Gradually declining benchmark interest rates have lured some investors back toward real estate investment trusts (REITs) over the past year. Those lower rates make it easier for REITs to purchase more properties, while shrinking yields for CDs, bonds, and Treasuries drove many income-focused investors back toward higher-yielding dividend stocks again.
But amid a good year for REITs, one that was left out in the cold was Sun Communities (SUI -0.88%), which mainly invests in manufactured home communities, RV communities, and marinas. Sun’s stock has fallen by about 8% over the past 12 months as the S&P 500 rose by nearly 30%. So what’s the right course of action for investors now when it comes to this out-of-favor REIT?
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Understanding Sun Communities’ business model
As of the end of the third quarter, Sun’s portfolio consisted of 659 properties, including 288 manufactured housing properties, 179 RV properties, and 138 marina properties across North America, plus 54 U.K. properties of various types. That represented a decline from a total of 670 properties a year earlier. That drop was mainly caused by a restructuring of its manufactured housing portfolio, where it struggled with high inventories as interest rates increased.
On the bright side, the blended occupancy rate for its North American manufactured housing and RV segments rose 50 basis points year over year to 97.7% in Q3. The U.K. segment’s occupancy rate grew 90 basis points to 91.5%.
From 2018 to 2023, Sun’s core funds from operations (FFO) per share grew at a robust compound annual rate of 9%, even as its residential business weathered the pandemic and rising interest rates. But for 2024, it expects its core FFO to decline by 4% to 5% as it prunes its manufactured housing business. It also plans to restructure its business to further cut costs.
Why aren’t investors enthusiastic about Sun’s future?
Sun’s business seems stable, but it was hit by some concerning allegations this past September from Blue Orca Capital, a Texas-based short-selling hedge fund. Short-sellers make money when a stock’s price falls, so investors should keep that bias in mind.
In its report, Blue Orca made several claims of financial improprieties by Sun President and CEO Gary Shiffman. Blue Orca further critiqued some of the approaches the company takes in its financial reporting. It also claims the company is too highly leveraged, with a net-debt-to-recurring-EBITDA ratio of 6.0.
However, investors may want to take those bearish claims with a grain of salt. Also, Sun isn’t the only REIT to report results in the way that it does, and it certainly isn’t unusual for REITs to take on lots of debt.
In its Nov. 6 quarterly conference call with analysts, the company reported that it had engaged an independent third-party law firm to look into matters after the short report was released. “…there have been no changes to our financial reporting practices and the Audit Committee determined that the company complied with its disclosure obligations,” Shiffman said.
Also on Nov. 6, Sun announced that Shiffman would retire in 2025 and that former Chief Operating Officer John McLaren was coming back to serve as the company’s president. (The board has begun a separate search for a new CEO.) The timing of that transition and Sun’s dim earnings outlook rattled investors, and the stock has tumbled by about 14% over the past three months. The company, however, noted that “Mr. Shiffman’s retirement is not the result of any disagreement with the Company on any matter relating to its operations, policies or practices,” and Shiffman said in the conference call that his decision was not related to the Blue Orca report.
Trading at around $124, Sun’s stock might look reasonably valued at 17 times last year’s FFO per share, but its forward dividend yield of 3.1% seems low relative to the yields of other REITs or the 10-year Treasury’s current yield of 4.1%.
Is it the right time to buy, hold, or sell Sun’s stock?
Sun’s prospects might brighten as it restructures its business and interest rates decline further, but it would be easy to find more appealing REITs with higher dividend yields and lower valuations. For example, Realty Income (NYSE: O) — a REIT giant that mainly serves large recession-resistant retailers — offers a forward yield of 5.8% at its current share price, makes payouts on a monthly basis, and trades at less than 14 times last year’s FFO per share.
So for now, it would be smarter to avoid Sun’s stock. It should eventually break out of this rut, but it doesn’t make sense to park your cash in this underwhelming REIT when there are plenty of better looking buys in the sector.
Leo Sun has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends Sun Communities. The Motley Fool has a disclosure policy.
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