Extra Space Storage Inc (EXR) — Q1 2021 Earnings Call Transcript

Thank you, Latif. Welcome to Extra Space Storage's first quarter 2021 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, April 29, 2021. The Company assumes no obligation to revise or update any forward-looking statement 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.

Thanks, Jeff, and thank you everyone for joining today’s call. We are off to a great start in 2021. The strong fundamentals we discussed on our fourth quarter call not only continued but actually accelerated as we move through the first three months of the year. Same-store occupancy remained at all-time highs for Extra Space with sequential growth in January and February at a time of the year when occupancy normally declines. Occupancy increased further in March, ending the quarter with a year-over-year positive delta of 480 basis points. Our elevated occupancy has given us significant pricing power, which has also accelerated during the quarter with achieved rates increasing from 10% in January to well into the teens by the end of March. These trends fueled same-store revenue growth of 4.6% despite a 110 basis point drag on revenue growth from lower year-over-year late fees. We had excellent expense control with a 0.2% decrease in same-store expenses. The result was same-store NOI growth of 6.5%, a sequential acceleration of 310 basis points from Q4 and year-over-year core FFO growth of 21%. With fundamentals holding and performance comps becoming much easier in the upcoming months, we expect continued acceleration in revenue growth through the second quarter. Our concern about a dramatic increase in vacate has not materialized, and now we are into our busy leasing season when demand is typically strongest. We believe that vacate risk to our elevated occupancy has likely been postponed until the end of the summer, or even into the fall. Turning to external growth, the acquisition market continues to be expensive, and we remain disciplined but opportunistic. Year-to-date, we've been able to close or put under contract a little over $300 million in acquisitions. These are primarily lease-up properties, and several of the properties came from our bridge lending program. Looking forward, we anticipate the majority of additional acquisitions to be completed in joint ventures. And we have plenty of capital to invest if we find additional opportunities that create long-term value for our shareholders. We were very active in Q1 on the third-party management front adding 61 stores in the quarter, which include the previously announced JCAP stores. Our growth was partially offset by dispositions where we only sold to other operators at prices we viewed as unattractive to the REIT. While this trend presents a headwind, we still expect solid growth in our third-party management platform for the year. As I said on our last call, we are mindful of the risks we face. These include difficult fourth-quarter operational comps, a tight labor market, and new supply and state of emergency orders in certain markets. That said, current fundamentals are the strongest we have seen in some time, and our team is prepared to use all our available tools to optimize performance. Our first quarter outperformance, coupled with steady external growth, and the improving 2021 outlook allow us to increase our industry-leading annual guidance by $0.075 at the midpoint. I would now like to turn the time over to Scott.

Thanks, Joe, and hello, everyone. As Joe mentioned, we had a good first quarter with accelerating same-store revenue growth driven by all-time high occupancy and strong rental rate growth to new customers. Late fees and other income continue to be down and partially offset rental income. But we will lap this comp in the second quarter, which will improve same-store revenue growth. Existing customer rent increases will also provide a tailwind in the second quarter since they were paused during much of Q2 2020. We delivered a reduction in same-store expenses despite property tax increases of 6.9% and repairs and maintenance increases of 20% due to higher year-over-year snow removal costs. These increases were offset primarily by savings in payroll and marketing. We believe payroll savings will continue throughout the year, albeit perhaps at lower levels due to wage pressure in certain markets. Marketing spend will depend on our use of this lever to drive top-line revenue growth, but it should also remain down for the year. Core FFO for the quarter was $1.50 per share, a year-over-year increase of 21%. Same-store property performance was the primary driver of the outperformance, with additional contribution from growth in tenant insurance income and management fees. As we announced during the quarter, Moody's issued Extra Space a Baa2 credit rating, our second investment-grade credit rating, now providing us access to the public bond market. We continued to strengthen our balance sheet during the quarter through ATM activity and an overnight offering which combined for net proceeds of $274 million. We sold 16 stores into a joint venture and obtained debt for that venture, resulting in cash proceeds to Extra Space of $132 million and an ownership interest of 55%. We plan to add a third partner to this venture in the second quarter, which will reduce our ownership interest to 16%. Our equity and disposition proceeds reduced revolving balances, and we ended the quarter with net debt to EBITDA of 5.1x, lower than our long-term debt target of 5.5x to 6x. Last night, we revised our 2021 guidance and annual assumptions. We raised our same-store revenue range to 5% to 6%. Same-store expense growth was reduced to 2% to 3%, resulting in same-store NOI growth range of 6% to 8%, a 175 basis point increase at the midpoint. These improvements in our same-store expectations are due to better-than-expected first quarter performance, relaxed legislative restrictions in certain markets, and better-than-expected resilience in storage fundamentals as the vaccine rolls out. We raised our full year core FFO range to be $5.95 to $6.10 per share, a $0.075 increase at the midpoint. We anticipate $0.14 of dilution from value-add acquisitions and Certificate of Occupancies, $0.02 less than previously reported due to improved property performance. We are excited by the strong performance year-to-date as well as the acceleration we see heading into the second quarter. With that, let's turn it over to Latif to start our Q&A.

Great, thank you. Good afternoon. My first question was just a follow-up on Joe's initial comments on accelerating trends that exceeded I think everyone's expectations. Can you comment a little bit more, Joe, on that, like what are you seeing into the quarter? And is this something we should expect going forward?

I think the most exciting accelerating trend we see is in rental rate growth, which has increased every month this year. Certainly, in the second quarter, we're going to have very easy comps and we're going to see some numbers that are eye-popping. But with very high occupancy and muted vacates, we've been allowed to be aggressive on rates.

Thank you. And then can you comment a little bit more on the third-party management business and the opportunities that you're seeing?

Sure. We have a very full pipeline in that area of our business and we're onboarding a lot of stores. We are very confident that it will achieve our original projections for growth in that business. What we're seeing that challenges pricing in the market, a certain number of our owners want to take advantage of where pricing is. And we can't always match it as we look at the pricing. It's achieved; we choose not to match it and not to acquire the store. We always get that opportunity. But at some pricing levels, we just don't feel it's appropriate for the REIT to buy those stores. So I think you're going to see in 2021 a lot more onboardings, also a lot more dispositions, but a very positive net increase in stores in our management platform.

Hi. Just hoping you could help us get a sense of what it means to be able to turn on the ECRI lever here in '21 relative to the easy comp you mentioned in '20, like any contextualization for what that could mean to same-store revenue having that back on versus not last year?

Yes, so well one last year we paused the existing customer rate increases for the months of April. Part of March, April, May we turned some of them back on in May, which meant the rent increase became effective in June and most of them were on by September. So between June and September, we basically started our existing customer rate increases. So easy comp for the months of April, May, June gets a little harder. And by the time you get to August, it becomes much more difficult in terms of a comp because some of those were catching up for multiple months. So you had multiple waves of rate existing customer rate increases happening in August.

I would add one is our guidance anticipates that the restrictions that are in place currently remain in place for the remainder of the year. So to the extent any of those are lifted earlier, that could provide some uplift to us.

Okay. And just maybe a bit of an unusual question, but just with the tenant reinsurance business, we've had a lot of REITs comment about insurance premiums going up pretty dramatically given higher casualty events and other issues. Is the profitability at all changing for that business, given weather events seem to be becoming more common to some extent, or how are you guys thinking about that risk in underwriting?

Yes, so we've not seen significant increases in claims. Now that's partly due to how we've handled certain things. Obviously, you can't control the weather, but some of our claims come from things like broken pipes that various things in tenant reinsurance. So we have tried to be proactive in terms of more video monitoring at our stores, more proactive in terms of pest control, more proactive in terms of doing things so that our pipes don't freeze. So while claims may be higher due to natural disasters, we're able to offset some of that by being proactive on managing our claims.

Thank you.

Hi. Thank you. First question in terms of the updated guidance, Joe, Scott, you both commented that the quarter outperformed relative to expectations. Does the revised guidance include any changes to the outlook and your assumptions for the balance of the year? Was it predominantly related to the first-quarter outperformance? Any color there would be appreciated.

So it's a little bit of both. So occupancy was better in the first quarter, rates played out similar to what we expected. And then moving forward, we're assuming some of that occupancy benefit moves forward. And then we have a little bit more rate power. So it's a little bit of both.

Okay. And what are you anticipating in terms of occupancy in the back half of the year? Can you share sort of your forecast for sort of third quarter, fourth quarter, year-over-year comps? What's embedded in the guidance?

Yes, so we're assuming that occupancy peaks in the summer at levels higher than they've been in the past, higher than historical norms. And then we're assuming that occupancy starts to move down in a more seasonal way in September, so you peak higher and then you end higher than a normal historical year.

So your year-over-year occupancy spread would still be higher and positive towards the end of the year. Is that the right way to interpret that?

Yes, higher than a normal year, but lower than last year. So last year was exceptionally high.

Okay, got it. And then I just had a question with regards to the new joint venture that you formed with the asset sales this quarter. Is there a growth mandate at all for that venture? Or will this be it?

There isn't a growth mandate for that venture. We have partnered with these companies on previous projects, and they have a growth mandate. If there's another portfolio, we would establish a third venture with these partners to achieve growth. We usually approach it this way with several of our partners to keep the promotes and store performance separate. While you could account for additional stores separately, it generally makes sense to have separate ventures.

Okay, got it. Thank you.

Does that answer the question? Okay, great. Thank you.

Yes.

Thanks, Todd.

Thanks. Just on the bridge loan looks like you sold some or one. We don't usually see that it's usually the borrower refine that at a lower rate, but maybe just some context around the sale.

So when we started the bridge loan program, we would simultaneously close the loans where we would keep the mezz position, and the first mortgage would add closing go to a debt partner. We found that a better execution was for us to close the loan, close both pieces of the loans on our balance sheet, package up a bunch of the firsts, and then sell them to one of our debt partners. We now have two debt partners who buy firsts from us. So in the first quarter, we sold $82 million of first loans that we had previously closed and kept the mezz position.

Okay, got it. Thank you, Joe. Just switching gears, maybe could we hear some comments on the state of the third-party management platform? Certainly developers and new owners would need you guys on the front end to lease the properties. Should we expect that pace to slow at all as new supply maybe comes in a little bit, maybe just kind of comment on the competitive environment.

I think this is a business that has a lot of runway to grow through all market environments, through periods where things are going very well and periods where things are going down, development cycles. I think that the advantage of professional management brings to the store is so compelling that there will be continued consolidation, and we should continue to grow this business year after year.

Great, thank you.

You’re welcome.

Thanks, Todd.

Could you provide some updated commentary on what you're observing regarding supply? Operating metrics appear to be very strong, but we keep hearing construction costs are increasing. I'm also curious about what you're experiencing on the bank lending side. Any insights you have would be appreciated.

Sure, Smedes. So, this supply environment doesn't change that much quarter-to-quarter. So we can give you some observations, but I caution that was just one quarter. I do see some indications of increased supply. So last quarter on the call, I related that in our management plus pipeline, we had switched to a majority existing stores and a minority of the pipeline was developing, which has been the first time in a long time. Well, we've now switched back this quarter. So more development. It's one quarter, but it is a data point. Also, as we update stores that new developments that compete with our stores, we saw a slight tick up of a couple of percentage points this quarter. Now it may be that stuff that was delayed or postponed from last year because there was a bunch of that now being into the pipeline. But overall, I think we're going to see continued development, right? Self-storage is performing very well. If you're a developer and you're trying to calculate your development yield, you can probably use a 3.6 exit cap and see if someone's going to accept that. So there's a lot of reasons people would want to get into this business. As you point out, costs are going up, lending is still challenging, but I think we're going to see development. I don't think the process is going to get shut off all the way.

Thank you. I would like to ask about your joint ventures and your plans to potentially increase them in the future. Are you altering the structure regarding your exit options or buyouts, or are you maintaining the same terms you typically had before?

No, I think we've had very sophisticated terms in the past in terms of our ability to exit, our ability to crystallize promote periodically on these ventures that are forever, which is very important. I think we had really state-of-the-art terms. So we don't need a lot of improvement. To the extent the market changes and the level of fees you can get differs or other things, we will certainly be at the front end of the market, but there's no significant change in terms of our ventures.

Okay, thank you.

Thanks. Good morning out there. So when you look at your move-in activity and move-out activity, I mean, the move-outs are down 10%, but there's still a decent level of move-out. Is there any discernible trends and types of customers using self-storage or types of customers designed to move-out, albeit at a lower rate?

I don't think there are any significant trends in that area. We really don't see much difference in move-outs among customers in different markets, which may be an indication of open versus closed markets. Therefore, we don't observe any substantial changes in that aspect.

I understand. Regarding your new joint venture, I'm interested in the overall strategic thinking behind it. Ten years ago, EXR's joint ventures involved a smaller company base and focused on optimizing return on equity, which makes sense. However, with EXR's larger scale today and the increased cost of debt and equity, it seems there might be additional considerations or rationale at play.

Our use of joint ventures serves multiple purposes, with a key one being that it enhances our returns. In a market environment that we perceive as expensive, this approach allows us to continue growing and delivering good returns to our investors. For instance, this year we have approved 12 wholly-owned acquisitions, all lease-up stores, with a first-year yield in the mid-3s and a stabilized yield around 6, based on a 16-month average stabilization. We have also approved 5 joint venture deals, which are also lease-up with a 12-month path to stabilization, yielding 6.9 in the first year and a stabilized yield of 9.9. This shows a significant difference in returns when engaging in joint ventures. While we invest less money, it raises the ongoing conversation about whether to invest more at lower returns or less at higher returns; the impact on our investors’ returns is substantial. Additionally, we get the opportunity for promote, which isn't included in those numbers, and currently, we’re benefiting from cash flow promotes in several ventures, along with realizing back-end promotes multiple times. Another advantage is that it helps us derisk transactions. By investing less in a deal, we can balance our portfolio more effectively. Lastly, we work with knowledgeable partners, and having extra insights on a deal, market, or opportunity is always beneficial.

Got it. Thank you.

Thanks, Ki Bin.

Yes, hi. I guess when you're thinking about rate increases that you see heading out to customers over the next couple of quarters, how do you think those increases will compare to prior to pre-pandemic increases?

So we're going to have a period of time where we have customers who came in during kind of the height of the pandemic at very, very discounted rates. And I would expect to see their rate increases be substantially higher than kind of our normal pre-pandemic rates. Once you get to a more normalized operating environment, we're going to do what we always do, which is we're going to optimize revenue by giving different customers different rate increases, depending on where they compare to market rate, or how the property is performing, and various other factors. So I don't think we're going to change our approach at all in trying to balance not raising them so high that you're pushing customers out the door, but also optimizing revenue.

Got it. Okay. And in terms of thinking about customer length this day, I know it's only been a year or so ago, but how has the average length of stay changed even in that short period of time?

So early on we actually saw decreased length of stay, and throughout the pandemic it continued to increase. And it is still slightly below our historical average of where it was, call it a year ago, but it is continuing to increase.

Okay. That was it. Thank you.

Thanks, Mike.

Thanks. Just on the bridge loan looks like you sold some or one. We don't usually see that it's usually the borrower refi that of it at a lower rate, but maybe just some context around the sale.

So when we started the bridge loan program, we would simultaneously close the loans where we would keep the mezz position, and the first mortgage would add closing go to a debt partner. We found that a better execution was for us to close the loan, close both pieces of the loans on our balance sheet, package up a bunch of the firsts, and then sell them to one of our debt partners. We now have two debt partners who buy firsts from us. So in the first quarter, we sold $82 million of first loans that we had previously closed and kept the mezz position.

Okay, got it. Thank you, Joe.

Sure.

Thanks, Todd.

Could you provide information about the 16 assets related to the joint venture? Where are these assets located? How did you choose which assets to include, and any insights on the cap rates would be appreciated.

We are continuously evaluating our portfolio to optimize it. This involves selling assets that we believe won't contribute to our long-term goals and reinvesting that capital into higher-performing assets. We are also reducing our exposure to certain assets or markets through joint ventures. The assets we chose for this reduction were selected based on our desire to lessen exposure while reinvesting the proceeds to enhance our overall portfolio. However, due to our agreements with partners, I cannot provide specific details on cap rates; it remains a market deal.

Got it. Just switching gears, just on the expenses, really nice controls this quarter. Just trying to get a sense of how much of the expense savings are a function of just the COVID, the post-COVID operating environment and the opportunity to save, and how much of the cost savings are sort of things that would have happened anyway. I don't know if that makes sense, but asked another way, and when you're thinking about sort of this post-COVID operating environment, how much more sort of expense-saving opportunities are there, above and beyond just what normally you would have done.

If we examine our savings related to COVID, most of it is tied to general and administrative expenses. For example, travel expenses have significantly decreased. There are some savings at the store level as well. Last year, in the first quarter, we had an easier comparison because payroll was higher when we entered the COVID lockdown. The same goes for the second quarter, where we expect an easier comparison, but we are also being proactive. We want to ensure we allocate the right number of hours in our stores since our store managers are key assets. We aim to maximize their time with customers. With the easier comparison, we anticipate savings. Additionally, we are slightly adjusting our expectations upward due to the tight labor market, which may lead to higher costs for hiring new employees or require us to be more competitive in terms of labor costs. The third area of focus is marketing, which we see as a lever we can pull to enhance our performance. This year, we've actually reduced our marketing expenditure compared to last year, and we hope this trend continues, but we will evaluate it on a quarterly basis.

Helpful color. Thank you.

Great. Thanks everyone for spending your time and your interest in Extra Space. We're obviously off to a great start this year. Occupancy is at an all-time high. We have exceptional new customer rate growth. We continue smart, careful external growth. And all of this leads to exceptional both same-store and double-digit core FFO growth. And all of this is due to the extraordinarily hard work, dedication, and focus of over 4,000 employees at Extra Space. And I want to acknowledge their work and thank them for what they've produced for our shareholders. I hope everyone has a great day. Thank you very much.