| SUN COMMUNITIES INC ITEM 1A RISK FACTORS RISK FACTORS Our prospects are subject to certain uncertainties and risks |
| Our future results could differ materially from current results, and our actual results could differ materially from those projected in forward-looking statements as a result of certain risk factors |
| These risk factors include, but are not limited to, those set forth below, other one-time events, and important factors disclosed previously and from time to time in other Company filings with the Securities and Exchange Commission |
| This report contains certain forward-looking statements |
| REAL ESTATE RISKS General economic conditions and the concentration of our properties in Michigan, Florida, and Indiana may affect our ability to generate sufficient revenue |
| The market and economic conditions in our current markets generally, and specifically in metropolitan areas of our current markets, may significantly affect manufactured home occupancy or rental rates |
| Occupancy and rental rates, in turn, may significantly affect our revenues, and if our communities do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow and ability to pay or refinance our debt obligations could be adversely affected |
| We derived significant amounts of rental income for the period ended December 31, 2005 from properties located in Michigan, Florida, and Indiana |
| As of December 31, 2005, 46 of our 135 Properties, or approximately 30prca of developed sites, are located in Michigan, 19 Properties, or approximately 21prca of developed sites, are located in Florida, and 18 Properties, or approximately 14prca of developed sites, are located in Indiana |
| As a result of the geographic concentration of our Properties in Michigan, Florida, and Indiana, we are exposed to the risks of downturns in the local economy or other local real estate market conditions which could adversely affect occupancy rates, rental rates and 6 property values of properties in these markets |
| The following factors, among others, may adversely affect the revenues generated by our communities: - the national and local economic climate which may be adversely impacted by, among other factors, plant closings and industry slowdowns; - local real estate market conditions such as the oversupply of manufactured housing sites or a reduction in demand for manufactured housing sites in an area; - the number of repossessed homes in a particular market; - the rental market which may limit the extent to which rents may be increased to meet increased expenses without decreasing occupancy rates; - the perceptions by prospective tenants of the safety, convenience and attractiveness of the Properties and the neighborhoods where they are located; - zoning or other regulatory restrictions; - competition from other available manufactured housing sites and alternative forms of housing (such as apartment buildings and site-built single-family homes); - our ability to provide adequate management, maintenance and insurance; - increased operating costs, including insurance premiums, real estate taxes and utilities; or - the enactment of rent control laws or laws taxing the owners of manufactured homes |
| Our income would also be adversely affected if tenants were unable to pay rent or if sites were unable to be rented on favorable terms |
| If we were unable to promptly relet or renew the leases for a significant number of the sites, or if the rental rates upon such renewal or reletting were significantly lower than expected rates, then our business and results of operations could be adversely affected |
| In addition, certain expenditures associated with each equity investment (such as real estate taxes and maintenance costs) generally are not reduced when circumstances cause a reduction in income from the investment |
| Furthermore, real estate investments are relatively illiquid and, therefore, will tend to limit our ability to vary our portfolio promptly in response to changes in economic or other conditions |
| Competition affects occupancy levels and rents which could adversely affect our revenues |
| All of our Properties are located in developed areas that include other manufactured housing community properties |
| The number of competitive manufactured housing community properties in a particular area could have a material adverse effect on our ability to lease sites and increase rents charged at our Properties or at any newly acquired properties |
| We may be competing with others with greater resources and whose officers and directors have more experience than our officers and directors |
| In addition, other forms of multi-family residential properties, such as private and federally funded or assisted multi-family housing projects and 7 single-family housing, provide housing alternatives to potential tenants of manufactured housing communities |
| Our ability to sell or lease manufactured homes may be affected by various factors, which may in turn adversely affect our profitability |
| SHS is in the manufactured home market offering manufactured home sales and leasing services to tenants and prospective tenants of our communities |
| The market for the sale and lease of manufactured homes may be adversely affected by the following factors: - downturns in economic conditions which adversely impact the housing market; - an oversupply of, or a reduced demand for, manufactured homes; - the difficulty facing potential purchasers in obtaining affordable financing as a result of heightened lending criteria; and - an increase or decrease in the rate of manufactured home repossessions which provide aggressively priced competition to new manufactured home sales |
| Any of the above listed factors could adversely impact our rate of manufactured home sales and leases, which would result in a decrease in profitability |
| Increases in taxes and regulatory compliance costs may reduce our revenue |
| Costs resulting from changes in real estate tax laws generally may be passed through to tenants and will not affect us |
| Increases in income, service or other taxes, however, generally are not passed through to tenants under leases and may adversely affect our funds from operations and our ability to pay or refinance our debt |
| Similarly, changes in laws increasing the potential liability for environmental conditions existing on properties or increasing the restrictions on discharges or other conditions may result in significant unanticipated expenditures, which would adversely affect our business and results of operations |
| We may not be able to integrate or finance our development activities |
| From time to time, we engage in the construction and development of new communities, and may continue to engage in the development and construction business in the future |
| Our development and construction business may be exposed to the following risks which are in addition to those risks associated with the ownership and operation of established manufactured housing communities: - we may not be able to obtain financing with favorable terms for community development which may make us unable to proceed with the development; - we may be unable to obtain, or face delays in obtaining, necessary zoning, building and other governmental permits and authorizations, which could result in increased costs and delays, and even require us to abandon development of the community entirely if we are unable to obtain such permits or authorizations; 8 - we may abandon development opportunities that we have already begun to explore and as a result we may not recover expenses already incurred in connection with exploring such development opportunities; - we may be unable to complete construction and lease-up of a community on schedule resulting in increased debt service expense and construction costs; - we may incur construction and development costs for a community which exceed our original estimates due to increased materials, labor or other costs, which could make completion of the community uneconomical and we may not be able to increase rents to compensate for the increase in development costs which may impact our profitability; - we may be unable to secure long-term financing on completion of development resulting in increased debt service and lower profitability; and - occupancy rates and rents at a newly developed community may fluctuate depending on several factors, including market and economic conditions, which may result in the community not being profitable |
| If any of the above occurred, our business and results of operations could be adversely affected |
| We may not be able to integrate or finance our acquisitions and our acquisitions may not perform as expected |
| We acquire and intend to continue to acquire manufactured housing communities on a select basis |
| Our acquisition activities and their success are subject to the following risks: - we may be unable to acquire a desired property because of competition from other well capitalized real estate investors, including both publicly traded real estate investment trusts and institutional investment funds; - even if we enter into an acquisition agreement for a property, it is usually subject to customary conditions to closing, including completion of due diligence investigations to our satisfaction, which may not be satisfied; - even if we are able to acquire a desired property, competition from other real estate investors may significantly increase the purchase price; - we may be unable to finance acquisitions on favorable terms; - acquired properties may fail to perform as expected; - acquired properties may be located in new markets where we face risks associated with a lack of market knowledge or understanding of the local economy, lack of business relationships in the area and unfamiliarity with local governmental and permitting procedures; and 9 - we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations |
| In addition, we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities |
| As a result, if a liability were to be asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle it, which could adversely affect our cash flow |
| Rent control legislation may harm our ability to increase rents |
| State and local rent control laws in certain jurisdictions may limit our ability to increase rents and to recover increases in operating expenses and the costs of capital improvements |
| Enactment of such laws has been considered from time to time in other jurisdictions |
| Certain Properties are located, and we may purchase additional properties, in markets that are either subject to rent control or in which rent-limiting legislation exists or may be enacted |
| We may be subject to environmental liability |
| Under various federal, state and local laws, ordinances and regulations, an owner or operator of real estate is liable for the costs of removal or remediation of certain hazardous substances at, on, under or in such property |
| Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous substances |
| The presence of such substances, or the failure to properly remediate such substances, may adversely affect the ownerapstas ability to sell or rent such property, to borrow using such property as collateral or to develop such property |
| Persons who arrange for the disposal or treatment of hazardous substances also may be liable for the costs of removal or remediation of such substances at a disposal or treatment facility owned or operated by another person |
| In addition, certain environmental laws impose liability for the management and disposal of asbestos-containing materials and for the release of such materials into the air |
| These laws may provide for third parties to seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials |
| In connection with the ownership, operation, management, and development of real properties, we may be considered an owner or operator of such properties and, therefore, are potentially liable for removal or remediation costs, and also may be liable for governmental fines and injuries to persons and property |
| When we arrange for the treatment or disposal of hazardous substances at landfills or other facilities owned by other persons, we may be liable for the removal or remediation costs at such facilities |
| All of the Properties have been subject to a Phase I or similar environmental audit (which involves general inspections without soil sampling or ground water analysis) completed by independent environmental consultants |
| These environmental audits have not revealed any significant environmental liability that would have a material adverse effect on our business |
| These audits cannot reflect conditions arising after the studies were completed, and no assurances can be given that existing environmental studies reveal all environmental liabilities, that any prior owner or operator of a property or neighboring owner or operator did not create any material environmental condition not known to us, or that a material environmental condition does not otherwise exist as to any one or more Properties |
| 10 Losses in excess of our insurance coverage or uninsured losses could adversely affect our cash flow |
| We maintain comprehensive liability, fire, flood (where appropriate), extended coverage, and rental loss insurance on the Properties with policy specifications, limits, and deductibles which are customarily carried for similar properties |
| As a result of market conditions in the insurance industry, we decided to carry a dlra250cmam000 deductible on our liability insurance |
| Certain types of losses, however, may be either uninsurable or not economically insurable, such as losses due to earthquakes, riots, or acts of war |
| In the event an uninsured loss occurs, we could lose both our investment in and anticipated profits and cash flow from the affected property |
| Any loss would adversely affect our ability to repay our debt |
| 11 FINANCING AND INVESTMENT RISKS Our significant amount of debt could limit our operational flexibility or otherwise adversely affect our financial condition |
| We have a significant amount of debt |
| As of December 31, 2005, we had approximately dlra1dtta1 billion of total debt outstanding, consisting of approximately dlra988dtta1 million in collateralized debt that is collateralized by mortgage liens on 108 of the Properties (the "e Mortgage Debt "e ), and approximately dlra135dtta4 million in unsecured debt |
| If we fail to meet our obligations under the Mortgage Debt, the lender would be entitled to foreclose on all or some of the Properties securing such debt which could have a material adverse effect on us and our ability to make expected distributions, and could threaten our continued viability |
| We are subject to the risks normally associated with debt financing, including the following risks: - our cash flow may be insufficient to meet required payments of principal and interest, or require us to dedicate a substantial portion of our cash flow to pay our debt and the interest associated with our debt rather than to other areas of our business; - our existing indebtedness may limit our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt; - it may be more difficult for us to obtain additional financing in the future for our operations, working capital requirements, capital expenditures, debt service or other general requirements; - we may be more vulnerable in the event of adverse economic and industry conditions or a downturn in our business; and - we may be placed at a competitive disadvantage compared to our competitors that have less debt |
| If any of the above risks occurred, our financial condition and results of operations could be materially adversely affected |
| We may be able to incur substantially more debt which would increase the risks associated with our substantial leverage |
| Despite our current indebtedness levels, we may still be able to incur substantially more debt in the future |
| If new debt is added to our current debt levels, an even greater portion of our cash flow will be needed to satisfy our debt service obligations |
| As a result, the related risks that we now face could intensify and increase the risk of a default on our indebtedness |
| 12 Our equity investment in Origen Financial, Inc, may subject us to certain risks |
| In October 2003, Origen Financial, LLC completed a dlra150 million recapitalization |
| In this transaction, we purchased 5cmam000cmam000 shares of common stock (representing approximately 20prca of the issued and outstanding shares of common stock as of December 31, 2005) of Origen Financial, Inc |
| Origen is a publicly traded real estate investment trust in the business of originating, acquiring and servicing manufactured home loans |
| Our equity investment in Origen is subject to all of the risks associated with Origenapstas business, including the risks associated with the manufactured housing finance industry |
| The failure of Origen to achieve its development and operating goals could have a material adverse effect on the value of our investment in Origen |
| The financial condition and solvency of our borrowers and the market value of our properties may adversely affect our investments in real estate, installment and other loans |
| As of December 31, 2005, we had an investment of approximately dlra13dtta5 million in a real estate loan to an entity which owns a manufactured home community located in Arizona |
| The loan is secured by a first lien on the underlying property |
| Also, as of December 31, 2005, we had outstanding approximately dlra19dtta6 million in installment loans to owners of manufactured homes |
| These installment loans are collateralized by the manufactured homes |
| We may invest in additional mortgages and installment loans in the future |
| By virtue of our investment in the mortgages and the loans, we are subject to the following risks of such investment: - the borrowers may not be able to make debt service payments or pay principal when due; - the value of property securing the mortgages and loans may be less than the amounts owed; and - interest rates payable on the mortgages and loans may be lower than our cost of funds |
| 13 TAX RISKS We may suffer adverse tax consequences and be unable to attract capital if we fail to qualify as a REIT We believe that since our taxable year ended December 31, 1994, we have been organized and operated, and intend to continue to operate, so as to qualify for taxation as a REIT under the Internal Revenue Code ( "e Code "e ) |
| Although we believe that we have been and will continue to be organized and have operated and will continue to operate so as to qualify for taxation as a REIT, we cannot assure you that we have been or will continue to be organized or operated in a manner to so qualify or remain so qualified |
| Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control |
| In addition, frequent changes occur in the area of REIT taxation, which require the Company continually to monitor its tax status |
| If we fail to qualify as a REIT in any taxable year, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates |
| Moreover, unless entitled to relief under certain statutory provisions, we also would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost |
| This treatment would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability to us for the years involved |
| In addition, distributions to stockholders would no longer be required to be made |
| Even if we qualify for and maintain our REIT status, we will be subject to certain federal, state and local taxes on our property and certain of our operations |
| We intend for the Operating Partnership to qualify as a partnership, but we cannot guarantee that it will qualify |
| We believe that the Operating Partnership has been organized as a partnership and will qualify for treatment as such under the Code |
| However, if the Operating Partnership is deemed to be a "e publicly traded partnership, "e it will be treated as a corporation instead of a partnership for federal income tax purposes unless at least 90prca of its income is qualifying income as defined in the Code |
| The income requirements applicable to REITs and the definition of "e qualifying income "e for purposes of this 90prca test are similar in most respects |
| Qualifying income for the 90prca test generally includes passive income, such as specified types of real property rents, dividends and interest |
| We believe that the Operating Partnership would meet this 90prca test, but we cannot guarantee that it would |
| If the Operating Partnership were to be taxed as a corporation, it would incur substantial tax liabilities, we would fail to qualify as a REIT for federal income tax purposes, and our ability to raise additional capital could be significantly impaired |
| Our ability to accumulate cash is restricted due to certain REIT distribution requirements |
| In order to qualify as a REIT, we must distribute to our stockholders at least 90prca of our REIT taxable income (calculated without any deduction for dividends paid and excluding net capital gain) and to avoid federal income taxation, our distributions must not be less than 100prca of our REIT taxable income, including capital gains |
| As a result of the distribution requirements, we do not expect to accumulate significant amounts of cash |
| Accordingly, these distributions could significantly reduce the cash available to us in subsequent periods to fund our operations and future growth |
| 14 BUSINESS RISKS Some of our directors and officers may have conflicts of interest with respect to certain related party transactions and other business interests |
| Ownership of Origen |
| In the 2003 recapitalization of Origen Financial, Inc, ( "e Origen "e ), the Company purchased 5cmam000cmam000 shares of Origen common stock for dlra50 million and Shiffman Origen LLC (which is owned by the Milton M Shiffman Spouseapstas Marital Trust, Gary A Shiffman (the Companyapstas Chief Executive Officer), and members of Mr |
| Shiffmanapstas family) purchased 1cmam025cmam000 shares of Origen common stock for dlra10dtta25 million |
| Gary A Shiffman is a member of the board of directors of Origen and Arthur A Weiss, a director of the Company, is a trustee of the Milton M Shiffman Spouseapstas Marital Trust |
| Accordingly, in all transactions involving Origen, Mr |
| Weiss may have a conflict of interest with respect to their respective obligations as an officer and/or director of the Company |
| The following are the current transactions and agreements involving Origen which may present a conflict of interest for Mr |
| Shiffman or Mr |
| Weiss: - Origen Servicing Inc, a wholly owned subsidiary of Origen, services approximately dlra19dtta6 million of manufactured home loans for the Company as of December 31, 2005 for an annual servicing fee of 100 to 150 basis points of the outstanding principal balance of the loans pursuant to a Loan Servicing Agreement |
| - Origen has agreed to fund loans that meet the Companyapstas underwriting guidelines and then transfer those loans to the Company pursuant to a Loan Origination, Sale and Purchase Agreement |
| During 2005 and 2004 the Company purchased dlra7dtta2 million and dlra4dtta8 million of these loans, respectively |
| - The Company purchases certain repossessed manufactured houses owned by Origen located in its manufactured housing communities |
| The Company purchased approximately dlra2dtta2 million and dlra3dtta1 million of repossessed homes from Origen during 2005 and 2004, respectively |
| This program allows the Company to retain houses for resale and rent in its communities and allows Origen to enhance recoveries on its repossessed homes |
| Tax Consequences Upon Sale of Properties |
| Gary A Shiffman holds limited partnership interests in the Operating Partnership which were received in connection with the contribution of 24 properties (four of which have been sold) from partnerships previously affiliated with him (the "e Sun Partnerships "e ) |
| Prior to any redemption of these limited partnership interests for our common stock, Mr |
| Shiffman will have tax consequences different from those of us and our public stockholders on the sale of any of the Sun Partnerships |
| Therefore, Mr |
| Shiffman and the Company may have different objectives regarding the appropriate pricing and timing of any sale of those properties |
| Lease of Executive Offices |
| Gary A Shiffman, together with certain family members, indirectly owns approximately a 21prca equity interest in American Center LLC, the entity from which we lease office space for our principal executive offices |
| This lease is for an initial term of five years, beginning May 1, 2003, and we have the right to extend the lease for an additional five year term |
| The current annual base rent under this lease is at dlra20dtta25 per square foot (gross) and increases dlra0dtta50 per square foot for each successive year of the initial term |
| Shiffman may have a conflict of interest with respect to his obligations as an officer and/or director of the Company and his ownership interest in American Center |
| We rely on key management |
| We are dependent on the efforts of our executive officers, particularly Gary A Shiffman, Jeffrey P Jorissen, Brian W Fannon and Jonathan M Colman (together, the "e Senior Officers "e ) |
| As disclosed under "e Legal Proceedings, "e the SEC has initiated civil action against three of our employees, including Messrs |
| Shiffman and Jorissen, with respect to our accounting of the SunChamp investment during 2000, 2001 and 2002 |
| The defense of this civil action may divert the time and attention of these employees, be costly to the Company and/or result in the loss of services, or change in duties, of one or more of these employees |
| The loss of services of one or more of our executive officers could have a temporary adverse effect on our operations |
| We do not currently maintain or contemplate obtaining any "e key-man "e life insurance on the Senior Officers |
| Certain provisions in our governing documents may make it difficult for a third-party to acquire us |
| 9dtta8prca Ownership Limit |
| In order to qualify and maintain our qualification as a REIT, not more than 50prca of the outstanding shares of our capital stock may be owned, directly or indirectly, by five or fewer individuals |
| Thus, ownership of more than 9dtta8prca of our outstanding shares of common stock by any single stockholder has been restricted, with certain exceptions, for the purpose of maintaining our qualification as a REIT under the Code |
| Such restrictions in our charter do not apply to Gary Shiffman, the Milton M Shiffman Spouseapstas Marital Trust and the Estate of Robert B Bayer |
| The 9dtta8prca ownership limit, as well as our ability to issue additional shares of common stock or shares of other stock (which may have rights and preferences over the common stock), may discourage a change of control of the Company and may also: (1) deter tender offers for the common stock, which offers may be advantageous to stockholders; and (2) limit the opportunity for stockholders to receive a premium for their common stock that might otherwise exist if an investor were attempting to assemble a block of common stock in excess of 9dtta8prca of the outstanding shares of the Company or otherwise effect a change of control of the Company |
| Staggered Board |
| Our Board of Directors has been divided into three classes of directors |
| The term of one class will expire each year |
| Directors for each class will be chosen for a three-year term upon the expiration of such classapstas term, and the directors in the other two classes will continue in office |
| The staggered terms for directors may affect the stockholders &apos ability to change control of the Company even if a change in control were in the stockholders &apos interest |
| Preferred Stock |
| Our charter authorizes the Board of Directors to issue up to 10cmam000cmam000 shares of preferred stock and to establish the preferences and rights (including the right to vote and the right to convert into shares of common stock) of any shares issued |
| The power to issue preferred stock could have the effect of delaying or preventing a change in control of the Company even if a change in control were in the stockholders &apos interest |
| Rights Plan |
| We adopted a stockholders &apos rights plan in 1998 that provides our stockholders (other than a stockholder attempting to acquire a 15prca or greater interest in the Company) with the right to purchase stock in the Company at a discount in the event any person attempts to acquire a 15prca or greater interest in the Company |
| Because this plan could make it more expensive for a person to acquire a controlling interest in the Company, it could have the effect of delaying or preventing a change in control of the Company even if a change in control were in the stockholders &apos interest |
| 16 Changes in our investment and financing policies may be made without stockholder approval |
| Our investment and financing policies, and our policies with respect to certain other activities, including our growth, debt, capitalization, distributions, REIT status, and operating policies, are determined by our Board of Directors |
| Although the Board of Directors has no present intention to do so, these policies may be amended or revised from time to time at the discretion of the Board of Directors without notice to or a vote of our stockholders |
| Accordingly, stockholders may not have control over changes in our policies and changes in our policies may not fully serve the interests of all stockholders |
| Substantial sales of our common stock could cause our stock price to fall |
| Sales of a substantial number of shares of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for shares |
| As of December 31, 2005, up to approximately 3cmam036cmam000 shares of our common stock may be issued in the future to the limited partners of the Operating Partnership in exchange for their Common or Convertible Preferred OP Units |
| These Preferred OP Units are convertible at prices ranging from dlra44 to dlra68 |
| The limited partners may sell such shares pursuant to registration rights or an available exemption from registration |
| Also, Water Oak, Ltd, a former owner of one of the Properties, may be issued Common OP Units with a value of approximately dlra1cmam000cmam000 annually through 2007 |
| may be issued Common OP Units with a value of approximately dlra1cmam250cmam000 |
| In addition, as of December 31, 2005, options to purchase 686cmam339 shares of our common stock were outstanding under our 1993 Employee Stock Option Plan, our 1993 Non-Employee Director Stock Option Plan and our Long-Term Incentive Plan (the "e Plans "e ) |
| No prediction can be made regarding the effect that future sales of shares of our common stock will have on the market price of shares An increase in interest rates may have an adverse effect on the price of our common stock |
| One of the factors that may influence the price of our common stock in the public market will be the annual distributions to stockholders relative to the prevailing market price of the common stock |
| An increase in market interest rates may tend to make the common stock less attractive relative to other investments, which could adversely affect the market price of our common stock |