Sun Communities: Growth At A High Price (NYSE:SUI) (2024)

Business Overview

Sun Communities (NYSE:SUI) is a non-traditional residential REIT that specifically focuses on mobile home parks, RV resorts and marinas. The company's properties could be either all inclusive (also known as all age communities) or senior citizens only (also known as 55+ communities). As traditional housing becomes less affordable and a lot of people get priced out of owning a traditional home, a lot of people are choosing these non-traditional types of residential arrangements which come with lower costs and possibly more flexibility. Typically the residents will purchase their own mobile home, manufactured home, RV or boat and pay rent to the landowner to be able to put their home on the property. This is basically what the company does for the most part.

In addition to providing with a space to put people's homes, the company also provides them with appropriate utilities such as electricity, water, natural gas and appropriate infrastructure such as a parking spot or other amenities that are often found in residential communities. The company owns 296 mobile home communities that host 100k sites, 179 RV communities with 58k sites and 135 marinas with 48k spots in the US with more properties in the UK. Basically each site or spot is one space where a home, RV or boat can be located which means that the company currently has room for more than 200k tenants across a variety of property types it owns and operates. Some of the spots are reserved specifically for transient residents, vacationers, short-term stayers or recreational stays while most spots are reserved on an annual or multi-year basis. In RV parks and marinas, contracts rarely go multi-years since these vehicles can easily be moved from one location to another but mobile home contracts tend to be more permanent in nature because they are very costly (and sometimes destructive) to move from one place to another. One could say that this group has the least amount of flexibility to move.

One concern investors might have regarding this company is that since it mostly caters to people with low income, rate collection rates might be lower but it doesn't appear to be the case. In the last 10 years, the company was able to consistently raise its rental rates by an average annual rate of 4.0% (ranging from 3.4% to 6.4%) yet, its same property occupancy often stayed close to 99% which indicates that most people are able to afford the company's rental prices and people are unlikely to leave. It appears that even with these increases, mobile homes still appear to be more affordable than traditional housing. This year the company anticipates a rent rate hike of 5.4% which is above the 10 year average but below last year's rate of 6.4%. Moving forward, this metric should stabilize around 3-4% as inflation stabilizes around 2% which means the company would be able to enjoy a 1-2% rent growth premium over the rate of inflation.

Keep in mind that the economy has been rather strong for the last 10 years and unemployment rates were pretty low if you don't count a temporary spike during the 2020 lockdowns driven by the COVID-19 pandemic. Even right now unemployment rates are coasting below 4% which means that most people should be able to pay their rent just fine. If we had a severe recession where unemployment rates were to rise significantly, these metrics above might not hold up. The company's rent collection rate might drop and some people might not be able to afford rent at all. Also, recreational short-term stays would probably drop since fewer people would be able to afford those types of spending. This is just something to keep in mind because the company probably owes some of its strong metrics to the strength of the job market.

Below is an interesting chart which may prove me wrong after all. It shows how things looked between 2008 and 2012 when the US economy was not doing so well and unemployment rate was close to double digits. Notice how the company's same property occupancy actually rose slowly but steadily from 82% to 87% during this period so perhaps the company has more strength then I am giving them credit to. Perhaps it is true that some people who were living in this company's properties were unable to pay their rents as a result of the last recession but at the same time a lot of people who were originally living in traditional homes had to "downgrade" to a mobile home so it brought new and fresh customers for the company that it didn't have access to before.

Operating Metrics

Over the years, the company posted strong revenue growth which accelerated even further after 2019. This was possibly driven by a few factors. First, rent prices started to rise significantly during this period driven by higher inflation. Second, the company invested into expanding its available properties which created more avenues to generate revenues. Third, more people retired and moved into senior communities which helped drive the company's revenues and fourth, there was an increase in shorter-term stays and transitionary rentals from people who were traveling for recreational reasons after the pandemic.

These revenues turned into strong cash flow generation for the company. In the last twelve months the company generated $790 million of cashflow from its operations, almost double from 2019. Last year the company ended the year with a loss of $213 million but most of this was caused by depreciation or goodwill write offs which don't affect the company's cash flows.

Dividends

The company pays a dividend yield of 2.8% which is not very high compared to most REITs since the current average dividend yield for REITs is about 4% (VNQ), but there are two things I must mention about this company's dividends. First, the company has a history of hiking dividends year after year. In the last 10 years, the company has raised dividends at an average annual rate of 5.5%. The rate of dividend growth has even accelerated a bit in recent years so this is good for those investors who pay attention to not only yield but also dividend growth.

Second, the company's dividend seems to be well supported by its current financials. SUI's AFFO Payout ratio is 59% as compared to sector median of 74%. This means that for each $1 SUI generates from its operations as AFFO (adjusted funds from operations) it pays 59 cents as compared to its peers which pay 74 cents. This makes not only the current dividend sustainable but leaves room for some growth in the future. The company's dividend coverage ratio is 1.91 as compared to sector median of 1.58, indicating that it can comfortably cover the current dividend. As a rule of thumb, you want this metric to be comfortably above 1.0.

The company has about $7.7 billion in total debt which is 6.1 times its annual EBITDA indicating that it would take the company only 6 years to pay off its debt if it put all its income towards debt payments. Last year the company spent about $330 million on debt servicing despite higher interest rates and it was well covered by the company's cash flow so I don't anticipate any problems from a debt standpoint unless something goes drastically wrong.

Valuations

When valuing REITs the primary metric we look at is FFO (funds from operations) and AFFO (adjusted funds from operations) which is different from traditional companies where we look at P/E ratios or P/EBITDA ratios. This stock doesn't appear particularly cheap when looking at the relevant metrics. Currently SUI supports a P/AFFO of 20.30 as compared to its peers that trade at a P/AFFO of 13, indicating a premium of almost 50%. In P/FFO we also see a similar 50% premium as the company trades at a ratio of 18.50 as compared to sector average of 12.50. This high valuation offers the company very limited margin of safety. Some might also say that this premium valuation is justified because the company's growth rate has been accelerating in recent years which makes this a growth play and we all know that growth plays tend to have higher valuations because investors expect them to have higher cash flows in the future.

Risks

Obviously one of the main risks for the company is its high valuation. Another risk factor is not necessarily the company's residential business but its recreational business which relies on short-term stays which is often a discretionary spending. If the economy were to head south, this particular category might take a hit.

There could also be regulatory risks in the future if some parts of the country decide to bring rent controls for mobile homes and dictate that the company can't raise rates as freely as it is right now. It would limit the upside in the company's growth rate.

Conclusion

This is a company with ups and downs. On one side, it has a strong growth rate with recent acceleration, a safe growing dividend and solid cash flow generation but on the other hand it has high valuation and low dividend yield. Whether investors buy this stock really depends on their priorities. If an investor is looking for high yield, they should probably avoid this one but if they are looking for steady dividend growth, this could be a good pick for them.

I own separate portfolios for separate goals. I have one portfolio where I have nothing but income plays, another portfolio where I have nothing but growth stocks. I also have another portfolio where I run my options plays. I try not to mix different portfolios because they all have different goals and purposes. Sometimes one of my portfolios outperform other times other do. I am a big believer of diversification of not only assets but also methods and investment philosophies. Diversification is not simply buying 20 different stocks, it is applying different methods to different goals that fit to serve an investor's short term and long term targets.I am a "long only" investor and stay away from shorting companies. I will also do a lot of delta-neutral options plays where I will try to benefit from a stock or funds lack of movement. Also a huge fan of options plays and strategies including but not limited to covered calls, iron condors, butterflies, calendar spreads, call-put spreads. I've probably tried every options play there is, sometimes with success, sometimes with failure.At Seeking Alpha, I mostly analyze and write about stocks and funds that I own or I plan on owning. I rarely ever write about a stock or fund I at least don't have intention of owning some day.