Public Storage. (PSA) — Q2 2015 Earnings Call Transcript

Good morning. And thank you for joining us for our second quarter earnings call. Here with me today are Ron Havner and John Reyes. Just want to remind you that 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, July 30, 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 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, hitting on all cylinders in Europe and in the U.S. and our development pipeline in tenant reinsurance. So, with that, let's open it up for questions.

Hi. Thanks. I wanted to ask you about Shurgard, which made a significant acquisition this quarter, and things appear to be going well. Have you met with your team there recently? How do you view your ownership going forward, either through a public vehicle or a private vehicle, or are you satisfied with the current situation?

Well, right now Smedes, our Shurgard Europe is relatively modestly leveraged. They just did another €300 million financing, so they have €600 million of term debt, average duration of about nine years sub 3% and they will be internally generating about €82 million to €90 million of cash flow with really no requirements other than for growth. So in terms of doing an IPO at this juncture, I’m not sure what we would use the proceeds on since they funded all their acquisitions and they're sitting on €70 million, €80 million of cash at this juncture. Longer term going forward, that will depend on market conditions, growth opportunities, those kinds of things.

Could I ask if you have any insights on the discussions surrounding potential changes to Proposition 13, particularly concerning commercial versus residential properties? As you are likely more informed on this topic, can you share your thoughts on what might happen?

Well, I can't tell you what might happen, but as far as we know there is no pending legislation or bills in California. But I don't know at the moment what is being introduced. We haven't heard anything to give concern at this juncture.

Yes. Hi. You said Europe is strong. Could you share operational occupancy and rent data for European portfolio?

Sure. The same-store portfolio for Europe operated at 90.1% for the quarter, that's up from 84.9% last year, so 6% increase in occupancy. Realized rents were down a point and a half, so revenue growth is about 4.5% to 4.6%, and at quarter end the portfolio occupancy was 91.1%. All the markets across Europe were up in occupancy year-over-year. The strongest being in Holland which closed out at quarter at 87.5% versus 76% last year, so 15% growth, but if you recall Holland has been a challenge for us over the last couple of years, so it is obviously recovering and catching up with the rest of Europe.

Good afternoon. If we could first focus on profit margins for the quarter in the U.S., saw a nice improvement there? Can you discuss, I guess, the declines in advertising, selling expense and R&M, what we should expect maybe going forward the next couple quarters or even into ’16?

Yeah. Jeff, this is John. On the advertising, advertising was down in the quarter primarily because we didn't do television advertising in this second quarter versus last year where we did do about $0.5 million of advertising. We also spent a little less on the key search terms on the Internet. I think that was down maybe a couple hundred thousand dollars there. Going forward on the advertising, I would expect that it’s probably going to be relatively flat Q3 and into Q4, because we probably go back to television in those quarters similar to what we did last year. As for the R&M, I think it's down but it’s mostly timing; I think we're expecting for the full year that R&M will be relatively flat. So there should be a little bit of an uptick in the latter half of this year.

Okay. Great. And then, I know that each quarter we asked about occupancy in the business, your portfolio as a whole for all self-storage keeps rising at national levels. I mean, any new thoughts on full occupancy levels to your portfolio even just in general for self-storage industry?

Is your question, what we think we possibly achieve, like what is the maximum occupancy level? Is that the question?

Yeah. Basically and of course, I would assume that's based on what you're seeing in your markets in general?

Yeah. We have a couple of markets, our better-performing markets in the quarter like Denver and Portland that had, I think they ran about 97% almost 98% occupancy for the quarter. So you can say nationwide, we could possibly achieve that where you have every market hitting on all cylinders. But more likely than not, there are some strong markets, some average markets and some weak markets. So that might be tough to achieve on a national basis. For instance, right now, our DC and Norfolk Virginia markets are languishing a little bit. The Midwest is not nearly as strong as the West Coast. So to say our portfolio will operate at 90%, that’s probably pretty hard. Having said that, we’re about 96% today.

Okay. Thanks. And then last question on the supply front, I know the last time I saw your team, we discussed the competition for land with departments, anything thereon on competition for site, anything on the supply front to share with us, any updates from June, July?

While I think our main competitors for sites are multifamily, not really retail. Some storage companies although once in a while we run into a storage operator competing for the site but it’s mainly the multifamily. In terms of supply nationwide, we think it’s picking up. If you look at our development pipeline as a percentage of our portfolio, it’s about 2.7%. So maybe you can extrapolate that in the industry and say the industry is growing at 2.7% as a whole. So that would be about 1,000 to 1,200 properties. Growth is not uniform across the country though. It’s occurring where you would expect Texas, Florida, the Carolinas. The positive of those markets is they have above-average population growth. It’s not occurring to any significant degree in San Francisco, L.A., Boston, or Miami, the markets which are much more challenging to get zoning and find sites to develop. Does that address your question?

Hi. Thanks. I was wondering if you evaluated the SmartStop portfolio and if so, why you decided to be less aggressive on the deal compared to your competitors, considering your cost of capital.

Todd, we did look at the portfolio but I prefer not to answer that question.

Okay. And thinking about your marketing platform and your digital footprint, how does the scalability factor into your decision to buy properties and does it factor into the equation at all for PSA when you’re looking to make new investments?

Certainly scale does. We look to increase our market share in our key markets where we operate. So if you look at our market like Florida, Miami, Fort Lauderdale, over the past five, eight years, we've grown from about 14% market share to 25%, 28% market share. The same has happened in markets like Minnesota, Seattle, certainly in Dallas and Houston where we’re building. Our market share is increasing there. So we very much focus our acquisition in our development program on expanding our platform in the key markets where we operate. And so that certainly factors into our decision in terms of when you look at our portfolio like the one you just mentioned, there are a lot of tertiary markets there where we have no product and in a number of cases, we have no interest in having a new product. So it doesn't do much for the platform. Certainly scale in markets is very important. John can touch on the marketing side of it and the pricing side of it and scale in terms of operating efficiency, managerial talent, brand awareness.

No, I don’t want to add anything.

Does that answer your question?

Yeah. That’s helpful. Just a follow-up then on selling and advertising expense; it was down nearly 10% but it was still about $5.5 million in the quarter. And just thinking about where occupancy is, why is that not down more? I would think that you could pare that back a bit more?

We’re doing everything we can to pare it back. Even though our occupancies remain high, we still had over 2,000 tenants move out during the quarter. So we still have to advertise to replace those tenants and maintain the occupancy level. So if people stop moving out, I can guarantee you, we will cut down that advertising cost quite a bit.

Dennis, following up on that previous question, as you approach 96% occupancy, having hit that in July, at what point do you think that level becomes sufficiently high? I understand you’ve been increasing rates, but should you consider raising them even more? When does the situation favor increasing the rate level more than just maintaining higher occupancies?

When you push rates too high, you risk attracting tenants who require ongoing discounts or who may not stay long-term. Success isn't determined solely by the initial move-in rate; it depends on securing tenants who will remain and accept future rate increases. While we could adopt a more aggressive approach to rate increases, doing so would likely lead to decreased occupancy and shorter tenant retention, which goes against our strategy.

For the quarter, the percentage of customers who have been with us for more than a year increased by 60 basis points to 55.9%, up from 55.3%. If you were to look at a chart, you would see that over the last three years, we have consistently increased this percentage of long-term customers each quarter and year-over-year. This ties into John’s earlier mention about building a foundation of stable customers who are somewhat of a long-term asset.

When you speak with many of the large operators outside of the five public companies, how have the discussions changed regarding their readiness to sell? Specifically, how does the gap between their expectations and what you are prepared to offer for assets look? Is it becoming more feasible to pursue larger deals, or is it still as challenging as before?

Well, usually the dynamic in the larger portfolio is not per se a question of price. At this juncture, it’s more a question of ownership dynamics, connecting the families that can be partners. That can be that other alternatives to selling, just simply refinancing because it’s not hard to refinance a full stable portfolio at this juncture. So there are a lot of alternatives to the more established operators besides just selling and/or price. There are other dynamics within the ownership going on besides just do you want to sell or do you not want to sell.

Yeah. Just wondered if you can comment on what the insurance participation rate was at the end of the quarter and then also if there is any update you can provide on any of the ongoing loss to the legal fees, whether it’s pertaining to tenant insurance or what other matters that may have been resolved that you can comment on?

So your first question was whether you were asking how much of the portfolio is covered by insurance or the customer base, or what the tenant insurance rates are for new customers?

What part of the existing portfolio?

George. So, approximately 66% to 68% of our tenants participate in the tenant reinsurance program that is offered at our properties. In terms of the G&A, this part quarter, G&A was up about $5.5 million and about $3.2 million of that were related to increased legal costs and it’s for various matters out there. And we are not going to go through what those matters are on this call.

Hey. It’s Ross Nussbaum here with Jeremy. Can you talk a little bit about the topic of move-ins versus move-outs? What was the percentage increase or decrease year-over-year for each of those stats in Q2?

Yeah. This is John. Move-ins were down about 1% compared to last year. However, rental rates for the quarter increased by about 8%. Move-outs remained relatively unchanged year-over-year, and the rental rate they retained was up around 4.5%. Does that answer your question?

I’m trying to understand how to reconcile the fact that move-ins are down year-over-year while the industry is seeing considerable occupancy and pricing pressure. Should we take that number into account?

I can’t speak about other people’s move-in volumes and whether they are up or down. But what I could tell you with respect to ours, with our occupancy as high as it is and our occupancy spread being higher than last year, we have less inventory to sell. So notwithstanding the fact that our absolute numbers of moving volume are down, the velocity of move-ins, the move-ins relative to what we have to sell as a percentage is up quite a bit. So, I mean, if you took it to an extreme and we were 100% occupied, we would have no move-ins, right. So, the closer we get to 100% occupied, it's very difficult to get move-in volumes on a year-over-year basis to increase. So, we are quite comfortable with the move-ins.

For the quarter, even though the move-in volume was down about 2,000 customers and the move-outs were about flat, we still had 21,800 net customers for the quarter. That’s less than last year when we had 24,000 net customers. But to John’s point, we still had 21,800 more people move-in to move-out during the quarter. Ross for the quarter, even though the move-in volume was down about 2,000 customers and the move-outs were about flat, we still had 21,800 net customers for the quarter. That’s less than last year when we had 24,000 net customers. But to John’s point, we still had on that 21,800 more people move-in to move-out during the quarter. Strategically you talked about the Shurgard European IPO in the works. You and I have talked in the past about PS Business Parks. And while you’re talking earlier, I was just pulling up a relative chart of PSA versus PSB over basically any timeframe you want to put out from year-to-date to 20 years. And PSA has been kicking PSBs, but from a relative share price performance. I guess what’s it going to take ultimately to spin those shares off to shareholders and what your existing shareholders say if they want them to invest in self-storage, let them surely invest in self-storage. And if they like PSB, they can hold those shares. Well, Ross, step back a couple of things. First of all, self-storage is a completely different business than flex industrial. So that’s one. Two, PSB is about 4% of our NOI enterprise value whatever you want to call it. Three, if for us to change our attitude on doing anything with PSB in terms of spinning off or sign it, there would be need to be a change in tax law such that we would not pay any taxes on that, because most of our interest are held in OP units, which have quite frankly a de minimis tax basis. And so whatever we did with it, we for the most part would be purely taxable income and that requiring a distribution.

Hey, I have a quick question. It seems that 10 Houston assets are included in the same-store pool. Can you explain what’s happening with those and what costs you anticipate to get them operational again, considering you’re self-insured? Thank you.

While there were flooded, there were some pretty severe weather in Houston in Q2. They’re poorly damaged and so we took them out of the same-store pool because they will require extensive repairs. And on tenant insurance business, we had about $800,000 additional cost for estimated claims related to those properties. In terms of our final estimate of how much it’s going to cost to repair, we don’t have that; that’s still under process. My guess is it would be a couple million dollars.

Hi, thanks. We saw that Shurgard issued the bond to fund their Netherlands acquisition. And Ron, you noted that they are generating free cash flow. But just as a reminder, is there a commitment in place for Public Storage to provide capital to Shurgard? Just get a reminder what the commitment is if any?

No, Shurgard operates as a standalone entity. We own 49% of it, a large pension fund owns 51% of it, the other 51% and Shurgard has taken quite a while to get here, but Shurgard is self-funding. And as I noted and it issued the bonds, the €600 million bonds without any credit support from either of the two shareholders.

But nothing in writing to say you would commit equity to a large acquisition or anything like that?

No.

Okay. Thanks. And then just to look at an update of your current expectations, your same-store pool continues to generate accelerating fundamentals at this point in the cycle. Any updated thoughts on what it takes to say stabilize new development and C/O deals, anything that you’ve revised anything internally as we enter August here?

Well, internally we continue to use our historical underwriting assumptions of generally about three years for a standard-size property. If it’s above average size, say like Gerard property, I believe we used four years. So for a 2000 plus unit property, we used the four-year stabilization period. The nice thing is we are exceeding those by quite a bit. We opened a new facility here in Glendale about 2000 units at the end of April and it’s already about 50% occupied in about two months. So that’s quite incredible; that’s a combination of it’s a great product, the marketing team, the internet marketing team highlighting that facility, the pricing team pricing it to sell, and then of course operational execution at the unit level.

Is that causing you to accelerate your underwriting as you look at stuff that may close in the second half of this year?

Accelerate, you mean accelerate development faster?

Your expectations of stabilization?

I think we will have all of our projects in the pipeline fully utilized.

I guess new deals.

We are well ahead across the board in terms of financials.

We are not changing our underwriting.

No, we are not changing our underwriting.

Okay. So still three years.

We continue to underwrite it conservatively to keep the discipline on what we’re developing.

Hi. Sticking with development for a second, it looks like right now the pipeline is $450 million to $500 million for development and expansion. Two questions, one, does it feel like over the near term that’s a good run rate for the size of the pipeline? And then secondly, if you didn’t start anything new, how long does it take you to complete those developments to bring them online?

Mike, I think the team has got their track shoes on and they are going around the track about as fast as they can with respect to the development team. They are doing a great job. And keep in mind in terms of the development pipeline, you’ve got stuff delivering, right? So we’ve got product like the Glendale property delivered in Q2, so that comes out of the pipeline and so you got to backfill that just to kind of run in place at $500 million or $480 million. So there's a continuous in and out process on that pipeline of deliveries and the new projects coming into it. So I wouldn't anticipate that number going much above $500 million, certainly not within the next six to 12 months. In terms of what we've got under construction and how long, it will be pretty much in the third, fourth quarter of '16 before that's all built out of the ground and up and operating and then you can figure two years after that before it stabilizes. So think in '18 before what we're working on now gets stabilized.

Thanks. Good morning. John, as you just kind of parse through the rent data, I guess, can you kind of hit on my question? But I’m just trying to think if you see anything kind of in the data as it relates to rent increases, pushback from customers, anything kind of by region, maybe by demographic profile of the center, just anything that you could sort of share with us about kind of the elasticity of demand here?

Yes. Steve, we do look at that, we look it by markets, by demographics. We aren’t seeing anything different than what we saw last year, so they’re behaving the same for the most part. So we’re continuing to send out those increases just the same strategy as we have last year. We probably year-to-date have spent out about 5% or more increases and the percentage increases about the same as last year, which is about 9% to 10%. Steve, we do look at that, we look it by markets, by demographics. We aren’t seeing anything different than what we saw last year, so they’re behaving the same for the most part. So we’re continuing to send out those increases just the same strategy as we have last year. We probably year-to-date have spent out about 5% or more increases and the percentage increases are about the same as last year, which is about 9% to 10%. Steve, we do look at that, we look it by markets, by demographics. We aren’t seeing anything different from the past year, so they’re behaving similarly for the most part. So we’re continuing to send out those increases just the same strategy as we did last year. We probably year-to-date have spent out about 5% or more increases, and the percentage increases are about the same as last year, which is about 9% to 10%. Steve, we do look at that, we look at it by markets, by demographics. We aren’t seeing anything different than what we saw last year, so they’re behaving the same. So we’re continuing with the same strategy as last year. We probably year-to-date have seen about 5% or more increases and the percentage increases are about the same as last year, which is about 9% to 10%. Steve, we do look at that by markets and demographics. We aren’t seeing anything different than last year, so their behavior is consistent. We continue sending out the increases just like last year. Year-to-date, we've implemented 5% or more increases, with percentage increases also about the same as last year, around 9% to 10%. Yes. Steve, we do look at that, we look it by markets and demographics. We aren’t seeing anything different than what we saw last year, so they are behaving similarly for the most part. So we’re continuing to send out those increases just the same strategy as we have last year. We probably year-to-date have observed about 5% or more increases, and the percentage increases are positioned the same as last year, at about 9% to 10%. Yes, Steve, we look at those factors. They are consistent with last year. We continue to implement increases. Thus far, we’ve had about 5% or more increases and percentages are similarly around 9% to 10% as last year.

Thanks. Good morning. John, as you just kind of parse through the rent data, can you sort of comment on any elasticity of demand you’ve observed?

Well, overall elasticity of demand is dependent on local market conditions. We're monitoring it closely and adjusting strategies accordingly. Even with rate increases, we continue to see strong occupancy.

Thank you all for your attendance this afternoon and your questions. We’ll speak to you again next quarter.