Sun Communities: Buy, Sell, or Hold?

Roughly half of Sun Communities' (NYSE: SUI) business is about providing affordable housing. The rest is tied to lifestyle-based recreation. This is not your typical real estate investment trust (REIT). Is the combination of assets it owns worth buying? Or is this a situation where dividend investors would be better off going with a more traditional landlord? Here's what you need to know.

Buy Sun Communities?

From a top-level view, 45% of Sun Communities' rental income comes from U.S. manufactured housing communities. Another 8% or so comes from similar assets located in the United Kingdom. These properties offer affordable housing options to people who either need lower-cost accommodations or want to keep costs down while still having a second residence. It's a pretty reliable business, since there aren't a lot of low-cost options when it comes to "owning" a home.

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Image source: Getty Images.

The key is that residents own the building, but they rent the property on which it is located from Sun Communities. This relationship leads to a 50% reduction in cost per square foot for the occupant, according to the REIT.

The problem is that there's not a huge amount of growth in the manufactured housing space. New properties are hard to build, and existing locations have a finite ability to expand. Still, rent increases and services, along with modest acquisitions and expansions, should support slow and steady growth over time. Expansion into other countries, like the move into the United Kingdom, could provide further growth, but this is a far less certain path.

The other half of Sun Communities is lifestyle-based, consisting of RV parks and marinas. As with mobile home parks, there's limited growth opportunity with these assets. RV parks aren't exactly high on the list of construction needs for most communities, and marinas, by nature, can only be located in select locations. Acquisitions offer growth potential, but slow and steady rental growth from price increases is likely to be the more reliable outcome. However, given that neither of these property types is actually a necessity for most people, there is a risk that demand could actually fall. Economic shifts could also lead to trouble, as people look for areas in which to trim costs.

In fact, the past year has been rather difficult for the RV side of the business, with net operating income expected to be down as much as 5% in 2024. Marinas, which tend to cater to wealthier customers, is projected to grow net operating income by as much as 5%. The manufactured home side of the business is expected to expand as much as 6%. Overall, Sun Communities expects net operating income growth of around 3.5% or so.

If you don't mind owning a fairly unique REIT offering slow and steady growth, it could be a good option for your portfolio. But there's one small problem that you'll need to consider before you hit the buy button.

SUI data by YCharts.

Sell or avoid Sun Communities?

Even after a 40% decline in the stock price, Sun Communities' dividend yield is only 3%. The average REIT has a dividend yield of 3.8%. Average annualized dividend growth for Sun Communities over the past decade was roughly 3%. Those just aren't impressive numbers in the REIT sector.

You'd probably be better off buying a REIT industry giant like Realty Income, which offers a 5.8% yield and has a similar, slow and steady growth outlook. Realty Income is a retail focused net-lease REIT (net leases require tenants to pay most property-level operating costs). If you are most interested in owning a housing REIT, apartment owners like UDR and AvalonBay would probably be a better choice. AvalonBay's yield is around 3.1%, while UDR's yield is 4.2%. The opportunity to acquire and build new apartments is also far greater than the opportunity set that Sun Communities has in front of it.

Basically, there's nothing wrong with Sun Communities, but there are probably more attractive investment options in the REIT space. If you bought it when the stock was much higher, you might want to harvest the losses and shift to a higher-yielding option, or one with more potential for growth.

You've really got to like Sun Communities

Sun Communities is not a bad REIT. But it may not have as bright a future as investors once believed. Wall Street has clearly soured on the shares. Manufactured housing is probably going to be a solid foundation offering slow and steady growth, but at 50% or so of the business, it isn't the only thing driving performance.

Can RV parks and marinas push growth into high gear again? Is there another property type that Sun Communities can expand into to boost growth? These are questions that an investor needs to answer before buying a REIT with a relatively low yield. Unless you believe growth can rise above recent levels, there are likely to be more rewarding REIT options elsewhere.

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Reuben Gregg Brewer has positions in Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends AvalonBay Communities and Sun Communities. The Motley Fool has a disclosure policy.