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

Good afternoon. I hope everyone had a good lunch. I'm really excited to host the Sun Communities team. To my right is the CEO and President, Gary Shiffman; and to his right is CFO, Fernando Castro-Caratini. And I'm going to pass it off to Gary for a few opening remarks, and we can jump into Q&A. Feel free to jump in if you have any questions from the field. But with that, I'll pass it over to Gary.

Good afternoon, and thanks, Josh, and thank you all for joining us on today's conference. And I don't know if my teeth start chattering, I'm wondering if anyone else feels it's a little cool in here. Little cool, okay. It's not just me. It's a brief introduction to everybody. Sun Communities was founded around 1975. It's been listed on the New York Stock Exchange since '93, under the ticker SUI, and we are in the business of renting parcels of land and water, or land that's underwater with the water on top. More specifically, we're the largest owner, operator and publicly-traded owner of best-in-class manufactured housing, RV communities and marinas. Each of these top property types is characterized by constrained supply and persistently strong demand, and we'll talk a little bit about those barriers. So in addition to the scarcity, if you will, of existing locations, it's the barriers to entry, the barriers to new supply are a result of difficult, complex and lengthy zoning and entitlement processes to be able to build out any new supply. And especially when it comes to the marinas, the environmental regulations play a big role. And in all 3 platforms, very, very little to no supply. And in the case of the marinas, even a shrinking inventory, if you will, of supply of marinas due to the fact that marinas are often waterfront, they're acquired by developers and redeveloped into commercial and residential type real estate. So high, high demand, very low supply. It's the demand for affordable housing and the existing base of RV owners and registered boats that represents this existing demand base that exceeds the supply that I just spoke of and the supply/demand imbalance is what makes our business highly what we refer to as recession resistant. And we demonstrated that with our positive same property NOI growth throughout all economic cycles. During our 30-year history as a publicly-traded company, we've established a track record of delivering attractive returns for investors by growing, diversifying our portfolio, and our business model generates consistent and dependable cash flow from the stickiness of the revenues with additional growth opportunities available through annual rental rate increases, consistently high occupancies and expanding existing properties on adjacent land that we either own or acquire. So a lot easier to expand an existing MH, RV community than it is to develop a new one from the ground up. With a large component of our growth since 2010 is driven by opportunistic acquisitions. We acquired about almost $12 billion of external acquisitions over the last 10, 11 years. Our primary focus today is to optimize the value of our existing properties. So we're very internally focused on our portfolio. We will drive higher internal growth through rental rates that exceed inflation through realizing operational efficiencies and growing our base of occupied sites. I'd also like to just share with everybody that the vast majority of everything that we own has the ability to increase rental rates on an annual basis equal to or greater than any CPI or inflationary pressure. So additionally, to increasing rents, controlling expenses, we're very focused right now and strategically recycling capital. And to that effect, we've been looking at our portfolio really and expect to prune some assets. The last asset sale that we really did was in 2017, about 30 assets, representing a total about $300 million worth of dispositions 2014. Thanks, not 2017. And the fact of the matter, these aren't distressed properties. We're not under any pressure to sell. But in looking through the portfolio, the fact of the matter is that we are able to identify some communities that are smaller that makes sense for our company today, some outliners of large communities where we anticipated buying more in the region or in the state and just haven't accomplished that. So through economies and efficiencies that would make sense to accretively be able to recycle that capital through the sale and pay down some of the debt on our floating rate line, which is at roughly plus 6% interest rate today. So our internal focus will be scaling corporate expenses and technology as we move forward, less dependent as pencils are down right now for external acquisitions, obviously due to cost of capital, and we expect to generate attractive earnings and growth through the long-term success that we employ throughout the portfolio to the benefit of all stakeholders. And I really do appreciate the opportunity to be at the Bank of America Conference today, Josh. And for follow-up questions on any topics, I'll turn it back over to you.

Yes. Thanks, Gary. Appreciate all the opening remarks. Before this panel started, we were actually talking about where you're spending most of your time today and got into why. I thought maybe we could actually kick off there.

Absolutely. I think that for those of you aware of a little bit of history of Sun and for those of you not, we are in the business of renting dirt in that water, as I said earlier, and we like to collect monthly coupons. The demand is such that in our MH and annual RV portfolio were 98% plus occupied. We're typically able to put through rental rate increases that exceed general CPI pressure, and therefore, our same community growth historically has reflected probably some of the highest consistent percentile growth in REITs of all asset classes, so we continue to do so. And our focus right now has been very much on the U.K., where we acquired an MH Park Holidays platform. It will be 2 years ago, April and have been experiencing the headwinds of inflation. It's been -- a year ago, it was 10% in the U.K., higher interest rate environment and the pressure on our home sales there. So a lot of focus has been on pulling every lever, working with a very experienced team at Park Holidays. And we've guided our home sales down from about 3,600 at the beginning of the year to a range of 2,800 to 2,900 homes to be sold. And through August of this year, we've now sold 2,220 homes. So we feel that we're on track for that 2,800 to 2,900 guidance and very, very focused and continuing to support the U.K. process. I always like to point out that it represents around 5%, 6% of our total business, but we are very focused on continuing to oversee that platform as it offers a lot of opportunity. And the opportunity is very much like our manufactured housing here, which has been consolidated over the years, and it's an excellent opportunity for us to grow in that part of the business in the future. So that's where we've been focused.

So one thing I've been looking at is just like trying to figure out like what are the macro drivers of like the U.K. home sales. Like I haven't found like a good correlation yet if any. Anything like you see on the macro front? Because I think last quarter, you mentioned the higher inflation, higher interest rates is potentially impacting the home sales in that business. Just kind of curious like how sensitive are these home sales to the macro environment? Or is it truly like internal levers that you can drive to push home sales and margin?

I think it's a combination of the two. Just for informational purposes in order to have a vacation home in a Park Holidays property by regulation of the zoning and entitlement, you must own a primary residence. So this is a vacation home, a second home. And the fact of the matter is that mortgages in the U.K., the fixed rates tend to be 2 to 3 years, sometimes up to 5, but they don't extend past that. So mortgages are reset unlike here in the U.S., where we might have 15, 20, 30-year mortgage fixed rates, every 2 to 5 years. So some of those potential residents are waking up and realizing that they're going from a low single-digit refinance to a mid- to high single-digit mortgage rate. So that has modestly impacted our sales. That primary feeder for vacation home sales is those that stay at a guest in one of our communities, and 40% of our homebuyers have first started out as a guest. And on the real property side and in the rental part of our business, we've actually raised guidance by about 10.6% since the beginning of the year. So we're still experiencing good uses of the communities. The retention, 10-year retention in the community has gone up from 7% -- 7 years, I'm sorry, to 8 years this year despite historically high 7.3% rental rate increase. So we're seeing strong, strong demand. But the headwinds of the economy, interest rate increases have caused us to adjust and guide downward a bit, but the levers that we can pull are to continue to market to reduce margins. We've reduced margins by about $2,000, $3,000 from an average expected to be $26,000 a home to about $23,000, $24,000 by year-end. So that's created some interest. And then some bundling opportunities that if you buy a home, will include the first or second year's rent. And thereby, you don't have to worry about the rent. And as I said, through August, we've experienced 2,020 home sales, 300 in August. These are new updates we provided in this presentation. September is the largest month for home sales. And then the fourth quarter accounts for 15% to 17% as the community is shut down for the winter holidays. So we feel we're on track, and we'll be able to report more with our October earnings.

So maybe just a follow-up on the margin comment. It sounds like you're [ counting ] them a little bit. What -- you quoted, I think, absolute numbers. What is that on a percent basis? Like I think, they're in like the 40s, the first half. Where are they trending now?

Josh, that's correct. Margins on a percentage basis have trended 40% or upwards of 40%. And so we're expecting to end the year on average over the full year, call it, in the high 30% margin range.

Long term, our strategy has been to get closer to the North American model in manufactured housing, where we're much less concerned about the home sales margin contribution and more excited about the opportunity to increase velocity of absorption and increase the more highly-valued sticky monthly fees or monthly rents. So it is our long-term goal to reduce margins and increase absorption and velocity in the property. So unfortunately, through the headwinds, it's happening a little bit faster than anticipated.

So one thing that I -- you produced that chart of the long history of home sales in the U.K. in your portfolio. I noticed from 2015 to 2019, it seemed like it was just above 2,000 on average per year and your guides for 2,800 to 2,900, was there something with like the number of properties that changed because there was a big jump up in COVID in 2021? Or is that like a potential COVID pull forward over the last 2 years and this year, it's been elevated for, I don't know, something other than just like a property count change?

It is -- josh, it is a larger portfolio today than back in 2015. So the -- I think the way to think about it in our presentation when we had an Investor Day in London in the U.K. in June of last year was sales as a percentage of total sites for the portfolio. And on average, over that period of time, we've run, call it, 15% to 16%. There's -- it certainly has gone higher over the course of the periods, immediately after the -- or still during the pandemic, but given the very strong demand for home sales at our properties. So that's a better metric and outside of gross number of sales because the portfolio has gotten -- is larger. Our original acquisition of Park Holidays was 40 owned assets and 2 managed. We have -- today, that portfolio is 55 assets. So the gross number would be less comparable than as a percentage of total sites.

Okay. So the -- you were in that 15 to 16 historical range. Okay. Okay. Interesting. Any questions from the field in the U.K. Yes, Colin.

So you're saying you're planning on transitioning as [indiscernible]. Is that always advantage? How many years has this really been accelerated?

So upon announcement of the transaction, strategically, we shared that plan with investors in the market. So it's always been the plan. We looked at a 5- to 7-year period of time. There is short-term contribution FFO dilution, if you will, as we bring down margins, increased velocity. We can't make it up in rent the first 1, 2 or 3 years, but we make it up over a period of time. And on the valuation of the higher-valued multiple on the sticky revenue. So we're probably accelerated, as I said, by the unfortunate circumstances by home sales being down, the percentage contribution of rental has gone up of about 600, 700 basis points. So almost 2 years into ownership, we're probably at 3, 3.5 years of where we expected those numbers to be.

When you're getting into 2 years [indiscernible] sale, just thinking about that site [indiscernible] started. Is that going to [indiscernible] so when they do start paying necessarily in today's rate, but...

Yes. And over the 40 years' of experience, public and private when we've used that kind of marketing tool here in North America. Generally, what we'll always do is we'll -- it won't be 100% -- it won't be 0. It will be some modest sum of money. It will go up each year according to the market rent for the 1 or 2 years. And the fact of the matter is we like them paying something, not nothing so that there isn't that tremendous sticker shot. But here, they make a big investment in the home, and they get the benefit, and it seems to be working. It's just enough to make them say, okay, we'll buy the home. One other new marketing piece that we've shared in the U.K., home buyers are giving a license, a term license, for which they can stay on the property that has been typically 20 years. We're increasing that to 10 years. So it's 30 years for which they know they can stay on the property now. And if they sell the home, the balance carries, and it doesn't -- it is really a positive thing as we see it. It's a longer, stickier rent, but is encouraging them from a closing standpoint as well.

Yes, Bill?

So I appreciate the number of home sales that we can get in [indiscernible]?

We -- both from a volume and contribution as far as the guidance that we provided by the end of the year, we expect to be within the range that we provided to the market for NOI contribution as well.

And as I indicated before, on a real property basis for the rents and the other parts of the business, we've increased guidance, I think, 2x, about 10.6% overall for the year. So it continues to perform as well. We've talked before about the pressure of Brexit and COVID being positive tailwinds, if you will, increasing demand of vacation in the U.K. More recently, there have been airline strengths and other delays that have caused people to think more about vacationing in the U.K. It's been a positive factor on the rest of our business there as well.

Joe?

As some of that discussed for [indiscernible]...

Yes. I think that moving forward in the U.K., which has hands down the most challenged economy in Europe, it's not without further risk. There's a lot of discussion that while interest rates can come down from 10% to 6.9%, they still got a long way to go. There's inflation. What did I say, interest rates? Okay. Thanks. Inflation. And the fact of the matter is they're talking about another potential interest rate in September. So as we look out to 2024 with inflation starting to come down, we believe that in a neutral scenario we are where we are and continuing to improve scenario. We'll start to see the improvement in the lift. That being said, we do expect a little bit of a lag, if you will, as rates come down, and there's a little bit of relief on inflation. It will take some time, I think, to get back to the sales that we expect, but we expect to be back on track.

And Jeff, from a macro backdrop, Gary mentioned the fixed mortgage for primary residences in the U.K., while the rate environment may be more constructive in 2024 than it is right now. Those that are refinancing their 2020 mortgage or 2021, we'll still see an elevated rate as compared to the last time that they refinance. So it isn't without right -- we're not saying that all of a sudden, there's a sudden bounce back from that perspective. But the market incrementally should be more constructive.

Any other questions on the U.K.? Switching gears a little bit to the U.S. I just wanted to touch base on MH. You're probably about to start planning the rate increases for next year. Just kind of curious like how we should be thinking about what kind of rate you should be able to push? And like is it different between all age and age restricted?

Yes. I think we're in the middle of the budgeting process right now. Our Florida residents, for example, will get their increase or their notice of increase for 1/1/2024 over the course of the next 2 to 3 weeks as the Florida requires a 90-day notice for the increase. This year, we are building up to an increase of about 6.3%, 6.4% by the end of the year. If you take that as, call it, the highest side of the goalpost and then our rate average increase over the, call it, the 3 years prior to the pandemic, which was around 4% per year. That's -- those are your markers as far as what the increase could be for manufactured housing heading into next year. Historically, there will be -- there is a differential between the increase across all age communities versus age restricted and that would be playing out in today's market as well. But ultimately averaging, call it, somewhere between that band that we've just provided.

Yes. I'd just add a little bit of color that strategically, we've shared the fact that we believe in a balanced portfolio. We tend to get stronger rate increases in nonage-restricted communities than we typically do in age-restricted communities in very difficult economic times. The retiree, if you will, has 24 hours a day to focus on things like complaining about their rent and being very vocal. So the fact of the matter is during good times, we get similar rental increases and in challenging times, probably it favors to the non-age-restricted, and we're kind of in that time right now. So that's why we believe in the balanced portfolio.

And maybe switching gears a little bit up on to the operating expense side has come up a lot in my conversations on resi. Just kind of any early indication on maybe what can happen in 2024 on the insurance side? It seems like across the board, there's going to be more pressure next year?

Sure. That's been a topic of conversation during our meetings over the course of the last couple of days. We are -- we will be heading to London over the course of the next couple of weeks to start the conversations with the insurance companies. Our increase happens to be -- or we bind our program at the end of the fourth quarter. The last year, that was -- or heading into this year that was a surprise to all from that standpoint where overall across our MH, RV and marina portfolio we experienced just over 40% increase in premiums. The overall insurance market, I would say, has not improved as far as macro backdrop for insurance. I think what's particular to Sun is the fact that we largely have the same insurance program as we've had historically. So low -- very low deductibles, very little inside of the captive insurance company that we've set up and very little self-insurance as it relates to our insurance stack. So those are levers that we expect to pull on a risk-adjusted basis as we negotiate our premiums for next year.

Does that imply you'll like look at setting up a captive or setup...

We have a captive setup, but we can, right -- we can increase. So it's -- today, our portfolio has, call it, very low deductibles, and so we can take up those deductibles, and that should have a positive impact on what our ultimate premium will end up being.

Any questions from the field?

Just want to follow up on the MH. I always thought that there was downturn, more risk than [indiscernible] comments on [indiscernible]?

Yes. We've been very vocal about it for much of our time as a public company. Intuitively, you -- the thought is we do lose people at the margin who lose their jobs and have to move for various reasons, but we gain far more occupants at the upper end. We're looking for value and affordable housing. So there is a great slide in our presentation that shows how occupancy trends through the GFC and other periods of time. But just the strong demand is what causes us to be able to increase in the all age plus the fact that they're not on a fixed income, if you will. And there are cost of living adjustments that definitely from time to time benefit the retirees, but not all of them depending upon how their pensions and their savings are -- can outpace what the expense increases, especially in the type of CPI environment we've just experienced.

As soften, but [indiscernible]?

Yes, on a rental rate increase and that's the recession resistance that we talk about, but keep in mind that less than 0.5% of all homes in our communities move out in any given year. The average stay tenure by a resident is right around 15 years and then the home sells in place. So when you run through that math, we're really getting uninterrupted income whether you call it 40 years, 50 years, 100 years, we haven't been around long enough to see that. But that's the stickiness in the high-value proposition of the rental income stream. And it's true for both, all age and age restricted. On the age-restricted move-out is more related to illness or end of life than it is on the all-age. All-age is more job related. But again, the funnel at the top is always so much greater. The waiting list, 50,000, 60,000 applications each year that we can't really process with a 98% occupancy.

What are the -- yes, Colin.

[indiscernible] just trying to start [indiscernible] sense of what acquisition is by buyers at this point [indiscernible]?

So we're just getting out there. And these are -- we're going to group together onesies and twosies and maybe 3 and take them out to market. We're really heading out there with the first group right now and see what the appetite actually is. It's not a distressed sale. We're not forced to do it. So we want to hit our mark. There are 2 other large portfolios that have been available in the market held by big PE firms. And the fact of the matter, the quality of those assets is much different than the quality of assets that either ELS or Sun has or would be interested. So the talk has been in the 4s for those, but nothing has been executed. So it really is an exercise in going out and seeing what takes place. And I'd probably share it would be good data point when you look at share price today and interpret that into cap rate on our NAV value. We think it's going to be important to show what the cap rates look like on these properties.

And Colin from a buyer profile standpoint, these -- we will be coming to market with, call it, a coast-to-coast portfolio. These will be, call it, localized marketing processes. So local, regional owner operator are going to our target audience as far as who the potential buyer will be for these assets.

I want to make sure we've hit on my favorite topic, marinas. It's been too long. Just thinking about like the NOI growth that you've produced in that portfolio, I mean, it's been the sector leading for -- among your 4 segments. Just how should we think about the continued outperformance of that segment going forward? Like how much more kind of like juice is there to squeeze as you look through like the operating platform?

I think overall and last quarter, I think we reported 11.9% growth. So really outperforming quarter after quarter than even our underwriting. But the fact of the matter is I alluded it to it earlier, if there was ever shrinking supply of inventory and a business platform that can't add new supply, it would be the marina business. So one thing we point to is that demand for the existing slips has never been higher. Boats are getting bigger and bigger. The percentage of boats being built over the last 10 years of 40 -- 30 feet and longer, has increased 50%. So while boat sales can go up and down, there is estimated to be around 10 million to 11 million registered vessels in the U.S. today with right around 1 million wet slips and/or dry stack storage. So supply/demand is such that we're virtually fully occupied. 85% of the properties have a waiting list on 30-foot and larger boats. And so we feel very, very comfortable that the demand for wet slip and dry stack storage, which is driving this will continue, and I'd turn to you as a boat owner, and you're not seeing any more marinas being built or anything like that.

I have not. What are you guys working on a -- on the operating initiatives on that side? Like is there anything -- like last year, you rolled out some initiatives on the fuel side, anything for 2024?

Yes. I'd share with you our strategy is one of membership at Safe Harbor. If you are an annual leaseholder in one of our marinas, you'd become a member, one of 40,000-plus members, you get certain perks for that. Perks such as we pass on our fuel -- about our cost with the expenses in that. That's a tremendous perk. If you are traveling, you get first right to get a transient slip. You get other certain rights as being a member. But the big thing now is the geographic footprint. You can travel down from Maine all the way to Puerto Rico and stay in a Safe Harbor marina and know that you're going to get a priority service experience. And then the other component is that we have strategically created service opportunity throughout the footprint as well. For those of you who have been on boats or have had an experience with boats, boats break. There's nothing worse than coming out for your holiday or for a Thursday to Sunday weekend and getting out there and your motor doesn't start. So the service creates high demand and much stickier steady in the leased slips. So it's kind of thinking through how we put together that membership and the benefits that you get that we think gives us an opportunity that differentiates ourself, if you will, from all the other owner operators that are out there today.

So we're about out of time here. But we have 3 rapid fire questions, 2 or 2 parters. The first 1 is, do you believe the Fed has done hiking? Yes or no? And do you expect the Fed to cut rates in 2024? Yes or no?

So no, and for the second yes.

Do you believe real estate transactions will meaningfully pick up by, a, the fourth quarter of 2023; b, the first half of 2024; or c, the second half of 2024?

I'm going to go with C.

Are you using AI today to help you run your business? Yes or no? And do you plan to ramp up spending on AI initiatives over the next year?

We are just in the early stages of studying it and learning as a group with some outside consultants and how -- and what opportunities might exist. So I look forward to answering that question in the future.

Great. Thank you, Gary. Thank you Fernando, I appreciate the time.