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

Great. Good afternoon, everyone. As we start our first roundtable session of the afternoon, which we will then head into a lunch break, we decided to still include a lunch break for folks, and then we will have our thematic panels this afternoon. So this is Jeff Spector. You're joining the Extra Space Storage roundtable session. Again, good afternoon, everyone. I'd like to welcome the Extra Space team. With us today is Joe Margolis, CEO; and Scott Stubbs, CFO. [Operator Instructions] And with that, I'm going to pass it on to Joe to make some introductory remarks, and then we will get into that Q&A. Joe, please kick things off.

Great. Thanks, Jeff. Also, together with Scott and I is Matt Herrington, our COO; and Samrat Sondhi, our Chief Marketing Officer. Thank you, everyone, for your interest and for joining our meeting today. For anyone not familiar with Extra Space, we are headquartered in Salt Lake City. We've been a public company since 2004. And we're known for strong same-store NOI growth; consistent external growth through acquisitions and third-party management; and the innovative use of technology in customer acquisitions, revenue management and operations. We have produced some of the highest long-term FFO growth not only in storage but in the entire REIT sector. And for the decade ending December 31, 2019, Extra Space Storage had the highest 10-year total return of any publicly traded REIT in the country and the 11th highest return in the S&P 500. We have an ownership structure with 3 verticals. We wholly own about half of our assets, joint venture, about 15%, and the balance are third-party assets that we manage without any ownership's interest. This provides us an asset-light structure option and allows us to grow efficiency -- efficiently, excuse me, in all market and economic conditions. It allows us options to effectively allocate capital as a tool to enhance our FFO growth per share. I'm sure we'll talk about 2020 performance in greater detail as we respond to questions. But first, let's talk a little bit about COVID. Like all businesses, storage was impacted by COVID and the stay-at-home orders beginning in March. We have to very quickly change our operating procedures, figure out ways to keep stores open, work from home in our call center, in our corporate office and respond to changed customer behaviors. COVID resulted in reduced rental and vacate volume, modestly lowered collections, discounted pricing and the inability to complete auctions for non-paying tenants or pass rent increases on to customers due to state limitations. However, we have now seen encouraging trends with improved rental activity, all-time high occupancy, which is almost 96% at the end of August, and the ability to resume auctions and rent increases in most markets. So we are very encouraged by these trends, but we still recognize some of the headwinds in our sector related to COVID, the general condition of the economy, its impact on customer behavior and elevated new supply, which has impacted our sector for several years now. So with that high-level overview, I'll turn it back over to Jeff, and we'll be happy to address any questions that you may have.

Thanks, Joe. That was very helpful. [Operator Instructions] Joe, for those that are new to the story, I mean, one of the key points you mentioned at -- in your opening remarks was innovation, the use of tech. I guess, can you talk a little bit more about that? What do you mean? And how did that help EXR so far through COVID?

So technology has been really part of our DNA since 1998, and we use it in many facets across the company. We have a very sophisticated pricing system driven by proprietary algorithms that price units on a daily basis based on historical data and projected activity. So similar to an airline or a hotel, you can search for a 10x10 today on your desktop; tomorrow, on your mobile phone; the next day, call the call center; and the next day, walk in, and you may get 4 very different prices. And that helps us optimize revenue. We use technology in our customer acquisition platform, both in terms of optimizing the web experience and in bidding for search terms on Google. We bid -- obviously, humans don't do this. We have algorithms that bid on millions and millions of search terms every day. And technology helps us spend money where it produces the highest return and not spend money where we don't need to. We also have very advanced data analytics, and everything that we do is based on data analytics and AB testing. So how did this help us during COVID when, all of a sudden, all the historical data of customer behavior becomes somewhat irrelevant? Well, because we have such a developed platform and such a large portfolio, we were able to very quickly institute many, many tests where we did -- took 200 stores and tried one strategy and 400 stores and tried another strategy and find during an unprecedented time what was the best way to maximize revenue.

And was it -- did it continue to vary? Is it varying by region? Or is there one particular method that's working?

So I would tell you that there's lots of different things that are working. It's not one method. It's combinations of different things. And certainly, in different market conditions, different things seem to be more or less effective.

Taking it back towards the top, when investors think about Extra Space versus your peers. I mean, how do you differentiate yourself versus your peers? I know you talked about some of the record results, but I guess I'm asking in terms of, let's say, strategy, market exposure. I know you talked about the emphasis on technology. What about experience in the store? How do you differentiate versus your peers?

So we have a very purposeful strategy of having a broadly diversified portfolio across primary and secondary markets. And this is based on a lot of research over CAGR performance over these markets over a 10-year period. And it guides us as to how to create a portfolio that performs best and reduces volatility in different times. Some of our competitors have similar portfolio constructions, other of our competitors do not. Secondly, we have this optionality of ownership structure and investment structure. We were the first company to start a third-party management business. We have the largest and most profitable third-party management business in the industry. And this gives us not only fees but an acquisition pipeline, cost efficiencies and, very important to our company, data. We have 1/3 more data, 1/3 more customer transactions because 1/3 of our stores are on this management. Most recently, we started a bridge lending program that no one else has, where we saw a void in the capital markets for bridge loans, and we've started this program. And not only has it provided very profitable bridge loans, but it just increases our interactions and exposures in the market. We get management assignments out of it. We bought 3 stores that were on bridge loans. It's another way -- innovative way for us to participate in the market that our competitors do not. You asked about in the stores. I would tell you, more than any of our competitors, we have valued our store manager. We believe that the interaction between the store manager and the customer is very important. Many -- maybe a majority of our customers have never used storage before. And most of them are in some stressful period of their life, and the ability to have a professional retail salesperson handle the situation for them, we believe, produces better results in the store.

Joe, one follow-up on that last point on experience. I guess, with the customers during COVID, and I don't know if you feel like this will go back to more normal situation where the future customer or your existing customers are interacting with that store manager, I guess, does that -- the story manager role change here if we -- if it remains more contactless, or EXR will continue to emphasize the importance of that store manager?

So I kind of believe both, if that's possible. I think that we will see -- and we -- even pre-COVID, we thought over time, we would see more online interaction with our customers. I know my kids don't want to talk to human beings, my kids want to do everything over the phone, and that's -- there is some of that in the future. So our obligation is to provide access to our product to the customer the way they want to access it. So whether that's calling the call center, going online or walking in the store, we need to make that a seamless and positive experience. But just because a customer accesses the product online doesn't mean they won't have interactions with the store manager. They will -- many of them don't know they need a 10x10. They just need -- no, they have a couch and a chair and a bureau, and they sign up for the wrong size or they have -- many of them having new storage. They don't know how it works, how to get in the gate. So having a store manager there to interact with the customer, even if the initial contact was online, is in many cases still important.

And on markets, you mentioned the importance of primary, secondary. I think initially, EXR was more primary. And then years ago, you entered more secondary. It is one of the key questions that we receive, especially these days on markets. Why is it so important to be in both? I mean, are you learning anything new during COVID that is changing your mind? Is there certain markets you want to -- you feel -- you wish you had more exposure to or less exposure to?

So I think it's difficult to make market selections based on what's going on right now because we invest for the long term. And we want to be in markets that will perform well over the long term. So when you look at any 10-year period and you look at the growth rates of primary and secondary markets -- primary, secondary and tertiary markets, you'll see that primary and secondary markets perform, in terms of return, very similarly and very similarly in terms of volatility, where tertiary markets perform okay, not quite as well, but produce an acceptable return, but are much more volatile. And the second thing you'll see is there is no pattern as to when primary markets and secondary markets do well and don't do well. It's not like all coastal markets do well in 1 year and then all markets based on manufacturing or whatever, however you want to look at it. So based on those 2 observations, of kind of noncorrelation of performance and return series and volatility, we believe the best strategy is to be as broadly diversified as we can in both primary and secondary growth markets. And we will construct our portfolio over that for the long term and not try to make any kind of violent changes. New York City is going to die because of COVID, sell everything in New York and go somewhere else. That's not our strategy.

Good points. Let's tackle, again, going back to the opening remarks, some of the comments that you've made on encouraging trends, all-time high occupancy. I mean I assume it's fair to say that things have turned out better over the last few months than the initial fear that probably set in during March. Is that a fair statement?

There's a lot of fear in March, no question about it. Not a lot of sleep. So yes, things have gotten better.

I've seen investors asking, and I have a similar question. I mean you mentioned a few things to -- look, again, encouraging trends, better than expected, all-time high occupancy but, and maybe it's all capital letters, economic uncertainty, COVID uncertainty and then, of course, just normal operating trends within your business. I guess what are you most concerned about? When you're talking about concern, is it just more the macro -- oh, I'm sorry, the last key part was supply. I'm sorry, supply.

Absolutely. Thank you for mentioning that.

Recession, COVID or supply, which 1 of the 3 really is the biggest concern?

Well, I'll tell you, supply is the one that's most real because we know it's there. We were dealing with it before COVID. And even though COVID has and will moderate new deliveries, self-storage, on average, takes 3 years to lease up. So we're still dealing with supply that has been delivered over the last several years. And the stuff that's under construction will get completed. So of all those things, the one that we're sure we're going to have to deal with is supply. The others are risks, but we don't know if they're going to come to pass or not.

Okay. And I mean we just updated our supply analysis that is showing on a national level, supply is starting to moderate. I mean is that a fair comment? But -- I guess is that a fair assessment?

So I would tell you that even before COVID, we thought supply was moderating, '18 to '19, slightly; '19 to '20, a little bit more. So it will -- the moderation will increase. I don't even know if that's -- you can say that there'll be greater moderation due to COVID. But as I said, we still have the kind of the backlog of new supply to work through. But yes, the situation is better because of COVID than it was before COVID.

Okay. And then an investor is asking, the 96% occupancy, is that sustainable? Haven't you received benefits from less move-outs? If move-outs were normal, what would occupancy be?

So I think it's a great question. And we do believe that customer behavior will eventually get back to normal and vacates will pick up. But I will also tell you, we don't solve for occupancy. If we wanted to have 96% occupancy for some reason, we could manipulate rates and discounts and marketing spend and create 96% occupancy. We operate to maximize revenue. And we use all of the tools, rates, discounts, occupancy, marketing spend. We use all of our tools to maximize revenue. And if we can maximize revenue at 92% occupancy or 94% occupancy, then that's where we'll be.

And you mentioned earlier that you have resumed the auctions. I guess, I think even on your last call, there was still some concern resuming auctions that it could create some -- more pressure on occupancy. But again, you're at an all-time high. Can you just update us, I guess, on the auctions versus the occupancy number you mentioned?

So I'll tell you that this is, again, another thing we had no experience with because we haven't had a period of time before where we were governmentally restricted from performing auctions. What we found is when we were allowed to resume auctions and we sent out lean notices, many, many customers came in and paid. So they were not paying their bill because they didn't have to because there was no stick. And once the stick was reinstated, they came and either paid or cut some deal with us and did not put auction.

Okay. Good to know. We have another question on urban to suburban. A lot of people have moved from urban cities, at least temporarily. How much of a benefit have you seen from that over the couple of months?

It's really clear when you look at our portfolio statistics that our performance is consistent across both urban and suburban areas, that we really haven't seen any difference in those areas in spite of the trend that's mentioned.

Yes, Jeff, both of those areas are highly occupied. I mean they're -- we're 96% across the board here, and it's not like the urban areas are 80% and the suburban areas are 100%. They're all very highly occupied.

Okay. And we have another question along similar lines. I guess, first, what percent of your customers is small business? And then similarly, with restaurants and small businesses potentially using more storage during the shutdown, is that a temporary boost?

So we believe about 15% to 20% of our tenants are small business, although it's a difficult stat to get because some people will sign a lease individually and then run their landscaping business or whatever out of it. And yes, we have seen an increase in usage by restaurants storing extra tables and chairs as they socially distance. And as the country gets back to normal, we would expect that use to dissipate.

We have a question on move-outs. I believe you commented that people are staying longer, but I guess, what is the typical move-out percentage maybe even this time of the year? And just to confirm, what are you experiencing now?

So August, and I guess we're into September, August and September, typically net move-out months where we have more move-outs than move-ins. And we're not experiencing that now.

Okay. Great. Let's turn to rates. We have a few questions on rates. How have street rates trended as we move through the summer? Cube did say today that they noted double-digit growth in street rates for their portfolio heading into September. How does your portfolio stack up in comparison?

Yes. So if you look at rates, let's maybe go back to the depth of when everybody would stay at home, we saw our rates fall about 20%. And that was a combination of us cutting rates but also a shift in channel. So many of our customers were now only contacting us via the web or our call center. And those are cheaper channels than if they walk into our stores. So the bottom, they were 20-plus percent down. Moving into June, they were coming back. In July, they were flat. And then in August, we saw close to 10% rate increase in terms of our achieved rate. That has continued into September. But the other thing that we would comment on is last July and last August were actually soft months for us in terms of rate, so it was a fairly easy comp. But as occupancy has been strong, as demand has been good, we pushed rates, and we pushed them close to double digits.

And Joe mentioned earlier in the call that you are starting to push rates again. I guess, can you provide a percent of the customers? Or are there certain areas where you're not certain -- areas of the country you're not able to do that yet?

Yes. So on our existing customers, most municipalities, we've increased rates. It started as early as the first part of May, and it's been as recent as in the last month. So we've worked with municipalities, followed closely the states of emergency. And we've moved rates up. So our rate increases that went out in May, for instance, were effective in June, and those caught up the months of March and April. So when we sent them out, they're cumulative. And those have gone out -- the ones that went out in July and August, again, caught us up back through the month of March. So we've pushed rates as allowed by state of emergencies, and we've pushed them reasonably close to what they've been historically.