Extra Space Storage Inc (EXR) — Q1 2017 Earnings Call Transcript

Good day, ladies and gentlemen and welcome to the Extra Space Storage Inc. First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. Jeff Norman, Vice President of Investor Relations. Sir, you may begin. Thank you, James. Welcome to Extra Space Storage’s first quarter 2017 earnings call. In addition to our press release, we have furnished unaudited supplemental financial information on our website. Please remember that management’s prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the Company’s business. These forward-looking statements are qualified by the cautionary statements contained in the Company’s latest filings with the SEC, which we encourage our listeners to review. Forward-looking statements represent management’s estimates as of today, Thursday, April 27, 2017. The Company assumes no obligation to revise or update any forward-looking statements because of changing market conditions or other circumstances after the date of this conference call. I would now like to turn the call over to Joe Margolis, Chief Executive Officer.

Hello everyone. We kicked off 2017 with a solid first quarter and fundamentals remain positive. We gained occupancy, grew street rates, and increased same-store revenue by 5.8%. We demonstrated great expense control with a 2% decrease in same-store expenses. As a result, same-store NOI grew 9.2% and FFO per share as adjusted increased by 20%. We saw positive year-over-year revenue growth in all MSAs. We also saw acceleration of revenue growth in several MSAs, including Boston, Chicago, and Philadelphia, demonstrating the cyclical nature of markets. We are enjoying the benefits of a well-balanced diversified portfolio, operational scale, and the ability to achieve outsized growth from storage added to our platform. We continue to be disciplined on the acquisition front. And we are committed to transact only at prices that will provide long-term value for our shareholders. During the quarter, we added two wholly-owned stores and two joint venture stores for a total investment of $28 million. In the quarter, we added 27 new properties to our third-party platform and we have a robust pipeline of additional stores, which we will manage under the Extra Space brand. These managed stores will provide us additional fee income, density in key markets, customer data, and potential future acquisition opportunities. Importantly, we are starting to see a more balanced mix of development and existing stores in our managed pipeline.

Thanks, Joe. Last night, we reported FFO as adjusted of $1.03 per share, exceeding the high-end of our guidance by $0.04. Revenues were in line with expectations, and the beat was primarily driven by property operating expenses. Property taxes and payroll were lower than expected, and utilities and snow removal were below budget due to a mild winter. Our 2017 same-store pool increased 168 stores for a total of 732. A change in the same-store pool added 110 basis points to revenue growth in the quarter, and we expect to benefit from the changing pool averaging 50 basis points over the year. Same-store NOI benefited 220 basis points from the changing pool during the quarter. Beginning January 1, 2017, we have elected to exclude revenue and expenses related to tenant reinsurance from our same-store numbers. This quarter we are presenting the impact of this change in our Q1 supplemental financial information, which shows the results of our 2016 and 2017 same-store pools with and without tenant reinsurance. Occupancy for the same-store pool ended the quarter at 92.2% with an 80 basis point year-over-year increase. We were able to push our rates to new customers approximately 3% to 4% during the quarter. We experience positive net rentals each month and continue to see steady demand. In the first quarter, we did not access our ATM. Acquisitions along maturities were funded by draws on our credit facility. At quarter-end, we’ve drawn $300 million on the term loans, with $350 million in remaining term debt available. The revolving portion of the credit facility had a balance of $337 million with $163 million available. Subsequent to quarter-end, we swapped $300 million from variable rate to fixed rate debt on a five-year term tranche. We reaffirm our annual same-store revenue guidance of 4% to 5%. Due to the Q1 expense beat, we are lowering our annual expense guidance to 2.25% to 3.25%. As a result, we are increasing our annual NOI guidance to 4.25% to 5.75%. We also reaffirm our original acquisition guidance of total investment of $400 million. The mix has changed slightly and now includes $325 million in wholly-owned stores and $190 million in joint venture acquisitions and developments, with approximately $75 million in capital to be contributed by Extra Space, approximately $150 million is currently closed or identified. Our guidance assumes the remaining unidentified acquisitions are closed in the third and fourth quarters. As a result of the Q1 beat, we’re increasing our full year FFO as adjusted guidance to $4.21 to $4.29 per share. Our guidance includes $0.07 of dilution from our CofO stores and an additional $0.08 from value-added acquisitions for a total of $0.15. I’ll now turn the time back to Joe.

Thank you, Scott. We have a solid first quarter with growth in rates, rentals, and occupancy. And we are well positioned heading into our busy season. Revenue de-acceleration from our core assets continues to flatten. We’re seeing great performance from value-added acquisitions as they are integrated onto our platform. We expect moderation in the back half of the year. We still expect stores to produce some of the best revenue growth in the real estate sector. We continue to monitor new supply in key markets to analyze its impact on our performance and adjust operations for affected stores to minimize impact. While certain stores in markets have felt the impact of new development, it has not prevented some from experiencing positive revenue growth. Also, we are seeing re-acceleration of revenue growth in some markets, including some that are on the front end of the development cycle. In an effort to maximize same-store operating performance, we continue to utilize other tools that enhance FFO. We are focused on building our third-party management portfolio and pursuing high-yielding redevelopment and expansion opportunities at our existing stores. Such efforts together with our solid operations should lead to another strong year of FFO growth. Let’s now turn the time over to Jeff to start the Q&A session.

Thank you, Joe. In order to ensure we have adequate time to address everyone’s questions, I would ask that everyone keep your initial questions brief. If time allows, we will address following questions once everyone has had an opportunity to ask their initial questions. With that, we’ll turn it over to James to start our Q&A.

Hi, thanks. Joe, just interested, and you mentioned re-acceleration of trends in some markets where development was kind of on the front end of the cycle. Could you maybe talk about which market specifically you’re seeing re-acceleration in.

I think the best example of that is Chicago, where we had a difficult time last year and we’re starting to come off of the floor there. Denver is another one, maybe not to the extent of Chicago. And I would just caution you that we’re not saying it’s a hockey stick, but we’re saying we’re moving in the right direction.

Okay, great. And then I just wanted to ask you quickly, you had mentioned on the last call that the visibility into 2018 supply was difficult to get a good feel for. And I’m just wondering a few months more into the year. Do you have a better feel for where supply might end up in 2018?

I think that’s a very difficult question. I mean, storage as a property type has a very short delivery cycle. You can build these stores relatively quickly. And we’re continuing to see a significant up to 60% fall-out rate in the development projects that are in our management plus pipeline. That is unsatisfactory and I think that we do believe that there’s not great visibility into next year.

Joe, would you – it’s Michael Bilerman speaking. How do you think about PSA will talk about what the public REITs are doing and extrapolate that based on the public market shares – share in the industry. So they would take the 5.2%, 5.3% that’s being developed by the public REIT. Take 13% and say there’s 45 million, 46 million square feet of development. I guess, how would you look at it overall? Do you think that overestimate or underestimate is an accurate estimate of the demand and supply that’s coming online?

I have great respect for Ron in Public Storage, but I don’t know the assumption that the percentage that the publics are developing versus the overall market will give you an accurate REIT.

Okay, thank you.

Thanks, Smedes. Thank you, Michael.

Hi, good morning. I was just hoping you could comment on street rate growth trends during the quarter and into the second quarter, and if there was any significant variance between the same-store pool last year and this year, where you included SmartStop.

Yes, this is Scott. I would tell you the street rates grew at – street and achieved rates grew at 3% to 4% in the quarter that continues in April. And I would tell you the SmartStop rates are actually probably slightly lower than that, as we continue to gain occupancy at those properties. But it’s been steady at 3% to 4%.

Okay, great. And then, what should we think of is driving the deceleration in the SmartStop contribution that you said you’re holding the 50 basis point contribution in same-store revenue for the year. Is that just filling up the stores and having less low-hanging fruit?

Tougher comps, you coming up against that – it was already performing fairly well in the back half of last year and this year compares to the back half of last year those comps get tougher.

Okay, if I can squeeze in one last quick one, you talked about a 60% fall out on new developments on your platform. Any sense of what that was historically?

It’s ticked up slightly, but I wouldn’t put too much emphasis on it. It’s been pretty steady between 40% and 60% over the last year.

Thanks.

Thanks, Juan.

Hey, guys. Just in terms of how you’re looking at acquisitions for the rest of the year. And what would have to happen to sort of change acquisition volume? I mean obviously, a better stock price would help. But in terms of kind of where pricing is today, where your stock is, how much of a delta is there between where pricing is and where it would have to be to get you guys to get more active?

We’re not pricing acquisitions on our stock price on any particular day. Our stock price is going to go up or down, I have no idea why our stock price goes up and down. And we’re trying to find acquisitions to produce long-term value for our shareholders without kind of comparing it to the spot pricing of our stock. What we’re looking and hoping will happen so we can acquire more properties by the back end of the year is that cap rates expand and sellers’ expectations for pricing come more in line with what we’re willing to pay for properties.

And any sort of general sense kind of ballpark sort of on a cap rate basis, 50 bps, 100 bps away or how far?

Yes, I think that’s a pretty fair range.

Okay, thanks.

Thanks, George.

Thank you. Joe, was I correct in hearing you in your prepared remarks referencing that you’re seeing a more balanced mix of development and stabilized properties in the managed pipeline?

Yes, that’s correct.

Would you mind just elaborating a little bit further just to explain what you mean and why it’s important to note?

So in 2016, the vast majority of projects that we signed up for were inquiries about having us manage these stores from new development. And now we’re starting to see more existing owners, I think as it gets a little tougher, realize the need for professional management. We’re having more and more discussions with existing owners. 40% of the properties we brought on in the first quarter were existing properties. And that’s important because when you bring an existing property on, we start making money right away because it’s full. Our fee is a percentage of revenue and when you bring on a developing property, it’s not as profitable until you can lease it up.

Okay, makes sense. Thank you. There has been some talk about smaller developers potentially becoming a little bit uneasy about the operating environment and potentially looking to sell sooner than they otherwise would have. Are you guys seeing that?

I don’t think we’re seeing enough of that to call it a trend.

Okay. Last question, any update on the potential disposition portfolio?

Sure. So to be clear, we’re looking to recapitalize a portfolio to sell majority interest in it or transfer to a JV in which we would own a minority interest, keeping it under the Extra Space platform. We are undergoing a process, we’ve collected first round bids and we’re in a process. We’ll talk more about it when we’re done.

Okay, are you able to provide any color about the likelihood of that being a new JV partner versus an existing partner?

We really can’t say until we know where we end up.

Understood, thank you.

Thanks, Ryan.

Hi, thanks. First question, around this time last year there was some softness in demand set in around the start of the peak leasing season. And I’m just wondering if you could comment on how the beginning of the peak season has been so far here, and if you’re doing anything differently this year having observed that softness last year.

So this year versus last year, I would tell you, this year has been steady so far. Last year we were probably a little bit more aggressive on pricing. And year-over-year we were not spending extra on the Internet; our year-over-year marketing cost last year actually went down and this year we’re spending more and budgets are a little bit higher. So that potentially lower prices and higher marketing spend is yielding a good result for us this year.

Okay, but you’re not seeing market pricing or any increasing competition necessarily creating softness so far this point in the beginning of the peak leasing season?

Year-to-date we have not; our rentals or demand has been steady to slightly up and our rates are still 3% to 4% above where they were last year. So we classify that as a solid year.

Okay. And then just following up on the impact from the SmartStop portfolio. So it sounds like you’re expecting the year-over-year contribution to be fairly muted by year-end, so essentially no benefit. Is that the right read and is that what’s embedded in guidance?

That is correct, and that is what is embedded in guidance.

Okay, thank you.

Thanks, Todd.

Hi, can you guys give us a rundown of how your largest markets are performing relative to expectations, and whether there were any surprises in the quarter?

So, first thing I would tell you is our markets – in our supplementals, we disclose two things: we disclose our same-store and our mature pool. And I think that there’s a little noise in both of those disclosures, as the SmartStop properties have been added to both pools as well as the larger Dallas acquisition we did last year. So a few of those markets could potentially be overstated as a result of adding those properties. I would tell you Los Angeles continues to do well. Sacramento, to a lesser degree, continues to do well, it’s a good growth story. Now this is under the third year, I would tell you we would probably expect that to tail off; it’s been 15% plus for a long period of time. Boston is not doing as well, but it has bounced back somewhat. And then Houston and Dallas continue to slide a little bit.

Okay, that’s helpful. And just one quick follow up on the topic of California. Have you seen any signs of suppliers starting to pop up in the larger metro areas that you are in?

So we’re very focused on South Orange County; the Irvine Company is very aggressively building. We’re managing those stores that we know, but there is a good amount of supply coming there. San Jose and San Diego are the two markets we’re looking at.

You mean in terms of supply coming on or you’re looking to build?

No, I’m sorry, I’m sorry to be clear. San Jose and San Diego are two markets where there is some supply coming on and we’re looking at that and trying to understand it.

Okay, thanks for clarifying.

Thanks, Gwen.

Hi, good afternoon. Thanks for taking my questions. Same-store revenues were up 4% in the overall New York same-store pool. But could you tell us what the revenue growth was in the 61 assets that are in the old same-store pool?

Our New York market did not see a huge benefit or huge difference between the two pools. So it was slightly less in the old same-store pool. We have seen the difference between New York, northern New Jersey, and the Boroughs. The Boroughs are not doing as well, but we do not have as much exposure to the Boroughs. So we may not have enough exposure for it to be a good sample size. But we are seeing slower growth in the Boroughs and better growth in northern New Jersey and Long Island.

Okay. Thank you, appreciate that. And then why would vacate activity be so favorable during the quarter? I’m just curious to know if same-store rentals and vacates were materially different across the old same-store pool and the 170 assets added this year.

Yes, your hard part I would tell you is you’re always comparing to the prior year and it depends a little bit on what happened last year. But I think that I wouldn’t focus too much on year-over-year, but we did have a mild winter this year, but last winter was not terrible either.

Right, okay fair enough. Just one more quick one, I’m sorry if I missed it earlier. But can you give us an update on occupancy today or the most recent number you have?

It’s not that different from where we ended the quarter in terms of year-over-year.

Okay, that’s it for me, thanks.

Thanks, Jonathan.

Thank you, just on the expense side, could you maybe just highlight if there are any one-time items and particularly property taxes? What are your expectations for the balance of the year?

Yes, if you look at the first quarter and how we performed quarter versus our budget. I would tell you our property taxes came in lower than we expected. Our property taxes beat our budgets by about $1.2 million and about – over just over half of that was a result of favorable outcomes for adjustments in accruals on the SmartStop and other assured portfolios with properties in Texas and Illinois. When we bought the properties we used property tax consultants to accrue on those for the first year and year and a half now. In those two states report on a lag, when we got the final bills we ended up reversing accruals returning to about $0.5 million. So we would tell you that those are benefits that we don’t expect to see throughout the year. We also had some benefits from payroll versus our budget, but we think we’re still early in the year and it’s probably a little bit too early to see whether or not that’s going to continue throughout the year.

Okay, thanks. And then just a bigger picture question on this revenue growth as you look out. If I’m correct last year you mentioned your view was that trends will decelerate, but will sort of trend towards long-term average. Your long-term average revenue growth, if I’m not correct, over a 10-year basis is about 4.9%, and your co-pool is probably growing around in the high fours. What are your expectations as you look out over the next few quarters? Are you sort of now trending at that long-term number and do you expect it to be there? Or could there be a likelihood of deceleration?

So I think our guidance implies that you decelerate some more through the year. But we think it’s still going to be in that 4% to 5% range, and depending on where you are in that range, you could go below that or you could stay at the 4% to 5% range depending on where you estimate we’re going to end the year.

Okay, great. Thank you.

Thanks, Vikram.

Yes, thanks. I just wanted to follow up on the mix of projects in the third-party management portfolio. So you noted you’re seeing more operating assets in the pipeline there. Is the interest from developers down or is the overall pipeline up with the incremental demand just coming from existing owners?

About a year ago we had 150 properties in the pipeline. And we have about 300 in the pipeline now. So both the pipeline has increased and the percentage of existing in the pipeline has increased.

And when you talk about it as a pipeline, those are future potential third-party management contracts that you’re discussing terms and hoping to land, right?

Yes, so it’s potential and that we’re not going to get all of them, but we also know we’re going to continue to add to the pipeline.

Sure. And then, do you have any sense in talking to the operators of the existing assets, exactly what it is that’s causing them to turn to third-party managers now? I mean, what is it that they’re seeing out there that’s becoming a little bit more challenging in a sense?

So we’re experiencing revenue de-acceleration in our portfolio and we know that folks who don’t have our platform and our systems are less able to deal with the tougher market. I think that as maintaining performance gets harder, more and more individual operators will turn to professional management.

Okay.

Todd, I would add that coming out of two best years, I mean for the last two years they were feeling pretty good about operations and didn’t feel like they needed any help. There is slowing; they may look for help.

Got it. And then just lastly, you mentioned the potential opportunity for redevelopment and expansions. That will become an increasing focus for the company. How big is that opportunity in terms of dollars and also the potential increase in rentable square feet and what’s the timeframe that you’re thinking about in order to extract that value?

Sure, good question. So, historically we’re always targeted $30 million to $40 million of kind of value-added activity. Now we’ve taken some of our acquisition resources and focused on our existing portfolio. We have about 55 projects in the pipeline now, somewhere from financial underwriting to feasibility, to pre-construction and a couple of under construction. About $175 million worth of projects, double-digit returns, and we’ll continue to try to push more projects into that pipeline. The difficult question to answer is timing because many of these involve getting some type of entitlements and it’s difficult to predict how long that will take in all the different jurisdictions.

Okay, thank you.

I want to thank everyone for their time today for their interest in Extra Space. And we look forward to catching up at NAREIT. Thank you very much.