Sun Communities, Inc. (NYSE:SUI) Q3 2023 Earnings Call Transcript

Sun Communities, Inc. (NYSE:SUI) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Sun Communities Third 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 to reflect events or circumstances after the date of this release. Having said that, I would like to introduce 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. For those who would like to participate in the question-and-answer session, management asks that you limit yourself to one question, so everyone who would like to participate has ample opportunity. 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.

Gary Shiffman: Good afternoon. And thank you for joining our call to discuss third quarter results and our updated 2023 guidance. We reported another strong quarter with core FFO per share of $2.57, exceeding the high end of our guidance range. Total same-property NOI growth of 6.7% meaningfully outperformed guidance, demonstrating how our properties high demand and scarce supply fundamentals generate durable growing real property income. Same-property NOI growth was fueled primarily by solid revenue growth and continued cost saving initiatives across our properties. In our manufactured housing segment, third quarter same-property NOI grew 8% as compared to 2022, supported by a 6.1% increase in monthly base rent per site and occupancy gains.

Within our RV communities, the 4.1% same-property NOI growth achieved in the quarter is a testament to continued high demand at our communities, exemplified by the successful execution of our strategy to convert transient sites to annual leases. To-date, our transient to annual conversion surpassed 1,800 sites and we are on pace to meet guidance for the year. On a combined basis, same-property adjusted occupancy for manufactured housing and RV communities increased 170 basis points this quarter compared to last year. And across the total portfolio, revenue producing sites increased by approximately 750 sites during the third quarter, an 8% increase compared to 2022. This brings year-to-date revenue-producing site gains to nearly 2,600. Marinas delivered another very strong quarter with same-property NOI growth of 8.9% over the prior year period.

Demand to join our unparalleled safe harbor network remains strong, as demonstrated by the increase in rate lift at 89% for Marinas. Our manufactured housing portfolio in the U.K. will be included in same property results starting January 1st, only reset the same community pool for 2024. For the third quarter, real property NOI in the U.K. grew 15.1% over the same period last year, in line with our expectations. Adjusting for exchange rate changes, U.K. real property NOI increased by 8.7% over the prior year quarter. Home sale activity, which supports the predictable rental income of our communities was in line with our expectations and is tracking within our guidance ranges for the year. Looking ahead to 2024, we expect rental rate growth in our same-property portfolio to exceed inflation.

At the midpoint, we expect to realize average annual rental rate increases of 5.4% for manufactured housing in North America and 7.1% in the U.K. We expect a 6.5% increase in annual ROI rates for our annual RV portfolio and 5.6% growth in annual rates across Marinas. We expect these strong rental rate increases, combined with modestly higher occupancies and our ongoing focus on expense management to produce another year of strong organic cash flow growth in 2024. And now I want to give you some perspective on Sun’s broader strategic objectives. The Sun Board and management team are laser-focused on implementing changes designed to streamline our company and position us for growth. Our goal in making such changes is to help ensure that our best-in-class, operationally resilient portfolio delivers the consistent FFO per share growth our stakeholders historically have enjoyed from Sun.

For example, we recently sold our stock position in Ingenia, generating over $100 million to pay down variable rate debt. This transaction had the added benefit of being increase the FFO. In addition, we have previously discussed, we continue to advance the process to identify select properties for potential disposition with the intent of further delevering proceeds. As we move forward, we are substantially reducing capital spending, including acquisitions and development activity, in light of the more challenging economic and capital markets environment. This year, as we have stated before, we are completing ground-up development projects that were already underway and a new external growth projects will be solely focused on the most strategic opportunities.

Our strategic positive investment activity can be seen in our U.K. operations as well. In 2021, after we announced the agreement to acquire Park Holidays, we extended a loan to RoyaleLife, a U.K. holiday park and manufactured housing developer and operator in a separate transaction. This development opportunity is distinct from our Park Holidays business. Our loan to RoyaleLife is collateralized by real estate and several other assets. We have selectively and partnered with strategic counterparts for development throughout Sun’s history. As macroeconomic conditions rapidly deteriorated in the U.K., we decided not to pursue incremental acquisitions to develop. Since that decision, RoyaleLife engaged with several lenders to repair a note, but was unable to do so.

Ultimately, at the end of September, we appointed a receiver to enforce our interest in the real estate securing our loan. We continue to assess our options as we take the note through the receivership process. Additionally, Sandy Bay is a premier manufacturing housing community in the U.K. we acquired in 2022. It has 730 operating sites and can be expanded by an additional 450 sites. As part of our broad strategic portfolio review, we decided to sell the property and headed under contract to be sold to RoyaleLife, backed by additional financial investors and lenders. While that transaction is not progressing, we are in discussions with other potential buyers and in the meantime, continue to benefit from the community’s contribution to real property NOI.

Now Sun has 30-year history as a public company, we have demonstrated operational reliability and cash flow strength throughout economic cycles and we are continuing to see this in the solid performance of our real property business. We remain optimistic about our performance and organic cash flow generation in the near-term, supported by our anticipated rental increases in 2024. However, we recognize the headwinds from today’s challenging macro environment. And as I said, we are taking actions and steps to realign our strategy to focus on our proven, durable income streams. We are recycling capital out of non-core investments, including our operating portfolio to monetize lower-growth communities and remaining disciplined and deliberate in pursuing only the highest growth capital expenditure projects.

As we implement these rate sizing activities in the coming quarters, we are optimistic the market will recognize how these activities will decrease our leverage and target a return to the consistency of our earnings we have long enjoyed. As always, the management team and I are grateful for the hard work and accomplishments of the entire Sun team this quarter and I would like to thank all the team members for their dedication and all of our stakeholders for their support. Fernando will now discuss our results in more detail. Fernando?

Fernando Castro-Caratini: Thank you, Gary. Third quarter core FFO of $2.57 per share was $0.01 above the high end of our guidance range. Expense savings at the property and corporate level were the primary contributor to outperformance as compared to our midpoint. Sun’s total same-property NOI for the quarter increased 6.7% as compared to last year, outperforming the high end of our guidance by 220 basis points. Our performance was driven by same-property revenue growth of 5.5% and lower-than-expected property operating expense growth of 3%. For the quarter, same-property manufactured housing NOI increased 8%, driven by a rental rate increase of 6.1%, continued occupancy gains and focus on expense management. RV same-property NOI grew 4.1% due to an 8.8% increase in weighted average annual rental rate, approximately 2,100 transient to annual site conversions over the trailing 12 months and ongoing operational programs to mitigate expense growth.

These were partially offset by a 4.4% decline in transient RV revenues, as transient occupancy normalizes. Adjusting for the decrease in sites converted to annual, transient revenue grew 2.2% relative to the prior year period. Over the Labor Day holiday weekend, same-property transient RV revenue was down 1.5%, as compared to last year’s holiday weekend. Adjusting for the 5.7% decrease in transient sites converted to annual, transient RV revenue increased by 4.4%. We continue to drive the pace of transient to annual RV lease conversions to increase our percent of sticky revenues. This quarter, we converted nearly 540 sites to annual leases, for a year-to-date total of over 1,800 conversions. In Marinas, same-property NOI increased 8.9% in the third quarter as compared to 2022, an 8.4% increase in revenues highlights the strong demand to be part of our network.

Our performance was due to solid rental rate increase, longer stays by guests in our Southeastern Marinas and operating expense savings, particularly within payroll and utilities. In the U.K., real property NOI for the quarter of $29 million was in line with our guidance. Retention rates among our U.K. owners is holding steady. With an average resident tenure that approaches eight years. The increased retention over 2022 was a meaningful driver of real property income growth this year. Turning to home sales. North American home sales contribution was broadly in line with our expectations for the quarter, where lower volume was offset by higher margins. In the U.K., despite economic headwinds continuing to challenge home sales volumes, we sold 2,310 homes through the end of the third quarter.

Fourth quarter to-date, we have sold 204 homes, leaving approximately 300 homes to be sold to achieve our full year volume guidance. In terms of NOI, we are on track to achieve the midpoint of prior guidance, which approximates just over $70 million for the full year. Regarding our balance sheet, since our last call, we have focused on decreasing leverage and variable rate debt. During and subsequent to the third quarter, we entered into $150 million of SOFR swaps on our U.S. dollar line of credit at a fixed SOFR rate of 4.8% through April 2026. As Gary discussed, we sold our position in Ingenia and used the net proceeds of approximately $100 million to pay down borrowings on our line of credit. Additionally, we refinanced approximately $118 million of secured debt that was maturing this year with approximately $250 million of new secured debt.

Adjusted to include the positive impact of a $50 million SOFT swap executed in March, the new loans bear interest at a fixed rate of 6.25% and mature in 2030. Taking this activity into account, we had $7.6 billion in debt outstanding at a weighted average rate of 4.15% and had a weighted average maturity of approximately seven years. Our trailing 12-month leverage ratio was 6 times and approximately 14% of our debt is floating. Turning to guidance for the year. We are revising our full year core FFO per share guidance downward by 1% at the midpoint to a range of $7.05 to $7.13 and establishing a fourth quarter core FFO per share guidance range of $1.28 to $1.36. Our revised guidance for the year is driven primarily by, higher expected interest expense in the fourth quarter, related primarily to the U.K. note remaining outstanding, U.K. home sales NOI performing towards the midpoint of our range and lower expectations for transient revenue in the U.S. Regarding the U.K. note, through the first nine months of this year, we recognized $28 million or approximately $0.22 per share in interest income.

There is no interest income from this note in fourth quarter guidance. We previously expected to pay down debt with the notes repayment, which would have generated roughly $5 million or approximately $0.04 a share of interest expense savings in the fourth quarter. For U.K. home sales, we expect to finish the year within our prior guidance range, with home sales volume of around 500 units in the fourth quarter. We are forecasting lower margins on these home sales as U.K. consumers continue to favor pre-owned homes and part exchanges to new home. NOI margins on U.K. home sales for the first nine months averaged $26,000 and our revised guidance assumes average NOI margins of approximately $20,000 per home in the fourth quarter. Our same property portfolio is by far the largest driver of our results, representing over 90% of NOI.

Based on results to-date and our expectations for continued strong demand, bolstered by effective expense management, we are increasing total same-property NOI guidance by 50 basis points from 5.7% growth at the midpoint of the prior range to a new midpoint of 6.2%. The increase is based on higher expectations at our same-property manufactured housing and Marinas properties, partially offset by slower growth in RV addressed earlier. At the midpoint, the 5.8% to 6.1% NOI growth we now expect from MH is 45 basis points higher than the midpoint of the prior range. And our same-property RV portfolio, we now expect NOI to grow 3.5% to 4.2%, which represents a 15-basis-point decrease at the midpoint as compared to prior guidance. For same-property Marinas, we expect NOI to increase to a range of 10% to 10.3% for the year, a 165-basis-point increase from our prior assumed range of 8% to 9%.

Additionally, and as Gary discussed, we are providing guidance on preliminary rental rate increases for 2024. At the midpoint, we expect to realize average annual rental rate increases of 5.4% for manufactured housing in North America and 7.1% in the U.K. We expect a 6.5% increase in annual rental rates for our annual RV portfolio and 5.6% growth in annual rates of cost Marinas. 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 October 25th. Our guidance does not include the impact of prospective acquisitions, dispositions or capital markets activities, which may be included in research anal assessments.

This concludes our prepared remarks. We will now open the call up for questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Samir Khanal with Evercore. Please proceed with your question.

Samir Khanal: Hi. Good afternoon, everybody. Gary, maybe provide a little bit more detail on your sort of your plan to sell assets. I guess what’s the transaction market look like in the U.K. and the U.S.? Just trying to figure out your ability to sell those assets as it relates to the U.K. loan. You kind of stated about Sandy Bay. I think it was in the market, now it’s held for sale. Just want to — maybe you can provide a bit more color on the market in the U.K.? Thanks.

Gary Shiffman: I think underlying our goal to sell assets as we have shared with the market. It’s just a use of recycling capital and paying down debt. Generally, these are all high quality assets and they are performing in the portfolio. But for various reasons, we think that bringing them to market and being able to pay down higher priced debt would be favorable as we go forward. So in North America, we have shared we have done a kind of deep dive and identified some assets to bring to market. Those first group of assets are either currently or in the next week will be marketed and we will determine at that time, how the market feels in North America. As everyone is aware, there’s been very, very little transaction in the manufacturing RV market.

So it — there are no data points to point to right now. We know that rates are significantly up, but these are good high quality assets. So we look forward to being able to share with you on our next call or if we are able to execute on anything before our next call, how the market is responding to those assets. With regard to the U.K., in particular, those that are collateralized by the Royale loan — RoyaleLife assets, because we are in the receivership period, there’s really little that we can comment on. But during the receivership period, we are in dialogue with optionality on those assets and will continue to be so. And then we talked about Sandy Bay, it’s a really high quality premier asset, 730 sites with a big expansion piece to it and we are in dialogue with a number of people regarding a potential sale there as well.

So we will be very pleased to be able to share with everybody what the market is looking like as we began the first steps of marketing.

Samir Khanal: Okay. And then, I guess, just as a follow-up and maybe changing the subject here on Marinas, that continues to show strength. I would have thought you would have been able to push the rates for 2024 a little bit higher. I mean your rate was 5.6%. I understand there’s been a moderation in inflation, but I would have thought maybe the rate would have been higher. Can you provide a bit more color around that?

Gary Shiffman: Yeah. I think it speaks to how we have shared with our stakeholders over 10 years, 20 years, 30 years, 40 years of business, kind of the slow marathon over the Sprint and our approach to want to be able to really get outsized growth above inflation. When inflation is low and when inflation is high, last year, we got off 7.2%, 7.3% rental increase. So we really are enjoying heavy, heavy demand and want to continue to see it continue. So we think that we have really set the rent in a way that over a long period of time, we will be able to maintain NOI growth in excess of inflation, and at the same time, retain high occupancy. So after a couple of years of tremendous growth, we look forward to continuing that growth and set the rental rate very thoughtful for 2024.

Samir Khanal: Thank you.

Operator: Our next question comes from the line of Wes Golladay with Robert W. Baird. Please proceed with your question.

Wes Golladay: Hi, everyone. Maybe looking into next year, can we talk about some of the bigger moving parts that we should be aware of. One, in particular, I want to give more clarity on, would be home sale volume expansion and development? Will that have any impact in the U.S?

Gary Shiffman: Yeah. I will take the first part and Fernando wants to add anything. I think we have been very, very clear that with regard to use of capital and our free cash flow, the most highest priority and best use for that free capital will be to reduce leverage. As we look at this high capital cost environment that we are in right now, recognizing that we do get very, very strong IRRs on expansion usually in the 10% to 13% range. I mentioned RV and new development on the high single double-digit, those are IRRs and they do take a period of time, they are initially dilutive. So by putting those things on hold moving forward, our expectation is that in a better economic environment. We have the inventory of sites on hand and we can resume our expansion and development activities.

So as it stands right now and we will share exact numbers as we go forward in guidance for 2024. The expectation is to have a very limited capital investment in the development area and it’s just a fact from where we are sitting and see the cost of capital right now.

Fernando Castro-Caratini: And Wes, to add to Gary’s comments, we have inventory to sell on the manufactured housing side. By the end of the year we will be delivering nearly 1,000. We will have to deliver nearly 1,000 new sites across expansion and ground up development. So that would support the home sales volume or contribution to NOI here in the U.S. Where we would say, should be around what we expect to get this year.

Wes Golladay: Okay.

Gary Shiffman: And with regards to home sales volume, again, in the U.K. we have the sites, we have the homes. The U.K. Park Holidays team is doing a remarkable job. We are very, very pleased with how home sales are continuing, although they are guided down from the beginning of the year and we will be able to share those guidance post with 2024 guidance.

Wes Golladay: And then a follow-up on the balance sheet. You have taken the variable rate down. I believe you said Fernando, about 14% is floating now. Should we think the balance just being repaid off with the asset sales? Are you going to keep a certain amount of floating?

Fernando Castro-Caratini: We will continue to look to move that percentage downward. Certainly, the immediate use of proceeds of free cash flow in 2024, as well as any proceeds from dispositions or other activities would be to pay down debt. Yes.

Wes Golladay: Okay. Thanks a lot.

Operator: Our next question comes from the line of John Pawlowski with Green Street. Please proceed with your question.

John Pawlowski: Thanks. Fernando, what percentage of the roughly $360 million loan to RoyaleLife is secured by real estate versus the OpCos or the manufacturers?

Fernando Castro-Caratini: Sure. Hi, John. About 70% is secured by real estate and the other $30 million by the operating companies.