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

Okay. Thanks, everyone, for joining us for the Sun Communities presentation. I'm Wes Golladay from Baird. I'm pleased to have with me Gary Shiffman, Chairman and Chief Executive and President of Sun Communities; and Fernando Castro-Caratini, CFO. We're going to begin with having Gary just give us a brief overview of the company and then jump into some questions.

Thanks, Wes, and good afternoon, everybody. Thank you for joining us today. For those of you not familiar with Sun or SUI as our ticker is, we were founded in 1975 and have been publicly traded on NYSE since 1993. So we're located in Southfield, Michigan. And each of our property types in our business are characterized by really irreplaceable locations and compelling supply and demand fundamentals where demand far outstrips supply, very, very limited availability due to nimbyism and difficult entitlement in zoning. So kind of a built-in situation of demand that far outstrips supply. So the scarcity in manufactured housing, the RV communities and our marina locations represents a demographic tailwind, if you will, and has been characteristic of the company for the 30-plus years that we've been a public company. It's these fundamentals that kind of combine in our overall business, as we refer to it as recession resistant and that we tend to do very, very well in difficult economic times. On the manufactured housing side preventing affordable housing at a time when there are economic pressures and affordable housing becomes even more important, on the recreational housing side or the RV side, affordable vacationing. And fundamentally, in the marina space where you even have a shrinking inventory of marinas as they get redeveloped into other forms of real estate, I thought manufactured housing was the most difficult area to get new zoning and to be able to build new communities until I saw how difficult it was as a company to get zoning and entitlement for marinas. Virtually no new marina is being built through the environment. And so a built-in fundamental demographic that's wind at our back, if you will, in these tough times. So in the marina business, 12 million to 13 million registered vessels, less than 1 million slips available to push your boats into so that 12 to 13 to 1 demand makes it very resilient in challenging times. So we tend to see positive NOI growth throughout all cycles. We do go back over a 20-year period of time and have demonstrated there's never been a rolling 4-quarter period where we didn't have positive NOI growth in our platforms. Today, we have 671 properties across the U.S., Canada and the United Kingdom. Notably, I'd say that we've achieved a same-property NOI growth that's averaged 5% or more for over two decades now. And as I indicated, there's never been a rolling 4-quarter period, where we haven't had that positive NOI growth. Turning to our most recent results. In the first quarter, Sun reported FFO per share of $1.23, exceeding the high end of our guidance, with strong performance across all segments. Our same-property NOI increased 6.7%, again surpassing the high end of guidance by about 230 basis points. And I think in wrapping it up and opening it up to Q&A with Wes and for the audience and participants, I would simply say that for the 12 -- the last 12 years, there's been a period of unprecedented growth, external growth through acquisitions has exceeded $12 billion. And now we have a period of time where we're very, very strategically focused internally. And with the supply-demand economics and occupancy in our MH portfolio of 98% to 99% in the marina business, where we have waiting lists in over 85% of our marinas, we're able to really focus on the internal growth that obviously comes from rental increases and expense control, but more importantly, from strategically being able to take the time after all these acquisitions to look for additional levers of growth internally. So as we look forward, we're really excited about the opportunities to demonstrate the growth we can extract from all the acquisitions and the consolidation of the industry that Sun's participated in. I think we do all this, maintaining an eye on flexible and conservative balance sheet, and we expect primary growth as it has been in the past, as I said, from implementing and providing rental increases that since 2020 have always exceeded CPI and expense growth. So internally, we've had that advantage that's really caused by the supply/demand in our industry. And with that -- since 2000, sorry. So 22 years of that kind of unprecedented rental increase above Consumer Price Index. And we haven't been subject to the swings, the ups and downs, if you will, of rental increases that other asset classes have from time to time. So with that, Wes.

All right. That's a good macro backdrop. Maybe we can just focus in on this year. You had a lot of moving parts in the guidance and more of a little bit of a lagging inflation play this year with the strong rental increases. But can you talk about how this year is shaping up, how your initial outlook began and then how it is today?

So certainly, MH, our RV properties and marinas have been performing exceedingly well in the U.K. and our Park Holidays platform. We have adjusted the home sales number down from a very aggressive 3,600 homes to be sold in the U.K. down to around 3,200. We did that at the end of first quarter. That being said, the base rental level and growth in the core portfolio in the U.K. has remained solid and has grown year-over-year. And overall, same community and marina growth is anticipated 5.5% this year. And I think there were some other updates to guidance. I don't want to...

We did. Based on performance in the first quarter and expectations for the rest of the year in our same-property pool, we did take up expectations for our manufactured housing portfolio by 40 basis points of growth, same 40 basis points as well for marina, offset by a moderation in expectations on the RV side, driven by transient demand that we're seeing over the course of the rest of the year, where a lot of that is shifting over to the annual side of our business where we've converted record sites from transient sites to annual leases over the course of the last couple of years, having converted 1,700 sites in 2021, over 2,200 in last year. And through the end of May, we've already converted about 1,000 sites, just over 1,000 sites in the portfolio.

Just one comment on the conversions. When we do actually convert an RV site from transient to annual, there's a pick of above 50% of revenue for the first year as that site is then leased for a full 12 months. And the average stay of a annual RV is approximately 4 to 5 years. So a lot easier to budget and forecast in the transient site.

Okay. Now let's go to the U.K., your recent new market, I would say. Maybe talk about the original rationale of the move to the U.K. and how that has evolved.

So when we look at manufactured housing as our platform in the U.S., it provides very, very sticky, dependable rent with margins in the 65% range. And the fact of the matter is that Sun has participated over the last 30 years in the consolidation. So very few available high-quality institutional acquisitions out there today. And touring the U.K. and watching it over a 10-year period of time, we identified Park Holidays as an opportunity to expand the foothold and the percentage of revenue related to manufactured housing, in an English-speaking country that was just in infancy, if you will. So very similar to our Snowbirds, they come down the manufactured homes that they own in Florida, Arizona and other warm weather parts of the country where they have a second home to come down to, the homes in the U.K. and the Park Holidays are vacation homes, although the seasons are opposite. Most of the vacationing in the U.K. tends to be in the summer season when school is generally out, the same similar aspects of the fact that the licenses to stay in a Park Holiday community are 20 to 30 years. And generally, the Park Holidays are coastal within communities that are within 2, 3 hours of London and the other major metropolitan areas of the country. With Brexit and the change to travel habits in the U.K., there's more interest in vacationing in the U.K. for the residents there. And we saw it, as I said, as an opportunity to expand our footprint into a larger pool of manufactured housing similar to the U.S.

Okay. You mentioned at the opening that you've been very acquisitive for the last 10 years. And I'm just curious if the current cost of capital holds, what is a reasonable pace of acquisitions?

I would say -- echo Gary's comments from the introduction, we are quite internally focused as far as where we will allocate capital. Any acquisition for external growth with our cost of capital today would have to be very strategic from that perspective. And we would not come to the market to fund that acquisition. We had one $100 million acquisition in the first quarter of a strategic marina in Savannah, where we paid for that with a convertible preferred operating structure at a significant premium to where our stock was at the time. During -- in this period of higher cost of capital, we will look to extract growth from our internal portfolio. There continue to -- we continue to have significant opportunities to provide the growth that you're expected to see from us on a same community basis. So great on the manufactured housing side, great business plan, right? We are 98% occupied. Rents this year are at 6.2%, 6.3%, where we expect to be by the end of the year. Historically, rental increases have been above CPI. But we've had a rental increase on an annual basis, and therefore, applying that on every year, a hawkeye on expenses and delivering that growth. So it's -- it will be a quite inward-focused strategy over this period of time.

We had a big rise in interest rates over the last few years. How has that impacted cap rates for your various asset types?

So interestingly enough, just due to the scarcity, I think in the valuation on the manufactured housing and RV side, over the last 10 years, we've seen significant compression on cap rates. And what we've seen recently with rising cap rates, certainly, on the institutional quality assets is not much expansion on the manufactured housing side. When that institutional asset comes to the market, which is infrequent, cap rates tend to be in the 3% to 4% range. On the RV side, we have fundamentally seen about a 50 to 75 basis point expansion on those assets. And then when we get into the marina space, after Sun acquired Safe Harbor Marinas, we've seen about 100 basis point contraction as the marina space has been understood and the characteristics of the supply/demand are being recognized and they're somewhere between 25 and 30 capital funds now seeking to create their own marina platforms. And that, of course, is causing compression about 100, 150 basis points in cap rates from where we acquired the Safe Harbor Marina assets.

Okay. The other topic more so earlier in the year was insurance. Do you have any updates on that?

Sure. So heading into our renewal on premiums this year was quite high for manufactured housing and RV. We experienced an 80% increase in premiums for the 2023 calendar year. If you combine that with our marina insurance program, just over 40% increase in our insurance. As we look at -- this is an annual renewal. As we look at our program heading into 2024, we largely have the same insurance program as we did, as we have historically very low deductibles, very small percentage of -- in a captive or self-insurance. So those are some of the levers that we would be able to pull in that -- in our negotiation with the insurance companies as we move forward for 2024.

Maybe switching topics over to ESG. What is your #1 priority in 2023?

Really, we've shared the concept of really our greenhouse gas GHG inventory, focusing on really putting it in a position so we can measure our results and achieve our goals. And this is really a year that we're highly focused on that GHG inventory.

Okay. I view Sun as more of a collection of assets, and you kind of -- in one of your answers, Fernando mentioned a strategic marina. But can you talk about some of the networking effect you're building, whether it's MH, RV, just kind of why are you more of the no collection of assets?

Okay. I think that -- when we talk about the marinas, we have focused on both a regional footprint and a strategic footprint. For example, you can travel down the East Coast, from Maine down to the Keys now and stay in a Safe Harbor Marina each step of the way. And if you're a one year -- if you have a 1-year lease, you're considered a member. We have a membership of 40,000 boaters now who actually keep their boats in the Safe Harbor Marina. They get things like discounts on gas, free transient stays if they're outside of their home base marina and a lot of other perks and strategically thinking through how to keep our members through the marinas, we acquire the best-in-class marinas, if you will. And Savannah, when we think about it strategically, it's one of three places in the world where you can take a 200- to 400-foot super yacht, motor craft or sail yacht, pull up on shore, make the repairs to it, service it, retrofit it, and it's already got a waiting list. And what it does is it keeps the large boats that would ordinarily have to go across to Europe for service over here, and it can take care of their service needs. And therefore, it creates stickier rent, if you will, in our marinas as they sign up for staying over here on the East Coast. And we saw incredible results of using this strategy for the two years that we've been reporting in the first quarter. Same marina growth was right around 15%. So it is these type of strategic acquisitions that are creating outsized growth as we refer to them.

Earlier in the commentary, you mentioned it's really hard to develop anyways, there's no supply, but there's one company I know that has been incrementally successful at getting entitlements and permitting and building, and that would be you. And I think you're a large share of the supply. So maybe talk about how long it took to get that reputation and how the pipeline has been building?

So I think, as I shared before, 30 years as a public company and almost 15 years it is private, our roots are in the development of manufactured housing communities and the expansion, approximately 5, 7 years ago when we saw the consolidation take place in the industry. We recognize the value placed on high-quality manufactured housing communities by virtue of the cap rates, somewhat 2 handles on them, but generally in the 3% cap rate range. And it's really due to the stickiness of the revenue and the high occupancy and the fundamentals of manufactured housing that we began to go back to our roots and focus on acquiring land, entitling it and zoning it. We have the skill set that our competitors in the market don't have and we have the capital to apply to it. And so it takes between 2 and 3 years to actually entitle and zone a piece of property, and you might have to be working on 10 or 12 different parcels to get one approved. So currently, after 5 years of work, we've got about 14,000 sites that are fully zoned and entitled. And we're starting to deliver those sites at around 1,000 to 1,500 new sites a year. So we can build a new community off of all this work and expertise that we have that I think is a fundamental differentiator from our competition. We generate yields of about 5% to 6% after stabilization 3 to 4 years and unlevered IRRs in the very low double digits after stabilization. And so we're able to give this -- yield these IRRs and really develop a site that is irreplaceable and modern in a space where they're valued at 2%, 3% and 4% cap rates. So it's great value creation. It is incremental to what we do, which is owning 100,000 sites and generally increasing the rents once a year and watching over expenses, but it's a very big differentiator. And as we look at these sites, we might bring 100 and 150 sites on in any given phase. And then next year, phase 2 of that same development will open up another 100, 150 sites, but we'll also start a new development. So during a 3- to 5-year cycle, we might have 5 to 7 new developments, bringing new sites online. And as Fernando indicated, at 98%, 99% overall occupancy, it's great value creation for our stakeholders. So we're very excited and pleased with the opportunity and the fruit of our work, if you will, over the last 5 years of getting the zoning and entitlement.

Okay. Now I'll turn it over to the audience for questions. Big audience. Anybody?

Can you say that you should [indiscernible] 80% [indiscernible]...

Our insurance premiums for MH and RV did go up by 80% this year.

Okay. We'll kind of get one more in. Maybe can we talk about the opportunities on the marina side? You did talk about conversions of slips. Maybe talk about the exponential growth you can get out of that.

Yes. Sure. I mean one of the -- given the marina sector has essentially been single ownership of one family to one marina, we would categorize as the marina space as being undercapitalized from that perspective, and they have not kept up with where trends have gone in the marina sector, where sales of boats and what our customers want to own are bigger and larger boats. That's not a Jaws reference there, but it turned into one. But the -- that is a tremendous opportunity for us as we acquire a marina where because trends have gone to sales of boats that are 30 feet and longer, we can take slips for a 20-foot -- three 20-foot Boston Whalers, let's call it, and turn that into two 30-foot slips, something interesting about the marinas and what we charge on a per lineal foot basis, there are no economies of scale in the marina space. The larger your boat, the more you're paying on a per square foot per lineal foot basis, and therefore, these are very accretive opportunities to us. We've -- underway, we have about 11 projects and have identified a few others across the portfolio that we can again drive internal growth within our existing footprint of marinas.

So I think I would add, very similar to how we look at expanding our existing manufactured housing communities. It's the greatest return on our capital investment, all the fixed costs are in place. So in expanding manufactured housing communities, we get 10% to 13% direct returns on the investment. And then the reconfiguration, the capital invested gets similar, 10% to 13% returns very rapidly after the capital is deployed.

Okay. Well, thanks, everyone, for joining. Thank you both for participating.

Thank you.

Thanks, Wes. Thank you all.