Extra Space Storage Inc. (EXR) Earnings Call Transcript & Summary

Hi, everybody. I'll get started. Good afternoon, and thank you for joining us for the Extra Space Storage presentation. My name is Todd Stender, I'm the senior equity analyst at Wells Fargo Securities responsible for the self-storage REIT sector. With us today, we've got Extra Space. They are a $14 billion market cap, self-storage REIT and a member of the S&P 500. EXR is the symbol. They're the second largest storage REIT, they are headquartered in Salt Lake City. They've got over 1,850 stores across 40 states. The company has a reputation for being a technology leader in the REIT space, and has long used data and technology to develop sophisticated revenue management and customer acquisition strategies in the storage industry. Extra Space has had an impressive growth trajectory over the past 10 years, illustrated by $6.8 billion of acquisitions as well as creating a formidable third-party management platform that remains the largest in the self-storage industry. For the decade ending 2019, EXR had the highest 10-year total return of any publicly traded REIT. And when you look at any company in S&P 500, they've had the 11th highest 10-year total return. So with us today from senior management, we've got Joe Margolis, CEO; we've got Samrat Sondhi, Chief Marketing Officer; as well as Matt Herrington, Chief Operating Officer. So I'll turn it over to management for a presentation, and then we'll certainly have Q&A at the end. With that, I'll turn it over to Joe.

Great. Thank you, Todd. Thank you, everyone, for your interest in Extra Space Storage and participating today. I'll make very brief remarks since I know this is -- we're time-limited and folks have questions. So the one thing I will say is I am very proud of the way the entire team in Extra Space has reacted to an unprecedented situation, quickly adapted to different and safe working environments, in several tests to optimize performance and has able to continue to keep our stores open, allow our customers access to their goods, rent units and optimize our performance during a very difficult time period. So with that, I'm happy to take any questions along with my teammates that anyone may have.

So Joe, it's Todd. I think I'll start things off. We'll see how the Q&A rounds out. But maybe just taking it from a fundamental perspective with self-storage right now. Certainly a mix of COVID impact. There's been some -- as states reopened, but we just went through a period where people were really staying in place at home. So maybe that just suggests that move-outs were down. But just maybe can you go through some of the top line growth drivers, occupancy, maybe how rate has been trending? And then during this period, are you raising rents on existing tenants? Maybe just some color on some of the drivers of the top line.

Sure. I'll ask Matt Herrington, our COO, to answer that question.

Okay. Thanks, Todd. Let's start with occupancy. In the month of -- obviously, in March and April, we saw a decline in occupancy on a year-over-year basis. In March, we're down about 10 basis points. We ended April down another 60 basis points. And the great news is that in May, we had a nice rebound and finished flat year-over-year, so 92.7%, which we're happy about, proud of. And I think we could speak to -- let's talk about May specifically. What happened in May, we saw on a week-over-week basis, things change. So the first 7 days of the month, we were down 26%, 27% in rentals, and by midway through the month, we had an inflection point. In the last 2 weeks of the month, we felt really good about, and specifically, in the last week, which we were up almost 8% in rentals on a year-over-year basis. And the way we got there was we had to buy a little bit of the occupancy. So our achieved rates in April were down about 10%. And in May, they were down closer to 20%. And there are really 2 drivers of that in May. One was that we obviously decreased our rates a bit. And the other piece, which is a significant piece, is we saw a channel shift of our customers who were walking in and doing rentals with us, started to do reservations through the web with us, which our cheapest rate is on the web. And so that drove our achieved rates down. The good news about that going forward is we now have every single office completely open with plexiglass up at our podiums, stanchions in place, so we can safely do business with our customers. So both our managers and our customers are safe, and we're hopeful that, that will bring the walk-in traffic back and drive achieved rates back up. In terms of ECRI, we have started to reimplement our ECRI program, where states have reopened and stay at home orders have lifted. So if I had to give an approximation, I would say that's about 27 of our 40 states where we've reinstituted our ECRI program. Those rate increases went out in May, and they will start to take effect, I would say, mid-June on the average, and we will continue to monitor state local laws. And as states reopen, markets reopen we'll continue with executing on our ECRI program.

Thanks, Matt. For rent increases on existing tenants, is that something -- is that a discretionary decision? Is that something that revenue management suggests? How do you guys look at that at this point in the COVID period?

So those are decisions being made by the Executive Committee at this point, that it crosses many disciplines, both revenue management, operations, the impact on the store managers having to deal with that, customer experience, brand. So we -- many disciplines have input and the executive team makes the decisions.

Got it. Okay. Then we look at -- when we touched on the reopening of states, looking at Texas, South Carolina, Florida, Arizona had a pretty brief shutdown period, I would say. Are you seeing anything worth noting when it comes to different geographies and how states have reopened when it comes to demand, self-storage demand right now? I guess when we look at the housing market, so far, it appears to be unaffected, that would just suggest the housing transaction activity continues. So maybe the demand is still there. But maybe any anecdotes you are seeing geographically?

So I'll answer that question. If you look at our top 30 markets, we are seeing improvement across the board, with no distinction between an open state, a close state, a state that's somewhere in the middle. So if you look at the 3 weeks since earnings call compared to the 2 weeks prior to earnings, 28 of our top 30 markets have improved in rental volume, with only North Dallas and suburban Atlanta being flat to slightly negative. So the improvement we are seeing in rentals is widespread and not distinguished by COVID impact.

Right. That's helpful, Joe. So we have been in the season, we're going to continue for, I guess, a few more weeks. When it looks at the peak season for self-storage demand, how is your occupancy at this point relative to maybe where you wanted it? I always kind of look at getting to as high occupancy as it can in the spring selling season or spring storage demand season so you could have some pricing power going into that period. How are you guys looking at where you wanted to be relative to where you are?

Matt, do you want to answer that?

Yes, absolutely. So obviously, we are happy to be back to the 92.7% as of the end of May. And I think we're on pace, Todd, is what I would say. We're back on pace. But we also have -- I'm sure this question will come up, so let's just talk about it. So there's 75 to 100 basis points worth of occupancy in there that's part of our delayed auctions. So we are off a little bit when it comes to that. But I think that from a strategic standpoint, the things that we're doing now are the things that we think will keep our occupancy going back in a separate trajectory. And it's similar to what we did, if you look at last June on this chart, from 2018 to 2019, we were behind the previous year's trends. We weren't thrilled with that. And so we decided to drop rates in the ballpark of 8% or 9% at that point, which bought back some of our occupancy that we wanted and got us back on track in July and helped us finish the year strong. So I hope that answer the question for you.

Sure does. And then in a previous discussion, you guys were referencing the web, reservations coming through the web being the cheapest of your rates. Can you speak to the marketing spend? Maybe just provide some color on how you guys are projecting that, I guess, at this point in the season with COVID, with competition, new supply certainly has been elevated the last couple of years. So maybe just comment on how you are feeling about keeping an elevated marketing spend level.

So Samrat is our Chief Marketing Officer, and I'd ask that he answer that question.

Thanks, Joe. Our marketing spend levels remain elevated. We continue to spend money on Google to fill top of the funnel as much as we can. If you look at on a year-over-year basis, it's really last year around the same time we started spending more. So it will -- we have favorable comps. So it look, appear flattish to last year. But our spend on Google remains high, and we anticipate that level to remain there for the next few months.

Thanks, Samrat. I'm going to see if there's live questions just to take a pause and just see if the audience has any questions. All right. We'll keep moving. I guess, we'll shift gears. You guys have been a real leader when it comes to third party management. It's become a meaningful platform to Extra Space. I always kind of look at the fee stream that good, stable, predictable fee stream that comes in, but also that provides a potential for acquisitions. So those are some of the benefits. You guys are the leader. We've seen some of the other REITs enter this business really to compete for privately held properties. But is there increased pricing pressure now, now that there's increased competition? How are you guys obtaining incremental third party opportunities? And how are you viewing the business right now?

Sure. That's a good question. So third-party management is an important business for us. We started it 11 years ago. We started it to have a capital-light income stream to produce acquisition opportunities. But just as important, to get scale and scale both in terms of cost efficiencies and maybe even more importantly, data. The more data we have, the more we can test against, the more customer transactions we have to look at. So right now, 1/3 of our portfolio is managed portfolio. We have 1/3 more data, 1/3 more scale because we're in this business. We have largely achieved that, and we have become increasingly more selective in new third-party management contracts we take on. We -- in certain markets, we don't need any more scale. And we are, frankly, trying to focus on good long-term partners who want to own their stores for a long time that we can have deep relationships with. So we will continue to grow this business, but we will be increasingly selective on who we take on. In terms of pricing pressure, we have always been the high cost provider. We have a different and higher fee structure than our competitors, and we're going to maintain that. As new competitors that also have a lower pricing structure enter the market, it doesn't really change anything for us because we have always competed with lower cost alternatives. And we are more focused on maintaining our profitability than on absolute number of stores. So we will continue to be in this business. We'll continue to win our share because we can convince people we will produce better returns for them even after our higher fees. And I look forward to continuing to grow this platform.

Great. We do have a couple of questions that are coming in. Here's one. Are you tracking any demographic shifts that will impact where you grow in the future suburbanization and moving towards or away from the coast?

So we always want to focus on growth markets as we create our portfolio strategy. I think it's a little too early to call a movement away from urban areas to suburban areas because of COVID. Certainly something we're aware of and talking about. But we haven't made any drastic changes in our portfolio allocation.

Okay. Here's another question that's come through, Joe. What extent is your tenant base moving away from individual tenants? And looking at more of flex storage needs driven by the growth in e-commerce. So maybe looking at individual tenants versus maybe small companies.

So we have always had a component of our tenant roster being commercial tenants, small businesses, whether that be, more recently, e-commerce or pharmaceutical reps or landscapers or whatever. And we see that component of our tenant base being pretty steady, pretty steady, maybe 15% to 20%. And I have not seen any statistics to tell me there's a dramatic change in composition of who those business tenants are.

And as companies have just a growing e-commerce offering, does that add to the potential self-storage demand at some point?

Potentially.

All right. Keep the questions coming in. We're happy to ask them. I guess, let's just switch maybe on the external growth side, maybe just kind of highlight, you guys are in various strategies, whether it's straight acquisitions or funding joint ventures. Can you speak to what your best use of cash right now is when you look at the highest potential cash-on-cash return of what's presented to you?

So the highest return on dollar invested we get right now is in our bridge loan program where we fund a loan and sell off the APs or replace that first to the mezz. Our remaining piece of that loan earns LIBOR plus 900 to 1,000, plus we have LIBOR floors, plus we require that we manage the stores, so it increases our management business, our management and insurance fees. The challenge with that is it's relatively small dollars, right? If we're making a loan from $8 million to $20 million, and we're only keeping the top piece of it, we're making a lot of money on a small number of dollars. So that's been a great business for us. It's growing more rapidly than we thought given the COVID situation. But in terms of absolute return, that's the highest percentage return. The next highest percentage would be redevelopment, taking existing stores and adding square footage, converting parking to storage, converting a single-storey to a multistorey building. And you have -- those returns are, say, high single digits, 9-ish. But again, you have the problem where those are also relatively small placements of deals. After that, I mean, I guess, our management business has an extremely high -- and our insurance business has an extremely high-margin because it's not very capital-intensive. After that, you have the age-old trade-off of risk versus return in stabilized acquisitions versus lease-up or development deals, where returns are higher in the lease-up deals, but you are taking more risk, and you have to balance that up.

Thank you, Joe. How about just your appetite right now? We just went through some pretty good opportunities. You gave some numbers for redevelopment, that high single digits. But what about your appetite for certificate of occupancy deals? We have seen you guys certainly participate in them over the years. Definitely, the demand and maybe even the transaction volumes are down, and I'd say that for all the REITS. But what is your appetite for taking on all that lease-up risk right now, whether it's on balance sheet or within a joint venture or maybe address both?

So I think the limiting factor in the number of C/Os we do is not our appetite, is not our capital availability. We have plenty of appetite for good deals. We have plenty of capital availability, and we can stretch that out to joint venture dollars. As you point out. The limiting factor is the number of deals that we see in today's market where we feel we're being rewarded for the risk we're being taken. We see increased risk in taking lease-up risk. And the returns haven't correspondingly increased. So if you look at our history of doing C/Os, we peaked in 2016, I believe, was our peak year of approvals, where we were earlier in the cycle and the risk reward was more balanced. And since then, we have been approving fewer and fewer each year. I think we approved 5 last year and 0 so far this year. And we've been doing more and more with joint venture partners as a way to enhance our return and reduce our risk. So we got plenty of appetite, plenty of liquidity, plenty of capital options for good deals. It's just those types of deals now don't seem to present an appropriate risk return profile.

Okay. We got an e-mailed question in about new supply. So just kind of going off that C of O question. Just an update on supply. What are you hearing? So going into COVID, I guess, maybe bifurcate them, but going into COVID, we did see a slowing in new supply. Certainly, new opportunities were coming down, I guess, and that was providing some type of tailwind to potentially a bottom in same-store results. So maybe just comment on what you are seeing in some of your markets about supply levels and any forecast that you have, or what kind of data points can you point to?

Sure. So pre-COVID, and I'm going to speak to our markets that we're in, and it may not coincide with Yardi data or whatever that speaks to markets we don't care about. So pre-COVID, we believe that the peak deliveries was in 2018, a modest decline in 2019, a little more decline in 2020 and going forward. And COVID certainly has had an impact. So we think that projects that are under construction are going to get completed. They will be delayed. The planning department isn't open, the inspectors aren't available, supply chain is disrupted. But they are half built. They're going to get finished at some point. Where we may see a larger impact is projects that are in the planning stage or the entitlement stage, where now the developer might have a different view of his pro forma, the lender may have a very different view, the equity partner may have a very different view. We think many of those projects will be canceled. And we've seen some of that already. And in fact, JCAP has announced they had 5 development deals with partners that they mutually agreed not to go forward with. And we -- there's other anecdotal evidence of this happening. So we would think that this will improve the supply situation in the future. Now if there's a V-shaped recovery and the economy goes back to screaming good and storage is doing great again, then this may change. But our best view of the future is a magnified slowdown in new development.

Right, Joe. I think that's going to do it for us. Okay. We're coming up to the end here. So I just want to say a big thanks for everyone joining us, and certainly to Extra Space management for the presentation today. And I think we'll wrap it up there. Thanks so much.

Thank you very much.