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

Welcome to Citi's 2024 Global Property CEO Conference. I'm Nick Joseph here with Eric Wolfe with Citi Research. I'm pleased to have with us Sun Communities, Inc. CEO, Gary Shiffman. The session is for Citi clients only. If media or other individuals are on the line, please disconnect now. [Operator Instructions] Gary we'll turn it over to you to introduce the company and team, provide any opening remarks, tell the audience the top reasons that investors should buy your stock today and then we'll get into Q&A.

Thanks, Nick, Eric, and Citibank for having us here today, and good afternoon, everybody. Thank you for joining us during today's conference. We look forward to answering your questions regarding Sun Communities. Today, Sun is the largest owner-operator of manufactured housing RV communities and marinas. Each of these property types is characterized by constrained Supply, strong demand and high barriers to entry. The supply demand imbalance, combined with our high-quality properties, their locations and operational excellence, makes our business highly recession-resistant. A fact, we have demonstrated by generating over 20 years of positive same property NOI growth throughout all economic cycles. As we step into this year and beyond, we're excited about the growth opportunities and our prospects. Our primary goal remains simplifying our operations to maintain focus on our best-in-class portfolio and our operations team who deliver strong same-property NOI growth by pursuing select capital recycling strategies and disciplined spending. We plan to use free cash flow and proceeds for deleveraging. A combination of our strong organic growth and portfolio maximization positions Sun to deliver attractive core FFO growth to our stakeholders, and we look forward to updating the market on our progress as we go forward. We're grateful to have the opportunity to be here before you and in person. On my left, Aaron Weiss, Executive Vice President of Business Development; and Fernando Caratini, our Chief Financial Officer. So from there, we'll kick it back over to you.

I think most investors would agree that you're doing the right things. You brought on new Board members, capital allocation committee, selling assets, deleveraging, reducing CapEx. But was just curious if there's anything that public investors have been sort of asking you for over the last 6 months, where you sort of disagree with them maybe in the long term. So for instance, U.K. investment maybe hasn't gone exactly the way you thought perhaps you think now would actually be a very good time to invest in it given cheaper valuations. Maybe you also think reducing some of your CapEx is a little bit shortsighted because the long-term returns there are great. So just trying to understand if you think there's any sort of disconnect between what public investors are asking you for and what you think in the long term will generate the best returns?

Good question Eric. I think overall, I would suggest that strategically, many of our shareholders have been long-term investors in the company, and we get to know them very, very well. And we have a good dialogue with all stakeholders. There's nothing that I could point to that the management team would differ with any of the constructive input we've gotten, certainly this past year, there were challenges in the U.K. macroeconomic environment, which resulted in downward guidance basically on home sales. And so the fact that we've been strategically internalizing the input we've gotten, we're running our business as we think it should be run. And I think it's very much aligned with any constructive commentary that we've got from our shareholders. So I don't think I could point to anything and suggest that we're not aligned.

And I guess if we fast forward a year, obviously, this year is hampered by certain things, at least from a core FFO growth perspective, other income and some other smaller items, interest expense, but if we fast forward a year from now, do you think you'll have shown to the market that you're able to generate that sort of core FFO growth that the market believes you should be generating given the strong same-store and fundamentals that you have?

And I think there's a good point to talk about where we would be without the headwinds.

Yes. I think as we think about this year in the [ core FFO ], that is a lot of the questions we're getting from investors. So it's a very good question and timely both for 2024 and then as you indicated, our outlook for 2025. What we've been trying to do is deliver that bottom line, you mentioned interest income from last year that would have equated to about $0.22 on our FFO for this year. We do have some interest expense headwinds for full in the higher rate environment. So in our guidance, you are seeing interest expense higher guided for 2024 than 2023. So as you look to see what the net impact of that would have been for 2024, you would have seen growth rates higher than you're seeing in our current guidance closer to 3% to 4% on a current basis versus sort of the 1% at the midpoint you're seeing today. And we do expect that to continue well into 2025 with some of the other things you've highlighted the reduced capital spending, the deleveraging which will continue to flow through because we feel very strongly in the long-term fundamentals of our businesses.

So I think I would add just a continued focus to translate the incredible core NOI growth into FFO per share growth as we get through '24 and without those headlines, we look at '25 and the years to come as getting back to that same kind of FFO growth that we've been able to deliver in the past.

And then maybe if we could go into each of the individual businesses. I think, I see some people that were on the tour with us on Sunday. It was a great tour and definitely taught me a lot about the Marina business and specifically that asset. I guess for the benefit of everyone on the line and everyone here, could you maybe just dive a little bit more into the Marina business? How do you set -- like I think everyone understands how you set your rates for MH, it's quite obvious, RV as well. But for MH, people don't quite understand the drivers of that business. So maybe you could just go into sort of how you set rates for annual customers what you think about the demand and supply dynamics over the next couple of years that should hopefully continue to drive that?

So we're talking about the Marina business?

Yes, just Marinas.

So I think I've set the stage and anyone can join in. But we're in the Marina business because of the same fundamentals that I spoke to earlier, just a high, high demand, very limited supply in the case of Marinas. There's actually declining inventory of Marinas out there as real estate developers like the Waterfront Properties and strong inclination to want to redevelop and the mixed-use resi whatever the case is. So you have 12 million registered boats out there today with right around 1 million slips or so. So that's 12:1 demand for slips in the highest part of that demand is what safe harbor, our Marina platform focuses on, average wet slip about 39, 40 feet, the largest growing segment of the Marina Sales of boats is in the larger boats and the wider boats. So right in the sweet spot of the type of marinas we're acquiring. So again, high, high demand shortage, no new supply coming on. And I think that, that gives us a similar pricing power, if you will, going forward. And the fact of the matter is that after acquiring the platform, the company was very acquisitive, bought about $2 billion worth of new Marinas. We usually see our greatest growth by finding the low-hanging fruit at Sun Communities and really putting it on our plan to form our systems. So we saw 7% growth 2 years ago in '22. We saw 11-plus percent growth in the same community portfolio as we absorb these acquisitions and good solid rental increase and guidance for this coming year. So I'll make the following comments and then anyone can follow up on my team. But the fact of the matter is we've always been in the marathon business, not the sprint business. For Sun Communities, we've been public for 30 years. For the last 20-plus years, we've never had a 12-month period of time where we didn't have increasing NOI. We've never had a negative rental increase year-over-year, always positive trajectory. And generally, the ability to increase rents sufficiently above CPI, so we can show the same kind of growth. That being said, it's a well-thought through program. Could we get a higher rental increase any given year? Sure that possible, but what might it mean for the next 1, 3 or 5 years. Certainly, an election year. We want to be very, very cognizant and thoughtful about not providing any kind of platform. So in year-over-year process of generating increases in rent, it's that thought process of being able to deliver something in that 4% to 6% range, if you will, of steady growth year-over-year, and that's how we think about our rental increases, and there is nothing in any of our platforms that I think we could point to. Certainly, after being asked the question several times over the last 1.5 days, that would make us think we couldn't continue growing Marina in the same type of format. We've done with MH and RV going forward.

And how should people think about sort of the stickiness of those revenues? And if you kind of break down the revenues by those that are sort of receiving lease payments for you can call it REIT income, but very predictable income versus things that are maybe less predictable, boat sales, food and beverage, maybe some aspects of service income. Like how does the sort of revenue breakdown within Marinas? And what percent do you consider to be very easily predictable versus those that are a bit more difficult?

Addressing the NOI split as it relates to the productivity of our Marina portfolio. About 85% of our NOI comes from real property, that's the rental of wet slips dry storage, commercial lease income as you've mentioned already, the remaining 15% comes from our SRD&E our service retail dining and entertainment, of which about 60% of that comes from service we see as nonelective, this is work that is required to be done to keep the vessels out in the water as they do break as you don't want to spend your weekend, getting your motor fixed, you want that to be working so you can go out and vote for the time that you have off, especially call it, north of the freeze line or in the Northeast, the winterizing and then commissioning those boats back to go in the water at the end of the winter. That is all nonelective as it relates to the work, so it actually is quite sticky as it relates to that year in year out service that we do at the property level. The remaining 40% of that NOI those come from F&B does come from -- there's some amount of boat sales there and restaurant income things of that nature that while in a, call it, in a recession, there might be -- might people are -- might be drinking less at the bar or eating less at the restaurant. But these are inherently business or parts of the business that are there in the service of the real estate piece, and therefore, they are lower margin, so the ultimate impact to NOI if there is a recession it is quite muted from that perspective because we can control the costs as it relates to those parts of the business.

The average tenure today of -- we call them members in our Marina network stays about 8 years. And the other thing that I would point to with regard to service. We find that the average stay in one of our Marinas is 20% longer when there is available service. So having a service center and a network, if you will. That service center can service many of our Marinas and really provides for the fact that we have a growing tenure based on those people in our Marinas.

And what percentage of your Marinas have that service capability now?

Direct service offered within the property. It's about half of the portfolio so 50%. But we do have clusters of Marina that ultimately do access these service centers. And that would -- we would put that at, call it, 3/4 of the portfolio do have access to service within our network.

Got you. And for the other 25% are you simply just working on that? Because I mean, I guess if you're getting that much better economics from those that have service, maybe that's just a higher-end properties, but I would think you just roll it out to all of your properties. So is that like an initiative? Or is there just something about those -- that 25% where you don't believe that if you were to roll it out there that it would have the same impact as the rest of the 75%.

Obviously, each property has its own restrictions, what the amount of uplands are that can provide the service. And more often than that, we'll look to align ourselves with third parties, who can provide the service and those type of relationships are what we're really looking to grow now with the size and scale of safe harbor and the tour that we took, one can see we're developing these relationships with the best service people, whether they be motor, electrical refit fiberglass exterior or exterior service. We'd much prefer to get the experts involved in that. So we will look and we're continuing to look to increase our relationships with those third parties. And then we will look to provide our own service where we can. But first and foremost, it would be with third parties.

And we have an audience question. Can you talk about the economies of scale in the Marinas business? And is there a sort of strong network effect? And maybe I'll add on to that. If you think about sort of the quality of the Marina properties that you target, what would be the sort of overall market that is out there to be acquired at some point? Like how big is safe harbor relative to the total quality of -- the total pool of properties that are of the quality that you would want?

Well, safe harbor is the largest without 135 Marinas. And I said earlier, we really do focus on the coastal Marinas and the Marinas with slip size of 40 feet or larger very unconsolidated marketplace, a lot of opportunity, as I said, after acquiring the platform, we were able to acquire about $2 billion in acquisitions in a 2-year period of time. Those are yielding the benefit that we're getting now is that 11% return as they fall into the safe harbor network. We talk about the network effect. As we said around the conference, anecdotally, we must have had a half a dozen people tell us our stakeholders and investors, they know people with boats and they stay and target for the safe harbor arena, specifically because of the benefits that they get there. Those benefits are such, we provide fuel at kind of a cost plus basis. When you think of the burn of fuel and when you get to the super yachts, the amount of thousands of gallons they need for a fill up, it's an enormous benefit from them. It's a low-margin business for us, so therefore, giving it away at cost plus and increasing the rental revenue of the actual slip has been very, very accretive for us. It's a benefit they get if they go to any of our marinas, if they're a member. Additionally, from a transient standpoint, they can go and stay at any one of our 75 coastal Marinas on a transient basis, no charge. So those benefits of size and scale and quality of operation have really propelled safe harbor to the forefront. I think the abundance of opportunity is there. It's a very fragmented mom-and-pop type operation even at the quality level of the marinas that fit the safe harbor platform. And as we look forward to what might be available in the future. There is and will be continued opportunity for consolidation there.

Maybe switching over to RVs. You mentioned in the call that you've increased the annual count of RVs by 24% since 2020. I'm just wondering where you think you can take that over time, trying to understand a few years from now where the sort of breakdown could be between annual versus transient?

Sure. Today, we have an inventory of about just over 25,000 transient sites that over the next 5-plus years, we believe somewhere around 40% plus minus, we could look to convert over time. We've been -- last year, we did about 2,100 site conversions just over. In '22, we did just over 2,200 conversions. This year, our guidance. We believe we'll do plus/minus about 1,700 conversions, and we'll continue to focus on being able to convert that transient night stay, that family to stay with for a 5-year, what today is a 5-year average tenure. That ultimately, over time, that provides an opportunity for margin expansion on the RV side as a more annual property is going to -- does operate at a higher margin than, say, a predominantly a transient community. And so there is a continued long runway for growth from that perspective.

Can you quantify that, the economics between annual and transient and the importance of transient is at least a lead generator?

Sure. I mean at every -- we don't have a property that is 100% annual. You always are going to need transient sites because that becomes the feeder that becomes new customers that come to the resort on an annual basis and then you look to convert them over time. So we'll always have an amount of transient within our portfolio because of -- to continue to drive conversions. The economics as we convert, we used to be able to make, call it, 60%, 50% higher revenue in that next 12 months after a conversion because you now have a site that's occupied for 100% of the time versus 35%, 40% of the season. That spread has compressed as transient rates have continued to increase. So those are sites that are more and more productive on a year-over-year basis. So that spread is compressing. We would put that average today, call it at around 30% to 40% depending on the site. But we expect that to continue to compress, and we could be talking here in a couple of years saying, well there's no revenue uplift, but now that's a family that is staying there for 5 years. That requires less advertising costs, things of that nature and ultimately drives that margin expansion that was mentioned earlier.

And the margin expansion piece, and it's -- we have 180 RV communities, 30% or so more transient. So it's a mix. There's apples and oranges a little bit, but a fully transient property could be a mid-45% margin, moving all the way to high 50% margin for more of annual. And so they all kind of sit in that range. So as Fernando said, over time, they will evolve. We're not looking necessarily for this to occur in '24 or '25, but over a period of time, as the conversion increases, you should see those benefits across the portfolio.

Got it. And I guess that was going to be my next question on it, which is you saw a pretty big benefit in the fourth quarter from, I think, what you referred to as aligning controllable expenses with lower transient revenues. But then if I look at your 2024 guidance, it sounded like you thought it might normalize a bit. So I was just trying to understand, I guess, why -- if you saw the benefit in the fourth quarter would normalize this year when you're seeing such a high number of transient to annual conversions.

I think at this time, our forecast transient revenue growth for the same property portfolio are roughly to be down between 2.75% to 3% at the midpoint of our range. We are -- the current budget has more, from a payroll perspective, a resort that is more fully staffed than it was last year as we those were some of the costs that we controlled, onboarding staff a little bit later into the season, potentially off-boarding sooner given in response to transient demand over the course of '23. So that's something that we'll continue to employ depending on how the year goes as it relates to transient demand.

So I guess you're saying that transient demand ends up being a little bit lower than you think you'd get an offsetting benefit from lower expenses and...

You would look to dampen the impact of that as much as possible on expense side, be that -- and that's essentially going to come from payroll that will come from utilities and supply and repair.

Got it. Maybe just last one. I guess do you have like seasonal sites that you consider purely seasonal? Is that just grouped somewhere within transient? Just curious, obviously, ELS breaks it out a little bit differently. And I know this is an important seasonal time for them being in the winter. So I was just curious if it was the same view as well.

I think the definition of seasonal from ELS are what we would call transient stays that are longer than 30 nights. We do have a component of that within our transient portfolio. We estimate that to be between 20% to 25% of, call it, overall transient revenue.

So now would be the important time period for that?

That is -- it is the season where snowbirds are coming down. They might stay with us for the entire season, but ultimately, you're not signing up at the end of the season to stay for the rest of the year. So yes, those -- we do have transient stays that are 2, 3, 4 months in length in Arizona and Florida, but especially in the southern U.S.

Yes. I mean, my last question on is really just if you could comment on sort of what you're seeing there right now in terms of seasonal and transient demand. I know there's not a huge sort of window into it, but maybe just talk about sort of recent demand trends and what that looks like year-over-year?

Certainly, booking times have reverted to pre-COVID during COVID. Everyone was frantically booking ahead. So we've seen a shortening, but with regard to the overall demand, as Fernando said, 2.7%, roughly transient reduction mostly represented by the conversions and the smaller amount of sites that will be available going forward. So it leaves us with the clear site to be able to adjust expenses. Should we need to? It's something we did last year. And there's nothing that I would really point to. Pacing is pretty much on track where it was, although those windows are shorter and shorter. And on the transient side, as we've always indicated, biggest impact on transient is weather. And now that we're past that pandemic period of time, and people don't feel so compelled to book earlier. They'll wait longer to see what the weather looks like. I'd remind everybody that the average drive time to one of our transient property is 2 to 3 hours from someone's home. So therefore, if they hear there's going to be a weather issue on Saturday or Sunday or Friday within our booking window, which I think is 7 days today. So they can't cancel. They'll wait closer and closer to that period of time to make a decision.

We have audience questions. How active/aggressive is the private equity buyer in MH right now? And can you compare that to peak levels? What type of buyer do you think has the lowest cost of capital right now? And there's a similar question, which I'll just add on, which is sort of if you could maybe provide where you think cap rates are for MH and RV?

Good question. And we've obviously talked about a disposition plan that we've circled around $300 million potentially plus or minus consistent with what we did about 10 years ago. We're doing it on a small single asset or a small portfolio basis across the region. I think what we'd say about the market is there does remain a large group of interested parties. It includes family run high net worth individuals who will buy 1 or 2 or 3 assets, and they have a small portfolio to include pension funds, it will include private equity and some permanent capital vehicles. So we're still seeing demand from all of those groups. I think what we would say is the interest rate environment remains elevated. You can certainly still get government-backed financing for MH to get done. It's obviously at a higher rate. And so the pool of those buyers who might have been 10 to 15 to 20 per asset might be 5 to 1%. So you're definitely seeing the breadth change, but it is mixed, and it really is asset and regionally specific. So we are seeing private equity interest in certain of the portfolios or assets we're in the market with. We're seeing interest from high net worth individuals looking to add to their portfolio. So it's a broad mix in terms of what's out there. And the folks who are willing to sort of deal with some unlevered returns early on are certainly being more aggressive, but it's a great asset class that we like to be in. In terms of the cap rate environment, valuation environment, I'll make a comment, certainly Gary could add to it. I think one, we're in the market today. So we're a little sensitive to discussing valuations until we get the portfolios across the line. They're generally consistent with what we expected when we first had these conversations 3, 4, 5 months ago. We expect our transactions to be accretive to our portfolio on a near and long-term basis. But again, we haven't seen a lot of transactions in the market away from us either. So we can't really point to those as third-party data points. We'll certainly update the market if and as the program progresses and we continue with that program over the coming 3 to 6 months.

And I guess within the U.K., it sounded like on the call that maybe you're planning on holding the Sandy Bay and the Royale Life, real estate assets for maybe longer than -- I initially thought or maybe you initially thought. I'm just curious, am I thinking about that the right way? Or is that sort of misinterpreted?

Well, I think the best way to think about it is -- we have just placed them under the direct management of Park Holidays, our operating team over there, inclusive of the collateral that we took back to the receivership, 3 parcels of land, Sandy Bay an operating manufactured housing community and 1 other property that has a little bit of a Park Holiday operation on it right now. As we put our hands around them and operate them. We're going to look for the best alternatives we can to maximize value. All options are on the table. So it isn't a matter of timing. It's a matter of maximizing that value and we think in Park Holiday's hands for right now as we examine every option, old, sell, venture partner they're being watched after by a great team there. And when we talk about Sandy Bay, it is a fabulous operating manufactured housing community, and it's growing. And about 10% of the guided home sales included this year in the U.K. is from Sandy Bay and it raises the average margin that we show for our home sales because they sell at about 5x the margin. They're full year round manufactured housing bungalows as they call them over in the U.K. And the profit margins there are $100,000 and more and have -- so 10% represents about 30 to 40 home sales that we expect to generate there this year.

So I guess the question is what -- I understand Park Holiday, a great operator. But I guess what can they really do with the development parcels because I would think you'd have to just put an incremental capital, right? I mean if there's only there's no homes to be bought or I don't know what needs to be done at the property is like what can Park Holiday really do with those 3 development parcels, without you putting more incremental capital into them?

Absolutely. They're holding conversations with interested parties as well as putting together the entitlement packages and all of the permitting and zoning to be able to understand how to market the properties and what the next steps would be. So they're working very diligently, and we're talking to them once a week, getting updates on where they are with those properties. It's important to understand that guidance for this coming year does not include any contribution -- capital contribution from the disposition of those properties. So that is not included at this site.

Got it. So you're not planning on putting more capital there for now?

At this time, as we would share with you, we're in a position where we're reducing our growth capital with regard to expansion development. Pencils are pretty much down as we're looking to recirculate all cash flow into the reduction of debt. So there's no expectation that we'd be putting capital into those properties.

I know we have rapid fire, but just really quickly, we had a question on Australia earlier. So if you can just touch on the JV there and capital plans?

Yes. We exited the headstock in [ Genia ] November, which we announced and then reiterated in January. We moved our Board's equal left with Sungenia JV, a great partner, a great developer there. There's 5 assets in that joint venture. We are in the status of selling homes and people are moving in and there's 2 more remaining in the existing JV. We reserve the right to continue to look at opportunities with them, and we continue to do so and the JV structure allows appropriate monetizations for us and/or Ingenia over time, providing both parties appropriate flexibility as we move forward.

Rapid rapid fire. Same-store NOI growth for the sector overall next year in 2025?

Rapid rapid. We're going right to it, Nick. 6%.

Will there be more or fewer of the same number of public companies a year from now?

Same.

And then what's the best real estate decision today, buy, sell, build, redevelop, develop or buy back shares?

Well, for Sun Communities, it's absolutely to hold and maximize the opportunities of what we have.

Great. Thank you very much.

Thank you.