Flagship Communities Real Estate Investment Trust (MHCUN) Earnings Call Transcript

Good morning, ladies and gentlemen, and welcome to the Flagship Communities Real Estate Investment Trust Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] This call is being recorded on Thursday, March 17, 2022. I would now like to turn the conference over to Kurt Keeney. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us today. Flagship has made tremendous strides since going public over one year ago. When we completed our initial public offering, we owned and operated 45 MHCs comprising of 8,255 lots in four U.S. states. Just 15 months later, we have achieved 37% growth in our lot portfolio. At the end of last year, we owned and operated 63 total communities comprising of 11,228 lots across 7 contiguous states, and we continue to make accretive acquisitions. During the fourth quarter, we solidified our existing footprint near existing communities where we operate. Early in the quarter, we acquired 2 RV Resort communities in Northern Kentucky and Central Ohio, and we then acquired 3 high quality MHCs comprising of 957 [Technical Difficulty] in Arkansas, which allowed us to further consolidate existing markets. And subsequent to quarter end, we added to our Ohio presence with the purchase of a resort community in Northern Ohio that included 100 MHC homesites with 141 boat slip marina. All of these acquisitions adhere to our methodical growth strategy and our [Technical Difficulty] accretive to our AFFO per unit with additional above-market growth over time. This acquisition success was complemented by our disciplined approach to operations. Once we acquire a high-quality property, we work to ensure that we provide a vibrant, family-friendly community in a location of choice. The best indication of the effectiveness of this strategy is our year-over-year increase in occupancy, which was 83% at year end, a 3.2% improvement over December 31, 2020. Attractive communities are also able to command higher rents. In 2021, our average lot rate increased by 4.8% to $369 from $352 in 2020. This combination translated into another solid financial performance for the quarter. Our revenues, net operating income and adjusted funds from operations all remained strong and increased compared to last year. These increases were primarily due to three factors: first, the acquisitions we completed during the quarter; second, community -- same-community growth -- NOI growth; and finally, the cost containment initiatives we realized during the quarter. While we experienced significant growth, our unwavering commitment to high-quality [Technical Difficulty] residents has remained the same since we began the business over 27 years ago and will be key to us maintaining long-term success. Our growth strategy is predicated on our experience. Namely, the best way to deliver sustainable value is by replicating our successful business model into new markets and then responsibly operating within these markets. Part of this commitment is the ESG, which makes us a better operators by supporting transparency and strong governance. This also contributes to improved safety and environmental performance and strengthens our connection with local communities. Our solar lighting initiative is an example of our commitment to the environment. We are in the process of replacing our traditional electric street lighting with solar lighting. To date, we've replaced over 500 street lights, and our goal is to convert every electric light pole in our communities to solar power. Our submetered water and sewer program continues to promote water conservation, and it's not uncommon to see a 30% reduction in water usage due to leak containment once we install these new systems. Other ESG highlights include that our management team is 75% women, and we have a 29% minority resident population. We consider ESG as an integral to our growth strategy, and it will continue to be a priority going forward. I'll now turn it over to Nathan to provide more detail on our operating results. Nathan?

Thanks, Kurt. Good morning, everyone. In addition to demonstrating our operating capacity, the acquisitions we have made speak to our long-standing industry relations, which are integral part of our ability to add off-market opportunities to our portfolio. We believe MHCs will continue to be the home of choice for the general population, especially as housing prices continue to rise in our core markets. The main reason for this is that manufactured homes offer a better living experience compared to other options. The homes are detached structures that do not share walls, utilities, air conditioning units, heating with their neighbors. Our community members enjoy 2, 3 and 4 bedroom homes, usually with 2 bathrooms, and they have a deck, yard, driveway and in-home laundry. Our communities also provide recreational facilities, common areas such as green space, playgrounds, basketball courts, soccer fields, fishing lakes and after-school programming. The MHC industry is highly fragmented and provides many consolidation opportunities. The top 50 MHC investors are estimated to control only about 17% of the estimated 4.2 million manufactured housing lots available for lease in the United States. There are many attractive targets and acquisitions we have completed along with our strict and disciplined criteria. First, we look for opportunities that are accretive to our AFFO per unit. Second, we seek opportunities that will allow us to leverage management synergies and create economics (sic) [ economies ] of scale. Finally, we pursue targets in adjacent U.S. states where we currently operate or in new states with similar regulation and characteristics as our current markets. This approach allows us to achieve measured growth as expand in our current markets or into new ones. As we did exactly this with the acquisitions we made in the fourth quarter, we continue to grow our presence in Kentucky, Indiana and Ohio and added our existing position in Arkansas, which will enter -- which we entered during the second quarter of 2021. Let's talk about Kentucky first. The Lexington, Kentucky acquisition has 546 lots across 71 acres and is close to two post-secondary institutions, state parks, popular eateries and major entertainment attractions, including the Kentucky Horse Park. The community is currently 92.6% occupied with no rental homes. And early in the quarter, we completed the acquisition of an RV park resort in a highly desirable area in the Northern Kentucky. The resort has been in existence for 51 years, includes 99 lots. It's located close to interstate I-75 and our corporate headquarters here in Northern Kentucky. We also made progress in Indiana. Here, we expanded our footprint with 200 home acquisitions in a central region of the state. The community is currently 92% occupied and includes 96 rental homes. Community amenities include a basketball court, a playground, a clubhouse, recreation facilities and fishing pond. In Arkansas, our Bryant community acquisition provides 327 lots across 97 acres and is located 20 miles southwest of downtown Little Rock, the location of our first MHC purchase in the state. The Bryant community is close to Bryant's public schools; base retailers, including Walmart and Dollar Tree; and two hospitals. The community is currently 98% occupied and includes 31 rental homes. Now on to our Ohio expansion. We expanded our footprint into Northern Ohio by acquiring a 70-acre resort. It is 368 lots complete with lakes, a swimming pool, splash park, playground, volleyball courts, picnic area and basketball courts. The community is one of the most family-friendly cleanest and scenic RV Resorts throughout of all of Ohio. And we also -- in the fourth quarter, we continue to strengthen our Ohio presence by purchasing a 13-acre high-quality resort community in Northern Ohio. Here, we will have 100 MHC homesites with a 99% occupancy rate and 141 boat slip marina. Now let's look at our entry into two new states, Missouri and Illinois. In Missouri, we completed a significant acquisition of a 500 lot community in O'Fallon near St. Louis. This is close to our Paducah communities. O'Fallon is a lovely family orientated property. It covers 103 acres and provides a playground and swimming pool. Our new acquisition in Illinois is in Springfield, the state capital, and close to our communities in Indiana. It has 231 lots. It's called Woodland Acres Pointe in a well-located area near employers, highways and recreation. This acquisition shows that we -- this acquisition shows that we -- a business model is scalable and can be applied across the United States. I'll now turn it over to Eddie, our CFO, to talk about our financial performance for the quarter. Eddie?

Thanks, Nathan. Good morning, everyone. Before I begin, I want to note that references to our operating financial performance from the prior period are from October 7, 2020, the date the REIT acquired the initial portfolio, to December 31, 2020. I will also discuss our full year results and our performance compared to the previous quarter. Please consult our fourth quarter and year-end MD&A and financial statements for more information. Now let's turn to results. We generated revenue of $12.2 million during the fourth quarter, 47% higher than prior period. Looking across the quarters, you'll also see steady increase in revenue as we added properties to our portfolio. Fourth quarter revenue was 7% higher than the $11.4 million realized in the third quarter of 2021. For the 12 months ended December 31, 2021, revenue was $43 million. Net operating income and NOI margins were $8.2 million and 67.2%, respectively, both higher than prior period. We also grew compared to the previous quarter with an 8% increase of NOI compared to $7.6 million in Q3 2021 with an NOI margin of 66.6%. For the full year 2021, net operating income was $28.7 million with an NOI margin of 66.6%. Funds from operations was $4.6 million in the fourth quarter compared to $2.7 million in the prior period, a 71% increase. On a per unit basis, FFO was $0.26 compared to $0.22 in the prior period. Compared to the third quarter, FFO increased by 4.8% over the $4.4 million realized in Q3 and increased by $2.3 million -- I'm sorry, increased by 2.3% on a per unit basis from just under $0.26. FFO was $15.9 million and FFO per unit was $1.03 for the full year. Adjusted funds from operations was $3.9 million, a 76% increase over the prior period. AFFO per unit was $0.22, a 22.5% increase. Comparing AFFO to our third quarter results, we increased by 4.8% from $3.7 million, while AFFO per unit increased by 2.3% from just under $0.22. We achieved an AFFO of $13.4 million and $0.877 on a per unit basis for the full year. These increases were primarily driven by our accretive acquisition strategy during 2021 as well as continued same-community NOI growth. To partially fund the acquisitions made in the quarter, we completed a unit offering for gross proceeds of $46.5 million in November. The offering was priced $19.25 per unit and the REIT subsequently issued 2.4 million trust units. In October, we increased distributions to unitholders by 5%. The REIT's unitholders are now receiving approximately $0.54 per unit on an annualized basis. To further bolster our acquisition capabilities, the REIT borrowed a total of $17.95 million over two transactions. In November, we borrowed $8.7 million at a fixed interest rate of 3.18% for 20 years. The first 81 monthly payments on the loan are interest-only. On March 10 of this year, we signed a commitment to borrow an additional $9.25 million at a fixed rate of 4.37% over 30 years. The first 180 monthly payments of this loan are interest-only. With the proceeds from these transactions and our cash on hand, we are well resourced to execute our growth plans. The REIT's portfolio continued to show strong performance in 2021. Weighted average lot rent grew by 4.8% to $369 in the year compared to $352 in the previous year. Rent collections for the fourth quarter remained strong at 98.6%, a slight increase from the prior period. In 2021, same-community occupancy of 80.6% was a 1.8% increase over the previous year. And on a total portfolio basis, our occupancy was 82.8% at year end, a 3.2% increase over the previous year. The increase in these metrics demonstrates the merits of MHCs in the REIT's portfolio in particular, specifically, their affordability and the high level of ownership in our communities. The ongoing COVID-19 pandemic has also amplified the benefits of MHC versus multifamily apartments. We ended the quarter with total cash and cash equivalents of $15.5 million with no near-term debt obligations. As of December 31, 2021, the REIT had a total weighted average interest rate of 3.43% and a total weighted average term to maturity of 10.7 years. Our debt to gross book value was 37.3% at year end, a 10.5% improvement over the 47.8% debt to GBV we had at December 31, 2020. Also to note, today's comments on the call may contain forward-looking information, and this information by its nature is subject to risks and uncertainties. Actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filing on SEDAR. These documents are also available on our website at flagshipcommunities.com. With that, I will turn it back over to Kurt.

Thank you, Eddie. The MHC sector has shown a consistent track record of growth in the past 20 years, and we remain bullish on the sector's outlook. Many macro characteristics and trends in the United States real estate housing industry offer investors significant upside potential. These are, first, United States is in the midst of a demographic shift that is expected to materially benefit from the residential real estate sector with new household formation. Second, lower housing affordability. As millennials enter the prime age for household formation, they are doing so in an economic environment in which housing price growth has outpaced wage growth over the past decade. Third, a declining home single-family homeownership rates. Mortgage lending standards have remained high, and as a result, traditional single-family homeownership is out of reach for many Americans, particularly millennials. With inflation over 7%, manufactured housing is becoming a more affordable pathway to homeownership for many Americans. And finally, there is a lack of new manufactured housing communities. This lack of new supply creates high barriers to entry for new market participants. We are one of the Midwest region's largest MHC operators, and we are the only pure-play manufactured housing investment in the Canadian capital markets. Our REIT offers investors an opportunity to participate in a niche and stable market with significant growth potential. We certainly thank you for your time today, and I will now open up the line for questions.

[Operator Instructions] Your first question comes from Mark Rothschild, Canaccord.

You spoke about the shifts in the market and demand you're seeing. I'm wondering if you can comment and maybe then quantify somewhat how you're looking at the returns that you're getting on properties as cap rates compress and rental rates rise? How this impacts maybe the long-term IRRs that you're seeing? And is there any compression in that number as well?

I think two multifaceted answer, Mark. So let me take the first part of it and then I'll turn some of the cap rate conversation over to Eddie. First, in our marketplace, what we're seeing is it's not uncommon for us to see $100, $200 or even more renewal rates for multifamily apartment kind of situations. That's where a fair amount of our new customers come from. They come from us from apartments and rental houses, and they're looking for an extra bedroom and maybe a higher quality neighborhood. So when we're seeing those, those are pretty large renewal rates, and it just makes the differential even more important between the alternative forms of housing. So with that, it's actually giving us pricing power for the future that we probably haven't totally tapped yet is what we really think. We're -- again, our average lot rent increase last year was about $17. I think this year, the average lot rent is in the $20 range. So we've left some room to grow, which should help the IRRs long term. But Eddie, do you want to talk about the cap rate suppression that we've seen and some of the other factors?

Yes. So I think what Kurt actually just alluded to is kind of a good segue. So yes, we're certainly seeing some continued cap rate suppression. High-quality kind of these five star assets are certainly trading [ subpar ], and -- when you're talking about going in cap rate. The -- I think that the thing that we look at for our opportunities though is we look for those opportunities where the going-in cap rate is -- yes, maybe it's sub 5%, 4.5%, but the opportunity is there for us to really drive NOI growth within the community. And I'll give you an example. The acquisition we did recently in the fourth quarter in Lexington, Kentucky. Certainly, it's a large community, five star community, best in the area. But what we've been able to do when we do those acquisitions is we go in and we implemented some of our operating strategies, one of which being the -- our water sewer submetering system and recapture. Just in the first month of the -- of that property, we've been able to reduce water usage by more than 20%. Those things help us -- yes, while the going in cap rate may be lower than what we've traditionally seen, we've still been able to drive consistent ROIs on our investments by going in and finding the properties that have, yes, low cap rates, but opportunities for growth from the other side after we take it over when we implement our operating strategy. So I would say, long term, ROIs are very in line to what we would have seen in the past. We just have to be a little more particular on those assets that we're buying when we're looking at them.

Okay. Great. And maybe turning to the balance sheet. You raised equity late last year and definitely strengthened the balance sheet considerably. Is there a range that you're targeting this year? Are you willing to allow leverage to tick back up to use the capacity you have? Or do you really want to keep that at this level?

Well, I think our long-term strategy is that we would like our debt as a percentage of book value to go down. Now it's -- pardon me, that's an interesting conversation because in the short term -- right now, as we speak, we have deals that we're looking at that are 20, 30 year fixed interest rates. So the debt market is with us right now. I think you could see a short-term moment where it goes back up into the low 40s. And then I could see it then continuing to march back down. We're certainly on a downward trajectory. And we believe less debt is more. And if you look at the debt maturities, Eddie has done a great job stretching the maturities now. I think they're over 10 years. Weighted average coupon is 3.43%, and we don't have anything maturing in the foreseeable future. So we're real thrilled with what debt we have put on. But look for it to march down long term. Short term, you might see a bump up a little bit.

Your next question comes from Brad Sturges, Raymond James.

I guess maybe just starting on the same-property NOI for '22. Your margins have been trending at, I guess, the higher end of the range that you think previously guiding for. How do you think about margins going forward, given the context of the rent growth opportunity that you're seeing today?

Eddie, I'll let you take the first swipe at that one.

Yes. So I think that when you look at our margins, when you look at our mature properties, the properties that we've held for a significant amount of time, so the initial properties, which is what we were discussed -- calling same-property, obviously, last year, those are mature properties. And those high NOI margins are kind of where we would expect it to be. Hard to push them much beyond where we're at on the mature properties, even when you get the rent growth that we're expecting. However, what we do expect is that as new properties come into what we call same-community drive, that you would have year-over-year comparisons for, we expect to be able to drive those margins up consistently over time, which should bring total portfolio margins up slightly. That's where the real opportunity is. Once you have kind of that maturity, we would certainly look for areas to continue to drive same-property NOI there, increases on margin, but the real opportunity is with these properties that are -- been in the portfolio for a year and then we can take those margins up over time.

Right. And from an occupancy growth perspective, you would think that could be consistent this year to what the growth rate was last year?

I do. Again, we still think a 2% to 3% range is the right range. Most of our rent increases, by the way, have already taken effect this year, and they were received well. And at the end of the day, we think occupancy is -- our guidance on that at 2%, 3% is still -- is good guidance.

Okay. You talked about increasing pricing power just given what's happening on the multifamily side. Does that translate into better pricing power for the rents you can get for the rental homes that you have in the portfolio?

It does. It does. We're crazy, mindful because, again, we'd like to -- we'll never be out of the home rental business. But at the end of the day, we need to get paid when we're in it, and I think we do. But I think the real pricing power in the future that's actually a needle mover is the one that I alluded to earlier. When the competing forces are pushing rents as hard as they are, they'll push them until they break them and then offer concessions. And we're kind of the opposite strategy. We're going to be right behind them and be very consistent and methodical about it, but it definitely gives us some runway to have top line revenue growth in the future.

Okay. Last question just on -- with the RVs and I guess you now have a little bit of marina exposure. Does -- I know that they tend to be annual leases, but would higher gas prices have any impact on demand within that segment?

I think as an industry as a whole, the answer is yes. They would. But the two assets that we purchased and the existing RV lots that we have, they're really not hospitality model. And I think if they were a hospitality model where they had a lot of overnight stays, I think then I would probably have more cautions in my tone of voice. But at the end of the day, our folks are parking their homes there, the campers, and their RVs there year-round typically, the majority of them, and they don't really move them. Well, we've been pretty thrilled with that new product lines for us so far. So it's been -- it's taught us some good things about how they continue to add amenity-rich or amenities to our other locations. So it's been a good adventure thus far.

Your next question comes from Himanshu Gupta, Scotiabank.

So just on the portfolio occupancy, if I look at the overall occupancy is around 82%, 83%. What do you think is the stabilized occupancy on this portfolio? Once you have done the value add, where do you think it will settle at?

When we look at a location and it gets to the mid-90s in occupancy, again, it's an interesting conversation for our industry because some of our housing stock is now getting old. So you have to start making decisions on what you should -- what should go in a community long term. And especially if you start getting 1970, 1980 series homes that have -- that are just aging out. So I think 95% is the answer to your question, and then we start making decisions about housing stock within that location. We certainly have room to organically grow. And we've got -- Nathan has done a great job. We have plenty of houses to sell and plenty of home rentals should we need them. We don't feel like we need any more home rentals. But whatever the market gives us, we seem to be prepared for to drive that occupancy up.

Got it. Okay. And then like typically, you have bought properties with some occupancy upside. And when I look at the two recent acquisitions, Lexington, Kentucky, 92% occupied, and then Bryant, Arkansas almost 98% occupied. So where is the NOI upside on these 2 recent transactions? Is it mostly NOI margin? Doesn't look like much on occupancy here.

Yes, it's absolutely [Technical Difficulty] in the top line rent number on those particular two locations. To Eddie's earlier comment, really, when we looked at the one in Lexington, we knew that it was the water and the sewer. The water and the sewer, when we did the underwriting, didn't match our historical knowledge base, and that's proven true. So while we didn't -- we're not going to have -- we didn't buy a property at 80% that we could drive to 90%, we did buy the best location in Lexington, and therefore, you can get premium lot rent. And more importantly, you can make your true margins on the operating expense side by just leak containment. And the beautiful thing about submetering leak containment is, you're not charging it to the resident. That's actually just you're taking it from the utility company. So -- and they don't want to spend it anyway because it's true water conservation. I think that's just -- we get up every day and we fight that fight. We have dedicated staff that does that, does nothing but that every day. And that's where we can drive some returns, in both cases, Bryant and Lexington.

And would you say that the NOI margin expansion would be something like 4 to 5 points for these acquisitions or typical acquisition?

Eddie, I'll let you take the first stab.

I think we're looking at 3% to 5% on margin expansion on those - on these acquired properties. What we see a lot of times when we go in is we see, number one, high rental homes and lack of attention to detail around, to Kurt's point, submetering water and sewer. We all know and we've talked about a lot of times that your rental -- the more rental homes you have, just in general, likely the lower your NOI margins are going to be in that community. So to the extent that we can sell off rentals and drive the water and sewer, it's generally somewhere 3 to 5 points that we can drive margin on.

Got it. Okay. And then just turning to the fair value gains recorded this quarter. I mean quite meaningful, $56 million. So what led to that increase? Is it mostly cap rate compression or NOI assumptions being revised as well?

Yes. So we go through a pretty stringent process on our -- annually on our portfolio as we talk about fair value. So we engage an appraiser to come in and do a complete appraisal of the entire portfolio, look at on an individual property basis to ensure that our minds set where our mind is and where theirs' is on cap rates are similar. So if you look at the total year, we had about $78 million of fair value gain across the portfolio. Of that, about $54 million was related to the cap rate compression and the additional $24-ish million is related to NOI margin gains. So we -- I'm sorry, our cap rate went from 5.52% end of last year to 4.73% end of last year -- I'm sorry, end of this year. And that's kind of consistent with what we've seen as we are looking at acquisitions. As we've done acquisitions, the cap rate compression has been there. And we'll see what happens with the -- rising interest rates may stem that a bit, but it's certainly consistent with where we've seen the market going.

Got it. Okay. And maybe the last question is that acquisition of resort community from Empower. So is there any seasonality in cash flows from this product? And then maybe how is the pipeline looking from Empower in general?

I'll talk about the seasonality, and then I'll turn Nath -- oh, Kurt is back on. I'll turn over the discussion of the pipeline to Nathan. But -- so the seasonality -- it's a resort community, but they are MHCs. People have their homes there, sit their year-round and 100% occupied and they pay their rent for the homes throughout the year. So no real seasonality. The only -- I mean, it's very, very minor, but the only seasonality there could be at all would be around the boat slips. But again, it's a very, very minor amount, very inconsequential amount.

Okay. And how is your pipeline from Empower?

Nathan?

Well, it continues to be extremely competitive. I feel like that our top line is where I would -- where I think everyone would be pleased with the pipeline that I'm working right now.

Your next question comes from Joanne Chen, BMO Capital Markets.

Just wanted to say congrats on a solid end to the year. And obviously, you guys been very, very busy. But one thing I do wanted to just go back on -- and I apologize if I missed this earlier. But obviously, it's great to see the concurrent year-over-year increase of both rent growth as well as occupancy. But did you say that you should probably expect to see a 2% to 3% bump in occupancy in 2022? Or sorry, if I missed that earlier.

Yes. No, that's still the guidance, Joanne, and we still think that's good guidance to have. The volatility that we see in occupancy, by the way, if you got into the weeds of it, is actually the rental home fleet. It's actually not -- it's not the lots because the rental home fleet -- that's about 1,000 units right now. And again, we'd like to be 1,000 minus 1 today. But they operate pretty much like a B-grade apartment in the form of turnover. They're going to turn over 50%. And that's where you normally see the volatility. You don't see it in the core lots but 2% to 3% guidance is exactly what we think on an organic kind of basis going.

Got it. Okay. That's helpful. And maybe this would probably be more for Eddie again, but I know we're all tired of talking about inflation pressures. But obviously, to your submeters, it sounded like you mentioned you guys are able to pass off a lot of -- some of that increase back. So that's always a positive. But are there any areas where there might be a little bit of a pressure? I mean, obviously, you guys have done a great job of ongoing cost-saving initiatives. But how should we, I guess, think about the margin trend through 2022 as we ride through this wave?

I think -- go ahead, Eddie. I'm sorry.

No. I'm sorry, Kurt. I think that the pressures that -- the biggest pressure we see is where you generally see it first is in utilities. And again, the beauty for us is, at this point, those utilities are submetered. And we don't necessarily have still the effects of that. Certainly, we continue to see the same trends that folks are seeing inflation around wages, and we've battled to keep those in line. But they're real. Some of that will be managed with as we continue to kind of look at our operating strategies within the communities. But yes, I mean, there's certainly some pressure that we see there. And frankly, just the cost of everything has increased, right? And so we'll have to be strategic move forward, but I don't foresee it having any significant impact on our margins.