K. Sun's value proposition of delivering high-quality attainable housing and outdoor vacationing and leisure activities leads to highly recurring predictable and dependable revenues across our business lines and is evident in our strong results throughout all economic cycles. And I think that's something that's on everybody's mind today is how does the company perform in such challenging times. Sun owns irreplaceable real estate and strategically identified business sectors, each exhibiting core fundamentals of growing demand against short supply with strong barriers to entry. And I think that's the key focus on our 3 business platforms: strong demand; short supply; and incredible barriers to entry. Sun's business platforms are characterized by attractive supply/demand dynamics fueled by compelling macroeconomic and demographic tailwinds with proven and tested growth potential, as I said, across all economic cycles. And we are in the business of affordable housing, affordable vacationing and affordable leisure activities. That's what differentiates ourselves. We're excited to have closed on the Park Holidays acquisition this past April. Park Holidays increases our foothold in the highly desirable yet consolidated space in the U.S. of the manufactured housing industry. Park Holidays' customers buy their homes outright, so they own them, and then they enter into a 20- to 30-year license where they get annual rental increases of CPI or greater. The acquisition gives Sun immediate scale in the U.K. and a platform continue -- for continued internal and external growth with an incredible management team that's been seasoned for the last 15 years. In addition to benefiting from the tailwinds and the manufactured housing and RV segments, we really are encouraged by the opportunities that we see to produce the kind of highly valued manufactured housing rent in a fragmented U.K. market as well as the marina market that we'll discuss in a little bit. As inflation is currently on everybody's mind, we wish to reiterate the nature of Sun's recession-resistant business model. We don't claim to be recession resistant, but I think a 20- and 30-year look of how our platforms perform throughout various economic cycles, we classify our business as recession resistant. On the manufactured housing side, the cost of a medium-sized built home continues to soar across the country with an average price increase this past year estimated to be 20% and an estimated shortage of 5 million homes to meet current home buyer demand, high-quality manufactured home in one of our communities is really an affordable and highly desirable way of home ownership. And for most Americans, especially in this inflationary period where we continue to see a greater gap between wealth and the ability to afford a home, it just drives more and more customers into the manufactured housing opportunity that we offer. Our MH resident stays for an average of 14 years as they recognize the value of living in a Sun Community and less than 1% of the homes move out during any given year. That fact has been the same for the last 15 or 20 years as we've tracked it. And the fact of the matter is the homes that remain and sell in place. So when we talk about sticky revenue, these homes sell to new parties, but there's no interruption in the rental stream and it's predictable cash flow for what we think -- would consider as 40-plus years as the period of time that we've been in the space. On the RV side, even with gas prices approaching or exceeding an average of $5 per gallon. The RV lifestyle remains one of the most affordable ways to vacation on a relative basis, especially in light of skyrocketing and all the cancellations, if you will, of flight travel that everyone has experienced most recently. One indication of how performance is, as gas prices are on everybody's minds and how they might impact transient RV travel, we look to the 3-day weekends as sort of the bellwether of how performance is year-over-year. During this past Memorial weekend, average rates year-over-year from '21, which was the fastest-growing year we've experienced yet. We're up over 20% on a rate basis, and revenues grew up over 12.5% for the same 3-day period. And that's based on 7% fewer available sites in the transient portfolio. Through the first 4 months of 2022, we've converted over 1,024 transient guests to an annual lease. When we converted a transient guest to an annual lease, there's a pickup of approximately 50% during the first year and then remainder of that individual site we have been converting at a rate of approximately 1,000 to 1,100 units year after year. To date in the first 4 months of 2022, we've already converted 1,024 sites. So if one were to consider that the continuation of that kind of pace, we can theoretically convert 10% of our transient sites to annual in the year 2022. So that's just doing the math, but with the 50% pickup, it's really an accelerated pace, way beyond anything we've experienced before. Perhaps one of the reasons is high cost of gas, where it's a little bit countercyclical to look at during the difficult COVID period. What happened, our business and the transient RV boosted to the highest levels everyone -- as everyone wanted an outdoor experience, didn't have to deal with common areas, elevators, check-in or anything like that. That's been pretty sticky as we continue to grow. We expect our guests to continue to move towards air travel and other vacations, but it's really a new base from which we work upon, okay? And as we move from COVID and look at the conversion rates skyrocketing to annual, it's probably also a function of fuel prices. As fuel prices get higher and higher, many of our transient guests are just electing to convert to an annual rate and leave their RV in for 12 months. And what they basically do is they -- it's their vacation home, okay? So whether they come for a week, 2 weeks, the season or just a long weekend, I think that there's a benefit to the high fuel prices on the conversion to annual. The marina side is very similar. Everybody is wondering how gas is going to impact marina occupancy. I can share with you there is no deterioration to occupancy, again, the same supply-demand fundamentals. And what we share with everybody even more so on the barriers to entry side, the environmental issues with the marina make it that much harder. There are virtually no new marinas that are going to accelerate any additional slip spaces. That being said, there's a little bit of the inverse as waterfront property highly -- under high demand. Oftentimes, the marinas get converted to other uses, condominiums, multifamily and other real estate developments and the supply is actually shrinking of available marina slips. We use 2 fundamental factors when it comes to our thoughts about the supply/demand, coincidently in both the RV space and marina space. There's an estimated 12 million to 13 million registered RVs in the country and 13 million to 14 million boats and vessels with a supply of RV sites with improved utilities and wet slips from marinas being at around 900,000 to 1 million. So you've got this roughly 13:1 demand with no new supply coming in and great opportunity for Sun to provide and continue to provide consistent, dependable revenue and income to our stakeholders. The marina side, I know fuel aside from not seeing anything what's happening there. Boaters love their boats. They come to their boats. They want to be on their boats. So a little less cruising around. Many of them are coming and just enjoying being on their boats, setting up their barbecue, maybe a cocktail in hand and sitting at the dock, or what we're experiencing is a lot less cruising and enjoying anchorage on the water and just sitting there again, enjoying the boating experience. As we look through the platforms of RV and marina, we have the luxury of looking back down 15-plus years. I'm probably the senior person in this room. So I've seen a couple of recessions and economic cycles. And I began my career for a long time at an 8% interest environment, with CPI that always seemed to be 5%. We turned in the same kind of predictable profitability in our platform then as we expect to do going forward. As we look across those segments of operation that we're in and the business model, the things that we would point to that I'm mentioning, consistent cash-flow, upside growth opportunities through rental rate increases. There is nothing in our manufactured housing communities for our marinas that could -- we can pass on CPI or greater rental increases. There's nothing restrictive with the exception of 13 properties in California, where we can only pass on 85% of CPI. When you think about MH, which has a 70% to 75% margin, expenses have a very small component on our ratio. So if we're passing through a CPI -- rental increase equivalent to CPI, obviously, we're getting a very large growth in NOI yield on the property level. So with the compelling demand and tailwinds in our asset classes, we're continuing to pursue greenfield developments and expansion in the manufactured housing area. There are opportunities where we're able to enhance growth and create meaningful shareholder value against the current cap rates. What's happening with cap rates? As interest rate is increasing, because of the consistent type of cash flow in MH, RV and marinas, we're really not seeing any change to cap rates. Currently, we expect there will be some upward pressure on them, but the range of those cap rates for an institutional quality manufactured housing community today, they are still trading -- when they come on the market at a sub-3 cap rate. Last week, we walked away from a 2.5 cap rate single asset sale. To give you some sense, the seller sits on our Board and as a director. So we did have a good view into it. And we were $60 million apart from where it traded. And one would say, until recently, we had a very low cost of capital. So it gives you some idea of the demand for the type of assets that Sun has. I think over the last 12 years, most of you who know us recognize that we've been a proven industry consolidator since 2010, we nearly doubled our portfolio by a factor of almost 5. The combination of the high barriers to entry and supply limitations for MH, RV and marinas bode well for our future growth. We do have long-standing relationships, as does our competitor. We will continue to acquire MH where we can based on relationships. But I think a distinct advantage of the company is the ability and the experience and our roots as developers so we can actually, when we can get the entitlement, construct a modern manufactured housing community to a stabilized yield of 6% to 7% to a low -- I'm sorry, a low double-digit or high single-digit IRR. And when you think about the cap rates I just shared with you, that's enormous value creation. We've been working on ramping up our development for 6 years now. And this year, we have shared with the market that we will -- have broken ground on 5 new manufactured housing developments and for the foreseeable future, it's a very attractive way for us, along with our acquisition in the U.K., to expand the percentage of manufactured housing in our overall portfolio. I think as we move forward, I'd share with you that we're committed to driving growth while maintaining a flexible and conservative balance sheet. We have a lot of opportunity, a lot of low-hanging fruit to extract from both the marina business and the U.K. platform, which we just acquired, Park Holidays, both in the marina business we're seeing fragmented ownership and the opportunity to be very selective about acquisitions and they trade the marinas in about the 6% to 8% cap rate range. And in the U.K., the manufactured housing communities and the portfolio that we bought was about 7.75% yield. So good spread, investing in opportunity still against even an increase in cost of capital and a meaningful increase in debt. So that's a little bit about our history, and I'll turn it over to Michael and for the time we have left to take any questions.

Yes. So maybe a good way to start is just to hit on some of these macro themes that I'm sure that we've all been hearing about through the conference, we're in a particularly inflationary environment. What impact does this have on operating expenses? And where can you push rates to offset some of that?

So inflation on everybody's mind, including the Sun management team. Had we had a crystal ball earlier in 2022, we could have set our rates equal to or greater than inflation because we have that ability to pass through. We're currently locked in for the rest of the year at a 4.2% average manufactured housing rental increase. Our expectation, we have to notify rents in September, determine them basically for January in one increase for about 60% of the portfolio. So we're looking at that right now, whether we're going to wind up in a 8% to 10% overall inflationary environment in both MH and the marina business, we'd be able -- we expect to be able to pass on the inflationary cost, if you will, in the form of a rental increase and accelerate from the 4.2% from where we're at right now. Interestingly enough for each of the last several years, we received 55,000 on average applications in our manufactured housing communities, which we can't satisfy. So again, strong demand against supply. We create a value proposition. It is evidenced by a 30% increase in average home sales that we broker in our communities because we think we deliver a real value opportunity. That 30% is a direct result of how we invest in our community. So therefore, we think that part of that 30% really belongs to our stakeholders and our shareholders because of what the Sun team is able to do in creating that value. So we're seeing the obvious inflation, certainly in utilities. The real estate has been pretty consistent at about 5% to 6% year-over-year growth. We don't foresee anything changing there. Over the last 5 years, certainly, there's been growth in the insurance side of things. But it's annually renewable. So we'll get a look at that in November this year. But those are the components of inflation that we're seeing similar on the marina business. So we can expect rental rate increase in MH and the marina business this coming year to be set to outpace inflation. With regard to transient RV, we get to set those rates every day. So we can keep up with inflation over there.

And along the same lines of inflation, the consumer is facing some pressure at the pump. So what sort of impact will the increase in gas prices have on transient RV and marina segments?

Yes. So I think that I'm sharing with everybody the concept of affordability in the transient RV. This is a business that tends to do well in challenging economic environments. Wherein -- I can't say that we won't be impacted by fuel prices, should they go to $6, $7 or $8. We don't have that crystal ball, but at a $5 average, I can share that we're performing to guidance or better. So like we've demonstrated for the last 12 years, quarter after quarter, we would expect exceptional growth within the portfolio. Most RVrs are, transient RVrs are traveling from a distance of 2 to 3 hours from their home for their stay in one of our communities. So even at the accelerated or the increased cost of fuel, it's a relatively small and reasonable amount of money for the enjoyment that they get in one of the Sun Communities. So there are surveys that seem to indicate right now that many of our guests intend to travel more and stay closer to home as opposed to cross-country travel in RV. So again, that bodes well for the demand within our communities. And then as we think about the affordability of an RV stay compared to other air travel and 3 or 4 days stay at Disney World, if you will, for a family of 3, 4 or 5, it's a very affordable option. And now with the platform of Outdoorsy and RV rental -- RVShare. You don't have to own an RV, you can rent one for that week, okay? And all the dormant RVs that sit in the driveway or a backyard for 50 weeks a year, 40 weeks a year can now be rented on these platforms. And it's just an increased amount of demand with no change in the volume of RVs out there for one of our sites. So it's another positive factor that takes place. I think it plays strong to the cost of gas. So performance is very, very good in RV portfolio right now.

And one of the things that you talked about in your prepared comments was about the recession resiliency of the business. Maybe you can break that down to across your segment so we can better understand that.

So it's really the affordability factor when it gets to MH and RV. As there's recessionary pressure in the general economy, as we experience the increased cost, multifamily rental rates 20%, single-family residential up significantly as well, albeit compared to reductions in the COVID '19, '20 period. I mean one of the things I'd point out to the resiliency. In 2020, unlike some of the other asset classes, Sun Communities grew NOI year-over-year by approximately 4.5%. So we didn't have a down period. We had increases to rent just under 4%. So we tend to perform in challenging times, and that's some of our resilience that I refer to. And as people look for affordable housing, affordable vacationing, it plays very, very strong to the offerings that Sun has. And I point to a slide in our deck, if anyone gets a chance. I forget the page number in it, but I usually know them. I'm thinking of the one that goes 20-plus years back. I was just going to point out, if you want an indication of resilience, there has never been a rolling 4-quarter period where Sun Communities didn't have year-over-year increasing NOI, when we talk about resilience versus all of the other asset classes, including multifamily that have huge dips like their dip in '20, okay? And that's the resilience when you look over the period of time.

And Sun has done a number of acquisitions over time. What does your acquisition pipeline look like now? And where are cap rates currently hovering for the different segments, MH, RV, marinas and holiday parks.

Yes. As I described, the shortage of MH and the demand for it because of the resilience, cap rates remain, let's call them for quality assets in the 3% cap rate range. For the C and D properties, of which Sun and our competitor to ELS would not be interested, they seem to be trading at a 4 handle. We sold 3 MH properties that were more or less not up to our performance. They came to us in a portfolio transaction. First quarter, we got a 3.5% cap rate for our cats and dogs, that's some indication of where the market is. When we get to RV properties, they're trading in a 4% cap rate range and the unconsolidated fragmented industry of marinas is still in a 6% to 8% cap rate range, and 7.75% yield in our U.K. assets is what we expect will continue over there. So we have not seen the expansion in cap rates, I'm certain they will be there. If you were to look at our cost of capital as an RG issuer -- IG issuer. We've seen -- if you take 10-year at around the 3 percentage rate, Fernando over there will tell you, the spreads 200 and 225. I like to think of 175, a little sub-5, but we haven't been out there to test it recently. We have about $400 million of free cash flow. We have $235 million of forward equity that we haven't drawn down yet. We have the dispositions and the recycling of capital. So I don't expect to be coming to the capital marketplaces in the near future, but we certainly have enough capital to execute on our internal and external growth plans for the foreseeable future.

So with that, I think we're out of time, but really appreciate your insights into the company.

Sure. Will stick around? Would we have 5 minutes to stick around for any follow-up questions, if anyone has them? And we do welcome anyone to reach out to any one of us at the company for any follow-up. We live and breathe our business, I like to say, 365 days a year. Some people say they take Christmas off over there, but I'd like to think we're working all the time. So please don't hesitate to reach out for us. And thank you, Michael, for moderating the panel, the panel of one.