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

Good afternoon, everyone. Welcome to the 4:20 p.m. session at Citi's 2023 Global Property CEO Conference. I'm [ Eric Wolfe ] here with Nick Joseph of Citi Research, and we are pleased to have with us Sun Communities and CEO, Gary Shiffman. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. And as a reminder, the questions I will ask today do not reflect the views of Citi or myself and are being asked for information purposes only. For those in the room or the webcast, you can sign on to liveqa.com, enter code GPC23, submit any questions if you do not want to raise your hand. Gary, I'll turn it over to you to introduce your management team, give some opening remarks, and then we'll go into Q&A.

Thank you, [ Eric ]. I want to introduce you on my right, Fernando Castro, and I'd like to welcome him as he joined us as our CFO. It's been how long now, Fernando?

10 months.

10 months. So getting through our first full year and he's done a fabulous job. So I'm glad to have him in the position at the company and haven't had this opportunity to join me today at this table at his first Citi conference. Although I will in full disclosure share with everybody, he had sat on that other side of the Citi table for a long period of time. So...

We're over there to the side [indiscernible].

So I think I'd get started by thanking everyone for joining us today during the conference. It's been an excellent conference for us, and we look to answer any questions after prepared remarks or to see you as we meet with everybody throughout the rest of the conference. Sun is the premier owner operator of manufactured housing communities, recreational vehicle communities and marinas. We've been public for 30 years and private for 10 years. So I'm speaking to you as somebody who has been in the business for 40 years. The persistently strong demand and highly constrained supply, it's those fundamentals that underpin our portfolio, make our business highly recession-resistant by generating steady NOI growth. At this -- and to this point for over the past 20 years, we've grown same-property NOI by over 5%. And every individual year or rolling 4-quarter period during the past 2 decades has achieved positive same-property NOI growth. Today, about 85% of our total portfolio is in our same-property mix. And during our 30-year history as a public company, we have a proven track record of delivering attractive returns. And very pleased that we've been able to do so for investors by growing and diversifying our portfolio. We're grateful for the opportunity of being able to meet with you today and answer questions during this session. So we'd be pleased to get started.

Great. We've been starting each session with the same question, which is, what are the top 3 reasons to buy your stock today?

I think that, first, we're in the best asset class, highly resilient, if you will, to very challenging economies and just really demonstrated long-term growth, really underpinned by the supply-demand fundamentals. You can't get zoning or entitlement for manufactured housing marinas, very, very challenging RV side. So there's no new supply coming in with a steadily increasing demand. So that is really what differentiates the business platform we're in. Second, we're positioned to generate revenue and NOI growth from our same-property portfolio. As indicated, that's about 85% of our properties. And third, we have a very solid balance sheet with less than 5% of our debt due over the next 3 years and approximately 85% of our debt fixed. .

Great. So let's start with the MH side. Great tour on Sunday. Thank you for being a part of it. One of the questions that was coming up a lot among investors was just your customers' ability to continue paying these sort of level of increases of site-run. I think this year, it's about 6.3%. They're facing a number of higher costs. The cost of purchased homes in your communities is higher. The property taxes that they're paying on their house, I know they don't pay tax on their land, they're paying on their house, presumably is going up. And then they're facing the same inflationary pressures that others are facing. So the question is really how sustainable do you think this level of increase is in the MH side of the business?

I think one of the strong characteristics of the business is the fact that we can pass on inflationary expenses through all economic cycles. If you look back over the last 7-plus years in the CPI or -- of 1% or less, our average annual rental growth was 3% to 4%. As you look towards where we are in the cycle right now, in the manufactured housing property that we toured that you referenced, the average MH rent for 2023 has increased by 6.3%. That 6.3% is not headline inflation, but it represents the expected cost of our expenses, and manufactured housing runs at a very healthy margin of 65% to 75%. So we're very, very confident in our history that we can push on our inflationary costs of operating, and I'd share with them everybody that there -- but for maybe 10, 15 properties out of a total of 290, the ability to push on is equal to market or CPI or greater. So there is nothing other than in those 15 properties that would prevent us from pushing things forward. One thing I would add, today, we sit at -- over 70% of the properties are 98% to 99% occupied. So the ability to continue to grow rent. There's that -- in fact, you don't want to create a vacancy. We've always said the most costly item that we can own is an empty site. So there's a delicate balance to think about the marathon, if you will, the long-term steady, predictable growth that we've represented against pushing too far in any given year.

And has there ever been a sort of another period of time where rents have sort of grown this fast over a sustained period? I'm trying to think about another inflationary periods, whether your customers have been able to sustain sort of 6%, after 6%, because obviously, you can start compounding that and ends up being quite a large number in a few years. So just curious whether you've seen [indiscernible] time line.

Yes. I have to look around and measure the age group here for a second. Because I'll share with you all, that I grew up in an environment where the normal CPI was 5% and interest rates were 8%, okay? And so having that advantage, I've been able to see over a 40-year period of time. That was before we were public. And I honestly think when you look at the delta difference between manufactured housing and RV vacationing, but in particular, the housing and compare it to single-family residential to multifamily into site built. That delta difference is always so great that we are the affordable choice. And in challenging economies, we do lose at the bottom a person who is a challenged by the economy, maybe a job loss, but we gain at the top of the funnel 2 or 3, 4 candidates or residents who are more interested in affordable housing, and that's the stickiness. And to kind of represent how sticky the rent is and the ability to push through rates, the average stay in one of our manufactured housing communities is 14 to 15 years, but less than 0.5% of the homes in our communities ever move out on average per year. So once a home is moved in the community and once we're at 98%, 90% occupancy, that home sells in place every 15 years or so, creating uninterrupted rent stream for a longer period of time than any of us will be around here. So yes, I do think it's very sustainable to be able to increase cost. And that's what history has demonstrated through the stronger and weaker economic times.

Got it. Maybe switching to marinas. You talked about a 12:1 ratio between the number of registered boats in the U.S. versus supply of boat slips. Just 2 questions there. First one, maybe it's stupid, but going to ask it anyways. Where are these other boats being kept that's a big ratio? And then second, why is 12:1 sort of -- where does that range versus history? Can you put some context around it? I mean has it ever been 15:1? Just trying to understand whether that's a really advantageous supply-demand ratio or if it's sort of average versus history.

Yes. I'm going to suggest I've been following the marina industry intensively for about 5 years prior to our acquisition of Safe Harbor. And it's been a pretty steady, healthy inventory that hasn't changed a lot. As boats age out, new ones come on to the market. And with supply-demand that we're discussing, we're not agnostic to boat sales. Boat sales go up and down. They're down right now from historic highs 2 years ago, but they continue to fill the inventory. And the thing that I've watched and one of the reasons we became most interested in the marina business is the fact that boats are tending to become larger and larger. So Safe Harbor Marina acquisitions focus on boats that are 30 feet or larger. The smaller boats can be trailered out. You see them in backyards and garages. The larger boats can't be trailered out. They can't be moved out. And oftentimes, there's homeowner associations that prohibit overnight stays. So it puts increased demand for those types of slips that Safe Harbor is focused on. And then I'd follow up and say that it's one of the few businesses with the same supply-demand fundamentals and that I've seen that it's harder to increase or to gain a new marina through the approval process mostly due to the coastal commissions and environmental issues. So what's interesting is you have an inventory that's actually shrinking as opposed to growing from the redevelopment of the waterfront properties into other real estate assets. There might be commercial mixed use, obviously, condominium on the waterfront. So things from a demand standpoint continue to increase today. 2 years after acquiring Safe Harbor Marina, there is a waiting list in 90% of our marinas.

And so maybe you could talk a little bit about sort of the annual turnover you see there. Presumably, if you have 91% of waiting list, again, I'm going to ask what that means. It means that if you have 100 customers, you have 91% waiting to be in your community, just so I understand.

It could be 1 waiting to get in. It could be 50 waiting to get in, in any marina, but it basically is a full annual occupancy in all slips 30 feet and over and very close to that into the smaller sites as well.

So I guess just 2 questions there. I guess, again, what's the turnover sort of in the marina business? And then historically, you've been growing things around, call it, 7% or so. I mean has that been the sort of average historical rate over time? Or is this sort of an unusual period of time where the business is growing faster?

So I'm going to suggest, since I've been following Safe Harbor Marinas, the average stay of a boat owner is 8 years, and it's been pretty consistent. As I've seen it, there's been more demand for the bigger boat. So some of the low-hanging fruit, if you will, that we look to deliver to our stakeholders is the fact that we can reconfigure for demand of these larger and wider boats. And rental increases, excuse the pun, aren't linear in the boating business, but it is a linear charge per foot, and that's how we charge the rents. And the bigger the boat, the greater the linear dollar because the higher demand that's there for the boat. So the anticipation is same community that we reported for 2022 was 7.7% growth. And our guidance for '23, it's right around 7.5%. Yes, at the midpoint. So we do believe, like we've done in the manufactured housing platform and when we consolidated the RV platform, that we do have good opportunity over the next 3 to 5 years to just expand the growth off of a very healthy base.

And [ Eric ], we have seen an acceleration on rental rate increases. We would observe that increases have historically been in line with our manufactured housing increases, that 3% to 4% last year. On average increases were about 5%. So certainly, this year, we're about 250 basis points above last year from a rental rate increase. It's the demand that we're seeing for our marinas both for our wet slips and dry storage spaces that gives us that conviction to increase that at a 7.5% level.

And a lot of questions coming in. I think this first one is related to the sort of demographics of your overall tenant base and sort of if you could break it out by various segments, and sort of talk about sort of what information you actually know about your tenants. You know their income levels. Do you know credit scores? What sort of information you gather along the various property segments?

Well, I think the best way to look at it in the manufactured housing segment of our business, we're approximately split down the middle, 50% age restricted, a little bit more than 50%, a little bit less than 50%, all age. We've been kind of quite clear as a public company that we believe in a balanced portfolio like this. So in our age restricted, at least 1 person in the home must be 55 years or older. And all age, obviously, there's no restriction there. So in having the balanced portfolio, what we've observed over a long period of time is that in good economic times, we get similar rental rate increases in both types of communities. In very challenging economic times, we actually get higher rental increases in all-age communities rather than the age restricted, where there is more pressure tied to CPI, tied to a retirement, tied to social security and other aspects. And then you also have a whole community of retirees with nothing to do all day, but give management grief with regard to rental increases. So that being said, the balanced portfolio, I think, has helped us to achieve top growth in our sector for a long period of time, and that's how we view we will go forward. So our demographic is really attractive on growth of boomers on the age-restricted side as well as the employment based on the all-age side. So we think about that mix portfolio of 50-50 going forward.

Obviously, we just talked about this, but from a fundamental perspective, it sounds like all your businesses are doing great. But you made a comment on the call that at times like this, when there's stress in the system is when you start seeing the best acquisition opportunities. I guess 2 questions on that. First, if fundamentals are so good in your business, I guess why would you end up seeing good acquisition opportunities? Presumably, if the fundamentals are good, there probably won't be that much stress. But then the second question is, if you are able to see some stress and you're able to go out and buy a portfolio or a couple of portfolios, how would you fund that today just given your lower equity cost of capital.

Both great questions. Certainly, whenever I made that statement, cost of capital has changed to the fact that I would share this with you. Challenging times tend to bring about opportunities. That being said, in consolidated markets like manufactured housing and RV, where all the institutional quality properties are really held amongst 2 public companies and 3 private companies. And the onesies and twosies that are out there that have demonstrated resilience in tough economic times and just continue to do well, they don't tend to come to market, and there isn't a lot of opportunity there. That said, with the deep relationships that we have, similar to those of our competitor, we do experience opportunity. And I think currently, we're looking at 2 opportunities, and they're funded with Sun securities, and they're funded with metrics that have triggers. So they'll take securities. They'll defer their taxes. We'll have the transaction. And they're structured in a way so that our NAV is protected in the future when those securities are freely tradable. And for now, barring a big change to capital costs on the positive side, them coming down, which after today, we can all scratch our heads and wonder, probably be a quiet time for acquisitions, and we will deploy capital where we can get the best returns by developing ground-up communities or expansions in our manufactured housing portfolio. We have about $200 million of internally funded capital from our -- after dividend cash this year that will go into ground-up communities. Last year, we developed 5 new manufactured housing communities from the ground up, delivered just about 2,000 sites. Our expectation is we will deliver 2 to 3 new manufactured housing communities for each of the next 3 years. So we'll be focusing on the deployment of capital internally, if you will, as opposed to externally until things change.

Gary, you mentioned the absolute cost of equity capital. I completely get that. That's somewhat macro-driven. There's also the relative cost of capital, right? So if you look at kind of your relative valuation versus your closest peer, there's a discount there. I think if we go back over the past few years, there's been times you've traded in parity times at a premium. What do you attribute that discount to today?

No question that it's tough for a management team to post the kind of growth we're posting and to see a bit of the discount. I think that over a 2-year period of time, the size of the acquisitions, both our entry into marina with Safe Harbor and the acquisition of Park Holidays in the U.K. have yet to be fully digested and fully understood. We are meeting with all stakeholders, understanding what the modeling challenges are and working enormously hard with an effort in 2003 and sharing feedback across the table to simplify that modeling. A lot of that has to do with shrinking, if you will, the size of our [ SD&E ] lower-margin business and moving more and more over to the rental side. We've owned Safe Harbor, as I said, for 2 years at this point and have had a property tour, have successfully integrated the financial reporting of a private company to a public company. On the U.K. side, we've done 1 property tour. We've only owned it 8 or 9 months in total right now. I think April will be the first anniversary. And I think there's a little bit of a continued show me the concept. What we see in Park Holidays in the U.K. is opportunity to expand our manufactured housing business, similar to our snowbirds in Florida, Arizona and elsewhere, where it's second home ownership, and the snowbirds come down for the winter season to be warm. In the U.K., it's a bit opposite, although they tell me that the sun doesn't necessarily shine in the summertime. But these are owners who have a primary residence and must have a primary residence in order to qualify for a second vacation home in Park Holidays. So they spend their summers there, their vacation season when the kids are out of school. And I think that as we look to integrate that platform, just as we did in 2016 with Carefree as we expanded into the RV business, it takes a little bit of evidence and the type of growth that we see and that we can produce and working with the stakeholders to help them understand it. So we had a property tour last year. We expect to have a property tour in the U.K. this year. And I think as people are starting to adjust to marinas and see the value proposition, we will start to see that value proposition with Park Holidays and begin to close that gap. So there's nothing like reporting solid earnings in each of those pieces of business that will overcome, I think, that discount that exists today.

Yes. And I guess just on the G&A point, right, purchasing these 2 companies, G&A has grown pretty considerably over the past few years as part of that. When should we expect to start to see actual G&A savings versus just growth or in line with kind of growth of revenue?

Sure. Outside of annualizing the corporate costs associated with our U.K. platform this year, you're seeing very muted growth here for our MH, RV and marina platform. They're using a lot of baseball analogies as far as integration points and shared services and things of that nature for our business. For our integration of the marina business, I would say the picture has made its way once through the lineup, but is still in the game. So there are continued opportunities from an integration perspective with our Marina platform here in the U.S. and certainly getting through SOX compliance, accounting and finance integration with our U.K. platform. We are looking at additional integration points with them as well. So we are -- this is after 2 years of recognizing large corporate cost growth. Given the integration of the 2 platforms, you are starting to see that leverage ability for us on the corporate cost side.

Maybe with regard to same-store expenses, a few investors brought up that sort of caught them off guard, so the total level of same-store expense, but also just the insurance, which was a big piece of that. So 2 questions there. You said that you can continue to negotiate, I guess, the contract throughout the year. So I'd love to sort of understand how that works and whether there could be some savings at some point. And then second, is there anything else this year that you think could provide meaningful sort of volatility, whether it's on power costs? Obviously, we saw with ELS in the third quarter last year, they got some surprising news in Florida on utility rates. So just other things that we can think about this year that might create some volatility on expenses.

I'll start with the first and on the volatility side, either one [indiscernible], but there is nothing that we have insight to at this time volatility-wise. But on the insurance piece, one thing that we want to make sure that everyone understands is that insurance and for Sun had been growing anywhere from 17% to 15% year-over-year for the last number of years. After Hurricane Ian, we had 3 communities that were totally impacted by it, fully covered for building them back up and full business interruption for a 5-year period of time after we get our certificate of occupancy. So we carry significant levels of insurance to really make certain that we can deliver the kind of growth that we deliver year after year, and it's not interrupted by weather events. That being said, we did share with the market that our expectation was that interest -- insurance rates were going to be significantly higher this year. We have a November renewal. We probably expected them in the 30% to 40% range, and they first presented them to us in the 100% increase range. That caused us to head to the U.K. to spend time at Lloyd's to hire a third-party broker to sit down and meet with the insurers one by one. And we had a 3-year extension agreement to keep our insurance -- sorry, 3 months through January to complete our insurance renewal. So we did get the advantage of a reduced same insurance for those 3 months. But the fact of the matter is we completed the deal at the end of January and signed up. So some of the constructive criticism was that we wish we would have had given a heads up on the magnitude of an 80% increase year-over-year on insurance. And the fact of the matter was we were sitting 18, 20 days away from our earnings announcement, completing our budget, completing guidance, completing our year-end work. And we thought it would be confusing to the market to step in and not be able to address a lot of questions and thought better that we should wait a couple of weeks to provide the update and information and guidance. So there was no intention of not releasing that in a timely method. That being said, we did negotiate something that's unusual in our insurance, and that is a 6-month window, after which we can pay a very small fee to readjust our insurance. And at this time, we have 2 outside consultants and our internal team looking at every aspect of our insurance, taking a look at the risk pieces that we take. Do we want to change our deductibles? We have a captive. Do we want to push more risk over to the captive? There's reinsurance opportunities. So we're kind of turning over every rock, but that could lead to the second half seeing some savings on insurance, and a better market by the insurers could lead to it as well, but where we really will see it certainly in 2024 in 2 ways. We do expect to have some normalization and dating myself again. 1992, I lived through Hurricane Andrew, Southern Florida, Homestead was just devastated by Andrew. We saw a similar spike in insurance, and it did normalize in a 12- to 18-month period of time. So we would expect some normalization and we would expect to be able to really carefully examine our existing insurance risk profile.

Just real quick. I guess we're running out of time here. A lot of questions that are coming through. You just made a comment on the call, and I just want to -- I think it's going to be easy answer. But you said given sort of the higher insurance and other costs, you were looking at Florida more carefully and strategically. I just want to understand, does that mean that you sort of consider parting with part of that portfolio just given expenses are growing too quickly because of insurance? I just want to make sure I understood it.

Yes. For clarification purposes, we're not considering cutting off a limb, but where Florida, because of the cap rates and the fact that it's in the top 3 growing states in the country still, so the demand is there, and we want to be by the demand, where we never considered a disposition of a Florida property in general. And in our asset management and thought process this year, we've kind of opened up Florida. So there may be onesies or twosies where a Florida property doesn't meet the growth that we're looking for in a property. Maybe there's some functional obsolescence or something like that. So now all properties are available to be thought through. We did about $40 million, $50 million of dispositions. I think last year in '22, we're usually somewhere in that range. We could be carefully looking at some more opportunity and thinking about redeploying the capital, paying down variable rate debt or putting it in other areas of the company where we can get higher growth opportunity than that. So I didn't mean to indicate anything more than onesies and twosies.

Got it. We'll go to rapid-fire questions, and I'm going to add 1 just because we've been asking in each session, your top ESG priority this year.

It'd be interesting to note. I would say, in at least 4 of our meetings over the last 2 days, the first question was about ESG, which I share with everybody as it's on everybody's mind. But for Sun, our #1 priority would be to enhance our GHG inventory as we've committed and are committed to achieving carbon neutrality. And the first step to that is kind of taking that inventory, and we're really hard at work at it right now. Probably a close second would be continuing to attract and retain top talent. In doing so, the benefits over a long period of time of transferring a knowledge base and not having to be...

Same-store growth for MH and RV next year?

6%.

More fewer public companies a year from now?

Same.

And best real estate decision today?

Best real estate decision today, hold on and watch the properties grow. Thank you.

Thank you so much.