Over the past three years, Sun Communities' (NYSE: SUI) stock declined 36% while the S&P 500 rallied 31%. Even after including its reinvested dividends, the real estate investment trust (REIT) delivered a negative total return of 31%.
Like many other REITs, Sun struggled as rising interest rates throttled its expansion and drove income investors toward safer CDs, T-bills, and other fixed-income investments. But Sun's decline was exacerbated by other challenges -- including a troubling short-seller report, the abrupt retirement of its CEO, and a shakeup of its board of directors.
Let's see if Sun has a shot at burning bright again over the next three years.
Image source: Getty Images.
How does Sun Communities make money?
Sun mainly invests in RV communities, marinas, and manufactured home communities. As an REIT, it rents out those properties and splits the rental income with its investors.
At the end of the third quarter of 2024, Sun owned 659 properties across North America and the U.K. -- consisting of 288 manufactured housing properties, 179 RV properties, 138 marina properties, and 54 U.K. properties. But its portfolio shrank from 670 properties a year ago. That decline was largely caused by the restructuring of its manufactured housing portfolio, which buckled under high inventory levels as interest rates rose.
Yet, Sun's occupancy rates for its remaining properties are still fairly healthy. In the third quarter, the blended occupancy rate for its North American manufactured housing and RV segments expanded 50 basis points year over year to 97.7%. The U.K. segment's occupancy rate also improved by 90 basis points to 91.5%.
If interest rates continue to decline and the macro environment warms up, Sun's prospects should improve. Unfortunately, that turnaround probably won't happen anytime soon. For 2024, it expects its core funds from operations (FFO) to decline 4%-5% as it shrinks its manufactured housing business. For 2025, it plans to continue cutting costs and restructuring its business.
Why is Sun Communities less appealing than other REITs?
Many people invest in REITs because they must distribute at least 90% of that taxable income as dividends to maintain a favorable tax rate. That usually gives them high yields and makes them popular stocks for income-oriented investors.
However, Sun only pays a forward yield of 3% quarterly. By comparison, the retail REIT giant Realty Income pays a forward yield of 5.8% monthly. Meanwhile, casino and resorts REIT Vici Properties pays a forward yield of 5.9% with its quarterly dividend. The risk-free 10-year Treasury still pays a 4.6% yield as interest rates stay elevated. Compared to those alternatives, Sun doesn't seem like a compelling income investment.
Sun also isn't a bargain relative to its peers. At $126, it trades at 19 times the midpoint of its core FFO guidance for 2024. Realty and Vici, which have higher occupancy rates than Sun, both trade at 13 times their adjusted FFO forecasts for 2024. It doesn't make sense for Sun to be trading at a higher multiple than those two recession-resistant REITs.
Lastly, a short-seller's accusations of Sun inflating its FFO (which the company hasn't officially responded to), the unexpected retirement of its CEO shortly after that report, and the departures of three of its board members are casting even more clouds over its future. All of these issues are making Sun a lot less attractive than many of its REIT peers.
What will happen to Sun over the next three years?
The next three years could be difficult for Sun. It's still trying to rightsize its manufactured housing portfolio, while its RV and U.K. segments are struggling to grow their same-property net operating income (NOI) in this challenging market. It also doesn't expect to name a new permanent CEO until the end of 2025, so we won't know if it will head in a dramatic new direction.
For now, investors should focus on the known factors. Interest rates should decline over the next three years as the macro environment stabilizes. As that happens, Sun will likely expand its real estate portfolio again, grow its occupancy rates, and raise its rent to boost its NOI.
Those improvements should support its future dividend hikes. However, those macro tailwinds should also help other higher-yielding REITs like Realty and Vici. So just like the past three years, Sun could struggle to attract more investors to its stock, as long as it's paying a lower yield and trading at a higher valuation.
Sun's stock probably won't drop off a cliff over the next three years, but I don't think it will outperform the market or most of its industry peers. That said, it might attract some short-term attention with its ticker symbol, which could be easily confused with the Sui cryptocurrency -- but long-term investors should tune out that short-term noise.
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Leo Sun has positions in Realty Income and Vici Properties. The Motley Fool has positions in and recommends Realty Income and SUI. The Motley Fool recommends Sun Communities and Vici Properties. The Motley Fool has a disclosure policy.
