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

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Sun Communities Second Quarter 2023 Earnings Conference Call. At this time, management would like me to inform you that certain statements made during this call, which are not historical facts, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although the company believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, the company can provide no assurance that its expectations will be achieved. Factors and risks that could cause actual results to differ materially from expectations are detailed in yesterday's press release and from time to time in the company's periodic filings with the SEC. The company undertakes no obligation to advise or update any forward-looking statements due to certain events or circumstances after the date of this release. Having said that, I would like to introduce the management with us today. Gary Shiffman, Chairman, President and Chief Executive Officer; and Fernando Castro-Caratini, Chief Financial Officer. After their remarks, there will be an opportunity to ask questions. [Operator Instructions] As a reminder, this call is being recorded. I will now turn the call over to Gary Shiffman, Chairman, President and Chief Executive Officer. Mr. Shiffman, you may begin.

Good afternoon and thank you for joining our call to discuss second quarter results and our updated 2023 guidance. We are pleased to share Sun's continued strong operating results. Core FFO per share was $1.96 for the quarter, was in line with guidance, supported by a strong 6.3% year-over-year growth in same-property NOI and 3.4% growth in recurring EBITDA. Our properties share the compelling fundamentals of resilient demand and low to shrinking supply, which when combined with the unparalleled customer services our teams deliver, historically generate high durable cash flow streams throughout economic cycles. Same property NOI growth in the quarter exceeded the high end of guidance by 150 basis points and was driven by solid revenue growth and the successful implementation of the ongoing expense management. In manufactured housing, same-property NOI grew 5.7% compared to 2022, driven by strong rental rate growth and bolstered by occupancy gains. In RVs, same-property NOI growth of 3.2% reflected our continued focus on converting transient guests into annual residents, which increases our stream of stable revenue and improves operational efficiencies. At the end of the quarter, same property adjusted occupancy for our combined MH and RV locations was 98.7%, a year-over-year increase of 170 basis points and reflects the resilience of demand for our properties. Additionally, across our total portfolio, we gained over 1,000 new revenue-producing sites during the quarter, which represents 9.4% growth compared to last year and brings total gains for the year to nearly 1,850 sites. Same property Marina NOI grew 11.9% compared to the prior year, exceeding our expectations. The outperformance was fueled by robust demand for wet slips and dry storage from boaters who increasingly discover the convenient unmatched locations in premium amenities offered throughout our best-in-class network of marinas. On a trailing 12-month basis, our same-property portfolio generates 91% of total real property NOI and is a powerful engine for EBITDA and cash flow growth. We intend to remain internally focused on optimizing our embedded portfolio growth. By reinvesting in our properties and providing the highest level of customer service, we present an increased value for the residents, guests and members and help ensure predictable long-term revenue growth. Portfolio optimization includes completing select property expansions and in the case of marinas, dock reconfigurations to enhance property returns and to scale property operations. In the second quarter, we delivered over 100 expansion sites across 3 communities. In May, we published our 2022 ESG report, highlighting our significant achievements, including the expansion of our GHG inventory to cover marinas and the U.K. and the board's commitment to achieving net zero emissions. These and other important initiatives reinforce our dedication to being responsible stewards of all resources towards a shared goal of improving the communities in which we live, work and serve. I would like to thank all Sun team members who have been instrumental in our accomplishments in the first half of the year. As we progress through the second half of 2023, I look forward to realizing even greater achievements that will further enhance Sun's platform through the value we deliver to all of our stakeholders. I'll now turn the call over to Fernando to discuss our results in more detail. Fernando?

Thank you, Gary. During the second quarter, core FFO of $1.96 per share was in line with guidance. Real property revenue growth as well as efficiencies in property and corporate level expenses drove the quarter's performance, partially offset by higher interest expense. Our same-property results were solid as demand for our properties remains strong. Total same-property NOI grew 6.3% in the quarter as compared to 2022, which outperformed the high end of our guidance by 150 basis points. Total same-property revenues grew 6.2% and exceeded property operating expense growth of 6%. The lower expense growth was broad-based with moderate year-over-year growth realized in payroll, utilities, real estate taxes and other expenses. Same-property manufactured housing NOI increased 5.7% during the quarter, exceeding internal expectations. Our performance was driven by strong occupancy gains bolstered by a rental rate increase of 5.7% and lower-than-expected expense growth, especially in payroll investments. In RV, same-property NOI for the quarter increased by 3.2%. We achieved strong 8.6% growth in weighted average annual rents over the prior year and operating expense efficiencies that resulted in modest 4.1% expense growth over the prior year. These partially offset a 6.1% reduction in growth in transient RV revenue. Our RV communities delivered solid results during the July 4 holiday weekend. Same-property RV transient revenue increased by 8.4% compared to 2022 even as we had 5.7% fewer transient sites available. July 4 fell on a Tuesday this year, whereas last year it fell on a Monday. Adjusting for just the Friday to Monday period, same-property RV transient revenue still increased by 2.7%. While we continue to see strong holiday and weekend demand, during mid-week periods, transient RV revenue growth continues to moderate from recent record levels. Strategically, we remain focused on increasing our stable annual property revenues through increased transient to annual site conversions. In addition to increasing the percent of revenues derived from annual residents, conversions result in higher NOI margins over time by decreasing the higher level of variable expenses associated with transient guests. During the second quarter, we converted over 750 transient sites across our total RV portfolio, bringing first half conversions to nearly 1,300 sites. Since the start of 2020, we have converted over 6,000 transient sites to annual and we intend to continue driving transient to annual site conversions to optimize long-term returns. In the second quarter, Marina same-property NOI increased to 11.9%. This outperformance was driven by a 9.2% increase in revenue from stronger demand overall and lower expense growth of 3.4% that significantly surpassed our internal expectations for mid-single-digit expense growth. Lower expense growth was most significant in Marina payroll and benefits, utilities and supply and repair. In terms of home sales, we were in line with our expectations in North America and are on track to achieve our guidance. Continued demand is demonstrated by an average price for new homes of $210,000 and higher margins. In the U.K., economic headwinds continue to impact vacation home sales. Home sale NOI margins, while 5.7% below prior year margins were in line with our expectations. The approximately 840 homes sold in the second quarter were 8% below our expectations. Inflation in the U.K. has remained higher for longer than anticipated. And in late June, the Bank of England implemented an unexpected 50-basis point increase in its base interest rate. We have seen the time home purchasers take to buy a vacation home continue to lengthen and the margins on those home sales remain under pressure. Our experienced U.K. team continues to successfully navigate this challenging market environment with a focus on optimizing volume and margins while these conditions persist. On the real property side, we are seeing higher retention rates for Park holiday homeowners, which leads to higher average resident tenure approaching 8 years. We remain enthusiastic about the growth opportunity in this segment of the business. As of June 30, 2023, our $7.6 billion in debt outstanding bore interest at an weighted average rate of 4% and had a weighted average years to maturity of 7.1 years. Our trailing 12-month leverage ratio was 6.2x. Based on our operating cash flow expectations for the remainder of the year and potential capital recycling opportunities, we anticipate deleveraging towards our long-term leverage target. As detailed in our supplemental, we are revising our full year guidance range for core FFO per share downward by 2.2% to a revised range of $7.09 to $7.23 and establish guidance for the third quarter. Our revised guidance is primarily reflective of lower expected home sales in the U.K. and higher interest expense expected in the second half of the year, predominantly from the flexible variable rate sterling-denominated debt that funded our U.K. business. Since our last guidance update in April, short-term interest rates have increased meaningfully. We are evaluating opportunities to refinance and pay down floating rate debt over the second half of the year. We expect continued strong same property performance and are increasing our total same-property NOI growth for the year to a range of 5.3% to 6.1%. The 20-basis point increase at the midpoint is driven by outperformance in manufactured housing and marinas, moderated by revised expectations for same-property RV. We also expect additional G&A savings over the second half of the year. Our revised same-property NOI growth ranges for the year are 5.2% to 5.8% for manufactured housing, representing a 50-basis point increase at the midpoint, 3.4% to 4.6% for RV, representing a 100-basis point decrease at the midpoint. The largest driver for the decrease is revised growth expectations for transient RV revenue, which is now forecasted to be a 3.9% decline for the full year, 8% to 9% from marina, representing a 110-basis point increase at the midpoint. For our U.K. operations, we are lowering our full year forecast for home sales NOI and [indiscernible] $65.7 million to $75.4 million. The revised range represents a $10.2 million decrease to prior guidance at the midpoint and assumes we sell between 2,800 to 2,900 homes for the full year, an approximate 11% decrease in volume from April expectations. For additional details regarding our updated full year guidance, please see our supplemental disclosures. As a reminder, our guidance includes acquisitions and dispositions and capital markets activity through July 26 and the effect of a property disposition under contract that is expected to close during the third quarter. Our guidance does not include the impact of prospective acquisitions, dispositions or capital markets activities, which may be included in research analyst estimates. This concludes our prepared remarks. We will now open the call up for questions. Operator?

[Operator Instructions] Our first question comes from the line of Josh Dennerlein with Bank of America.

So this is the second time in a row you've taken down U.K. home sale profits and I think the volumes as well. What's to say this is the bottom? And can you kind of walk us through how do you forecast or come up with that guidance range for the home sales and the profit?

So Josh, you know to really look at how we're thinking about the fact that we've had to reguide before on the U.K. I'd underscore that the home sales forecast has built really from the bottom up at the community level, taking into account all available sites to sell home loan, which include vacant sites, sites to be delivered from expansion activity and rental home, higher fleet sites that we can convert to be able to sell homes and create an annual fee [indiscernible] And this exercise that is completed, let's say, a lot of those [indiscernible] sites have built up from the property level. Our revised range really incorporates current market conditions as we understand them. It doesn't assume any major decline in inflation or interest rates in U.K. for the remainder of the year. And we think even if we were to see them, the lag between those changes and improvements wouldn't impact results for the balance of this year. Certainly, they move into '24. So the high end of our range currently indicates what we believe is the most likely of outcomes and the low end of our range really had -- tend to caps that outcome further to what we would consider worst-case scenario. As Fernando mentioned in his remarks, since we met [indiscernible], certainly, the conditions since that have changed in the U.K., much slower reduction in CPI, although there has been some modest reduction. But the Bank of England 15-basis point rate increase was unexpected and it does have ramifications on the buyers of our vacation homes. So from the best insight that we can see, we feel that we've done a good job really thinking through what the scenario should be through 2023 and that's how we adjusted guidance and came up with a range.

Okay. And then could you walk us through how most people finance or pay for their park holiday homes? And is there a -- do a lot of people use like a second lien on their primary home to pay for it?

Sure. So Josh, about 30% of our homeowners are purchasing with financing that would be akin to channel financing here in the U.S. The other 70%, we see it as cash. In some instances, they are, right, using proceeds from refinancing their home, their primary home in order to purchase their vacation home. Certainly rates are -- refinancing rates are higher for primary homes. So that's going into the equation as far as lower volume expected sales.

The only thing that I would add that in the U.K., the single-family residential primary home mortgages and the fixed rate for a shorter period of time here in the U.S., 3 to 5 years. So certainly, those potential vacation homebuyers are experiencing a reset to their mortgage rates. And that probably is a factor on why we're seeing a slower conversion to buy homes from our potential customers. The interesting thing I just would add is that these, how these platform really continues to put a strong -- to markets through the changes in Brexit, the location of the units, the worth of the properties, the work from home that's taking place there. So there's still -- when we talk about the real property activity, still high demand, high tourism, high usage and the high anecdotal interest remains in buying homes but it's definitely influenced by a slower pace of sales because I think they're experiencing financial ramifications in the U.K.

Our next question comes from the line of Brad Heffern with RBC Capital Markets.

Sticking with the U.K. home sales. Can you talk about what underlies the guidance for the rest of the year in terms of the ASPs and the margins compared to last year?

Sure. So Brad, our 2,800 to 2,900 home sales expectations for the full year have us having a margin of between $24,000 and $25,000 NOI margin. As you see -- as you can see reported for us. So we do have a moderation to margin expected. On a year-to-date basis, we have been achieving about a $26,000 margin.

Okay. Got it. And then how do you think about what needs to happen for that business to recover? Is it just rates need to stabilize or go down? Does the U.K. economy need to improve? And how long do you think about that potentially taking?

Yes. I like to think we had a crystal ball. And if we build on our assumptions, we would have thought earlier we would start to see some improvement but that hasn't taken place. So clearly, when you look through Europe, U.K. has the most challenged economy right now. I think the steps that have been taken by the Bank of England have begun to show some improvement in CPI, which was right around 10% a year ago. As recently as a little while ago, we dropped to [ 7.9 ]%. So it still has the ingredients to go. But I think as we see that improvement, we would expect there would be a commensurate rate decreases in conjunction with that over time. So as we look out into 2024, we think that's when we'll begin to see the change in realization that we go back to more normalized sales.

[Operator Instructions] Our next question comes from the line of Keegan Carl with Wolfe Research.

[Technical Difficulty] ...doing so well. Just curious, one, what you're seeing on the Safe Harbor platform. Two, how you're thinking about underwriting the long-term view of the space? And then three, what the marina performance does to your views on long-term capital allocation going forward?

Keegan, the first I would say 5 seconds of your question, 5 to 10 seconds of your question did not come through. Can you repeat, just start over.

Yes. So just focusing on the marina business because obviously, our performance is really impressive, I think people should be focusing on that. So one, given what you're seeing in the Safe Harbor platform, how is that trending versus your initial expectations? How are you thinking about the long-term underwriting of the space because of this? And then what does it mean from a capital allocation standpoint going forward?

I'll start out, Keegan and just suggest that the Safe Harbor outperformance really was driven by strong demand for slip and dry storage rental across the entire waterfronts, small to medium, all the way to the [indiscernible]. The peak season rate increases were passed through and occupancy remained very strong. We're seeing increased demand for slips across the board. And a lot of it, we really do attribute to the value of the Safe Harbor membership, which includes such things as an unmatched network of locations out there today to travel between, best-in-class facilities and amenities for the members to use and really best-in-class customer service that we talk about. And then the perks like passing on fuel at basically our cost, we noticed that fuel usage is up 13% year-over-year on a per gallon basis. So some of the impact of [indiscernible] which was a decision we made intentionally to sacrifice that margin is really paying reward in the more important slip rental. So we're very, very pleased at how things are performing at Safe Harbor Marinas and we've seen it in performance quarter after quarter. With regard to our long-term outlook, I think we have shared with you that capital allocation is fairly restricted at the company today. We're very internally focused on using our capital in a very disciplined way within our portfolio as marinas are a great example. We have identified 27 opportunities to reconfigure marina slips. And when we invested reconfiguring the slips, we get about a 10% to 12% return on that investment. Of the 27 opportunities, 7 reconfigurations have taken place. We are under construction right now and about 10 others are in the permitting process and 3 or 4 are still being worked on. So that's where we'll see capital allocation. If we're looking for external growth, it will be restricted to a really accretive opportunity in a situation like a savanna, yard marina, where strategically, it has a lot of benefit to the network effect that we're trying to achieve within the marinas. So I don't know if you have anything to add. Hopefully, that addresses some questions.

Can I just follow up just because Fernando called out capital recycling is an opportunity. Is it fair to assume you might sell some MH, RV assets and recycle the capital into that the higher cap rate, higher-return marina business? Is that the right way to think about it?

Keegan, I think that as we look at our portfolio and evaluate, there is a bottom tier of assets, always [indiscernible] ranking. So we'll look to selectively and strategically look to recycle out of some properties that maybe aren't meeting the long-term growth profile that we're looking for. And today, any immediate use of that capital would likely go towards deleveraging. But certainly, we'll evaluate all opportunities in front of us.

Our next question comes from the line of Eric Wolfe with Citi.

It's actually Nick Joseph here with Eric. Gary, if I think about kind of really over the last 10 years, I think the company has really benefited from a stability of results. And if we go back to kind of the guidance questions earlier, definitely seems like things are a lot more volatile now. Obviously, part of that is probably the recent acquisitions. But at the end of the day, it's missing guidance and calling into question kind of the forward guidance from here. So as you think about what do you think needs to change from the corporate side to forecast results more accurately? Are these just growing pains, I guess, within U.K. and maybe some of the macro volatility that you cited. And ultimately, we get back to kind of how it was traditionally or is the range of outcomes just a bit broader given the new businesses?

I'll give you with some thoughts that I have and Fernando certainly can share his thoughts. But we have shared with our stakeholders that complexity is something we're working very hard to reduce, taking all the steps that we possibly can to get back to helping and assisting with the simplification in the modeling forward guidance. There is no doubt the headwinds we're experiencing in the U.K. have caused a lot of challenges with regard to guiding forward. And when we think about things, we use the best tools that we have at the time, whether it be the forward curve, whether it be meaning everything we can with regard to how we look on the economic challenges there. Obviously, we've had to reguide, so that makes things difficult. But all in all, when we think about 91% of the entire contribution from real property is what we're trying to guide to. We have a lot of work to do in the U.K. that we're working on. On the marina side, we've worked very, very hard to be able to put together the same site marina data so that we can measure going forward. And I know that Fernando in the disclosing supplementals has been working to simplify a lot of things and kind of present a lot of benefits that can help the modeling. And I don't know if you have anything you want to add from there. So we are very, very attuned and aware of the complexity that has been created in large part through the acquisitions, both in marinas and the U.K. recently. And as a company that's been around 30-plus years in the public marketplace, we've listened to our stakeholders and we're very, very focused on step-by-step reducing that complexity and making the modeling and the forward guiding as good as possible.

Maybe just a follow up on that. What can you do to reduce the complexity kind of in the near, medium and longer term, right? Is it selling the U.K. home sale business? Is it somehow restructuring it? How are you thinking about actually reducing that complexity?

Well, certainly, one piece of it is the fact that strategically, we have shared with the market that our long-term goal in the U.K. was to deemphasize contribution from the home sales margins and focus on the very, very stickiness of real property contribution like we do in the U.S. and that was a kind of a 5-year strategic plan. We're slowly making progress out there. Ironically, as a percentage, with home sales down that real property side percentage is up but we're working on it over a long period of time. And I think that we've already increased the average stay in the U.K. to around 8 years. We're expanding our licenses to stay in the U.K. properties for -- from 20 years to 30 years. So we expect that in years to continue to grow and look more similar to the 15 years, if you will, in the North America manufactured housing. So deemphasize the margins on home sales and really focus on the real profit contribution and we've taken similar steps in the marina side to accomplish that as well as we convert some of the SRD&E and pick you as a service over to rental income from third parties. All that, I think, as we look out over a period of time, will help to simplify things going forward.

Our next question comes from the line of Anthony Powell with Barclays.

So question on, I guess, normalization of various leisure adjacent businesses. It's been a topic of a lot of calls over the past few days. Transient RV and marina, you're still seeing growth in transient RV, I guess, on holidays, not necessarily midweek. And then marinas has been pretty strong. Do you see any risk of normalization impacting these revenues in the next few years as people will turn to maybe more older habits post COVID?

I'd say, Anthony, I think we're overall on the transient RV side, we're seeing that normalization from record years over the last 2 to 3 years, given the bump over the second half of 2020 and into 2021. We are -- we continue to see a lot of demand for our properties. I think you see that with the record number of conversions that we have, having converted over 6,000 sites over the course of the last 3.5 years, which greatly outpaces what we were averaging on a per year basis prior to the pandemic. And so now we're taking that transient guest and they're choosing to stay with us for call it, on average, about a 5-year period of time and on an annual basis, getting a rental -- predictable rental increase from our standpoint. On the marina side, we've certainly seen very high demand on the transient side as well in the first half of this year, I would say, right, we're not underwriting double-digit transient growth for that line item. But I'll remind our stakeholders, the percentage of rental income coming from transient. On the marina side, it is much smaller, it's about 5%, 4% to 5% of total rental income. So we have seen outperformance on that line item but are not underwriting double-digit growth for over the course of the mid to long term.

Our next question comes from the line of Jamie Feldman with Wells Fargo.

Great. So appreciate all your commentary on park holiday and [indiscernible] But if you think about some of the other areas where you took down guidance, how do you create more visibility on that and simplify that. And then along the same lines, your credit line balance is up above $800 million. Can you talk about plans to either keep it there or refinance that to bring it back down?

Thanks, Jamie. On the -- we modestly brought down expectations on the SRD&E [indiscernible] side. That is, as Gary mentioned earlier, we are looking to deemphasize that over time as we, especially on the marina side, we convert the service business over to third parties paying us rent at the property level. So I think we'll continue seeing that over time. And that ultimately will benefit real property NOI and rental income that we receive, not just from our members but then third parties that pay us rent to be at our properties to provide that service. As it relates to our line of credit, we have -- we've mentioned over the course of the last couple of months, pursuing various strategic alternatives where -- whether that's capital recycling from operating assets that the immediate use of that capital would be to pay down debt. I think as you look towards the second half and into 2024, there will be a moderation in capital investments as well that will convert more free cash flow towards deleveraging. So we are evaluating transactions in the capital markets as well in order to bring those balances down and delever towards our long term target of being in the [ mid-5s ].

Okay. And if I could just ask a follow-up on that. So the interest expense guidance reduction, is that because you used the credit line and didn't expect to or because rates are higher than you thought they would be? And if you did use it more than you expected, what was the reason for that?

Sure. On a forecast to forecast basis, I would say primarily would be expectations from the forward curve, where, in general, ending the year rates for both SOFR and SONIA are up on average about 70, 75 basis points from our last forecast in -- at the end of April.

Okay. So it's not balanced. It was really just forecast.