Public Storage. (PSA) — Q1 2015 Earnings Call Transcript

Good morning, and thank you for joining us for our first quarter earnings call. Here with me today are Ron Havner and John Reyes. All statements other than statements of historical facts included in this conference call are forward-looking statements subject to a number of risks and uncertainties that could cause actual results to differ materially from those projected in these statements. These risks and other factors that could adversely affect our business and future results are described in today's earnings press release and in our reports filed with the SEC. All forward-looking statements speak only as of today, May 1, 2015, and we assume no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. A reconciliation to GAAP of the non-GAAP financial measures that we are providing on this call is included in our earnings press release. You can find our press release, SEC reports and audio webcast replay of this conference call on our website at www.publicstorage.com. Now I'll turn the call over to Ron.

Thank you, Clem. We had another solid quarter. We continue to execute on all fronts. In the U.S. and Europe, revenue growth continues to accelerate, our development pipeline continues to expand and industry fundamentals are good. With that operator, let's open up for questions.

Europe is obviously pretty small at this point relative to everything overall. Can you just give an update on pricing, occupancy and NOI trends there?

Occupancy for the quarter for all of Europe was 87.9 versus 82.1 last year, so up 7.1%. Rates were backwards 3%. So REVPAF was up close to 4%, 3.8 for the quarter. So, we’re feeling good about Europe. All markets, but one was up in NOI and Holland our most challenging market, occupancy was 81.4 versus 70.7 last year, so a big 15% increase in occupancy year-over-year.

And I forget, is there a follow-up or is it just one question?

You can follow-up.

Can you talk a little bit about the G&A increase relative to prior quarters and what’s a good run rate to expect for the balance of 2015?

This is John. So our G&A for the quarter was about $24 million and that compared to last year at around $19 million. And the major swing items, the increases were basically of three categories; one was share-based compensation expense which was up about $1 million; the second item was our development overhead that’s been expensed, that was up about $0.5 million; and then legal cost which is up about $4 million for the quarter. So on a run rate basis going forward, I would expect that our G&A, although it's running about $24 million for the quarter, don’t think it will run $24 million for each of the next three quarters, but it will continue to run higher than last year. Primarily due to we expect additional increases to legal cost as well as share-based compensation and development overhead cost expense, so expect higher G&A going forward.

And what’s the legal cost tied to?

Various litigation matters, I mean various parts for the company.

I was just wondering if you can take a little bit more about traction that you're making on rate growth. You obviously see some good acceleration in 1Q, it appears to be at some of the highest levels in quite a long time. How much of an impact is lower discount having and where realized rents were moving relative to move outs?

Jeremy, this is John again. For the quarter, our street rates were up about 6% roughly and our move-in rates were up about a little over 5%. Our volume of move-ins were up about 1.3% and so I'm pretty happy that we're able to move street rates and people are accepting those higher rates. We're seeing competition also raise their street rates, which we really haven't seen a whole lot over the past couple of years. So I have to believe everybody is fairly full and people are getting more aggressive on rates. On the discounting side, at least for the quarter, the number of move-ins receiving discounts was about the same as the first quarter of last year. So roughly about 80% of our move-ins were getting discounts. I expect that as we move forward, given our occupancies, we'll start turning that back, and we're starting to do that in the month of April. Street rates continue to move higher in April. They're now somewhere in the neighborhood of about 7% higher and moving rates are also moving higher at this point.

Great, and then just one for Ron if I can, just a little bit bigger picture on the development front more broadly. Obviously, you guys' pipeline grew a little bit this quarter. But anecdotally, we're hearing about a pickup from all the new money entering the stores, looking for different ways beyond acquisitions and looking at more fair deals just given your footprint. Where are you seeing any sort of national trends in the development front?

Jeremy, we started our development program a couple of years ago in part because acquisition pricing was starting to trend above replacement cost and in many cases well above that. So we're already happy we've got a good development program growing. Despite some meaningful deliveries this quarter, we still expanded the pipeline. We worked at 31 projects about 3.6 million square feet. We're seeing increased development across the U.S. Is it something to worry about today? No, not really. It's kind of natural given the comments John just said in terms of rates moving up. It's natural then that developers will look at those rates and say, okay at those rates I can develop and make a decent return on capital.

We have David Doll here any color on development?

No, I think we're pretty happy with the things that we're opening. In fact, we'll open one next Tuesday in Glendale and continue to see other new development in natural markets like Miami, Houston, Dallas but not so much in Southern California, Northern California or some of our other key markets.

Yes, internally in the acquisition environment, are you seeing any difference in the composition of potential buyers out there and also any difference in the motivation from sellers? Is anyone feeling more of a rush to get deals done nowadays?

Not in terms of new equity players; there has been a constant inflow of folks trying to come into the marketplace. I don't think that's changed any perception over the last several quarters. But in terms of quality of product coming to the marketplace, we don't see high-quality products available today and hence it's one of the reasons why we're so happy with our development program; it gives us an opportunity to bring better product to the market for our customers.

And then in terms of development you guys are seeing outside of the projects you are doing? Who are the developers or the operators of these facilities?

Many of the local regional players have continued to hold their portfolios and have active development programs started. There are a number of developers that have sold out in the prior 2006, 2007, 2008 timeframes; they're back in business again trying to start up development programs. So, it's generally people that have been in business over the years.

Keep in mind, remember the industry rights got 50,000 facilities. The top five operators have less than 10% market shares, so the industry’s highly fragmented. You can extrapolate that into the development programs as well. It's highly fragmented—lots of small one, two, three property operators doing development programs.

I was curious, where do you think the portfolio can get from an occupancy standpoint? Is 96% possible in late July? Along those lines, are you seeing any changes in move-out activity related to existing customer rent increases, any changes in behavior around that?

I'll start and Ron can jump in as well. In terms of changes in customer behavior with rate increases, no we haven’t seen any changes. Customers are still sticky for the most part. We're seeing tenants staying with us longer than a year on an annual increase and we're not seeing any change in that. In fact, we’re seeing that our aging of our tenant base continues to improve. I think we're just about 56.5%-57% of our tenants have been here longer than a year. So that continues to improve. How high can occupancies get? I don't know. I made a comment two years ago saying that it can get higher than 94%, and we're higher than 94% currently. So can I get to 96%? We have properties that are at 96%, we have properties that are probably higher than 96%. So there are certain properties and maybe even markets that can get to those levels, but I don’t think our entire portfolio can get there.

Just to add, during April we had three markets where the total market was at 97% or better occupied during the month of April. I would agree with John that getting 2000 properties at 97% is probably not going to happen.

Okay, that’s helpful. And if I could just follow up with regard to litigation matters, can you just shed some light on what that pertains to? It seems like sort of a big number. Is that something that you foresee continuing throughout the balance of the year?

Whatever we could talk about will be in the 10-Q. So that’s what you should read for clarity on the litigation.

I wanted to ask you, as you look back on some of the properties that you've acquired, are you reaching stabilization maybe faster than you would have expected given how strong fundamentals are in the business? And as you look forward, have you changed your expectations around how long it would take to reach stabilization as you lease up new assets?

Generally, what we do on properties that aren’t what we consider stabilized—90% plus occupancy—is we'll tend to be a little aggressive, actually a lot aggressive, on rate to fill them up. As they fill up and stabilize, then we'll start to push the street rate and in-place rents for customers. Are we filling up faster than we anticipated? Yes, you take the Gerard property which opened in May or June of 2013 with 4,000 units and ended April at 93.9%. I think we forecast that property would take four years to fill up and it's basically filled up in less than two. So much faster than we anticipated. However, it is filling up at lower rates than we had anticipated. But we think we'll make that up and so net to net we'll be ahead of the game and we're seeing that in both our developments and acquisitions. The table that is in the press release if you look at the 2013 acquisitions will give you an indication of what we're doing: last year there were at 863, then in Q1 at 928, so up 7.5% and then you see the contract rents moving from $13.25 to $14, up 5.7%. You should expect in that portfolio that occupancy comes up a little bit in terms of stabilization but the rates will continue to move up at above-average levels for probably the next couple of years because we filled them up at below market rates.

And then I just wanted to ask you about the redemption of some preferred shares in the quarter. Are you still leaning towards issuing that at some point as well for your financing needs? If you have any thoughts around that, have they changed at all?

No, we're still looking at potential issuance of debt sometime in 2015.

So, following up on the last question, if you did pursue that, where is your mindset? Because obviously you expanded your line of credit. Is it more shorter-term duration or are you looking more at the 30-year type of range?

What we did expand our line of credit so most likely what we'll do is we'll get deep into our line of credit before we start thinking about longer-tenure debt. We could do anything from 7, 10, 12, 15, up to 30. I think we can consider the whole spectrum and tranche up to see what fits best for public storage. We haven't had to make a decision yet, but I think we have a lot of options open for us.

And maybe just turn to your same-store expenses. You’ve done a very good job of keeping it very flat and we were mostly expecting a lot of expense increases. I'm curious, besides the payroll part of it, which we talked about last quarter; how are you keeping it flat? I noticed that your allocated overhead was favorable to the expense number by about $1 million or so? If you could talk about that and how long can this be sustained? Or does it have to return to an inflationary rate?

Well, the answer to the second part of your question is: Will it return long-term to an inflationary rate? Yes, we consistently say that. Having said that, as we’ve also consistently said, we’re always working our way to take cost out of our system, to get more efficient and more productive in all aspects of our business. If you look at Q1, the big increase item was snow removal; we were up $1 million over last year. I can’t believe we’re up $1 million over last year considering where we were. Utilities are down, gas prices are down, oil prices are down, and so I think—and we’ve renegotiated some new utility contracts. So I think that number could remain flat to slightly down. Advertising and selling were 95% occupied; there isn't a lot of need for that. I think when we get to Q2, we didn’t do advertising in Q2 last year, so you won’t see advertising this year. Therefore, that line will probably be flat, and whether we do advertising for the balance of this year is yet to be determined. Other direct property tax costs were up 3.6%, and then allocated overhead was down mainly because we used to have our annual sales conference in the first quarter and we moved it into the third and fourth quarters of last year. So last year was a double up, and this year we have the expense savings in Q1.

For the acquisitions already completed this year, the annual contract rent is $11.65 and is just lower than some of the previous years. Is there anything we can read into that number, is it a reflection in the markets you're entering or any specific deals included in that?

It's a function of—it really varies by market. You’ve got some of the properties that are down in Texas and I think we got under contract in East Palo Alto which probably has an in-place rent of double what we see down in Houston. So it just depends on which markets the properties are in for that quarter's acquisitions. We’re not sitting here targeting; we want to buy properties at $13 or $14 of in-place rents. It’s really a function of do we want that property? Yes, and therefore, if the rent makes sense, we’ll buy it.

Maybe the sample size is small. I'm just looking at that. And then just second, can you provide any color on the land lease buyout that you had in Q1?

It was a remnant transaction from the Shurgard merger in '06 and we had an option to acquire the land lease this year. With a pretty terming formula, we exercised our option and closed on the transaction. It was a pretty good transaction for us, only $15 million, but a solid deal.

At this time, there are no further questions. I’ll now return the call to management for any additional or closing remarks.

Thank you again for your interest in Public Storage, and we'll speak to you next quarter.

Just bigger picture question on supply for you. There is a lot of concern over this new supply that is emerging, but in light of your strong operating results, the question is, how much new supply does the industry need? It seems the supply is needed, and when you take a step back Ron, and you look at eight square feet per capita, does that seem like the right level going forward?

Dave, I think I said that before and if you take the U.S. population, seven square feet, eight square feet per capita, normal population growth of 1% a year, you're going to take 50,000 facilities and 1% a year that's 400 to 500 facilities per year, and that keeps everything at seven feet or eight feet per capita. I will tell you as you go across the country, markets vary greatly between two square feet and three square feet per capita and 12 square feet and 15 square feet per capita. Obviously, the ones that have the higher square footage tend to have lower growth rates. If you ask me where development will happen fastest, New York has been working on development programs for a while, so I think we’ll see a big uptick in supply in the New York area. Then across the country, it varies between infill markets and then outlying markets where it's easier to get zoning, permitting, and land is cheaper. But 400 to 500 properties a year keeps things static, and we haven’t had much development since '09, so we’re kind of four or five years behind in terms of the curve of new supply relative to organic population growth.

Ron, I may have missed your opening comments because I dialed in late. Did you comment on how you are going to replace the COO role? I know Shaun left in March to be, I think, with some private educational company. Can you just talk a little bit about what those plans are?

Well, those plans have already been put in place. We have divided up the country and given responsibility to three outstanding executives that have been with Public Storage for 15 plus years. Those three exceptional executives are now running operations by committee.

By committee.

With the team.

The three report effectively. I ask it more—I think the CEO role has had some turnover over the last five or six years. I think Shaun made it third in that seat. So I didn’t know if there was something structurally that wasn’t working; just talk about what those inhibitors were or reasons why each of them left.

There are different reasons why each of them left, but you could describe it as my inability to hire a COO. So I'm just leaving it at that. But the guys we have running the operations are long-time Public Storage executives that have grown up here in the operations. You can tell by the results they're doing an exceptional job.

And then what was the change in Chief Legal Officer during the year? Was that a retirement or what transpired there?

Yes, Steve retired and actually, I don’t know what Steve is doing. But he is retired and we brought on a new Chief Legal Officer.