National Storage Affiliates Trust (NSA) Earnings Call Transcript & Summary

[Audio Gap] 9:30 a.m. session at Citi's 2020 Global Property CEO Conference. I'm Smedes Rose of Citi Research. We're pleased to have with us Arlen Nordhagen from National Storage Affiliates and Joe Saffire from Life Storage. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the disclosures tab. For those in the room or on the webcast, you can sign on to liveqa.com, enter code citi2020 to submit any questions or you can just raise your hand if you're here in the room. What I'd like to do now is turn it over to you, Arlen and Joe. Introduce your companies quickly and your team that's with you here today. And then if you could provide -- if you can provide 3 reasons of why investors should buy your stock today, and then we'll go into some Q&A. So why don't we go alphabetical order, starting with you, Arlen, by first name.

Okay. Thanks, Smedes. So I am Arlen Nordhagen, I'm Executive Chairman and Founder of National Storage Affiliates. I have also with me, Tamara Fischer, our CEO; and Brandon Togashi, our CFO. And National Storage Affiliates is the newest of the public REITs in the self-storage sector. We've been public almost 5 years. We are a very high-growth company. We started with about $1 billion of market cap when we went public. And currently, our enterprise value is about $6 billion. We have 750 properties, roughly, in about 35 different states. And we use a very different model, which we call our PRO model, which stands for Participating Regional Operator model, where we recruit large independent privately owned operators to join NSA by contributing their properties into NSA in return for equity in NSA. They then continue to manage those properties for us and grow within the territories that they're allocated. So every PRO is allocated territories for growth. And the 3 reasons, I think that I would recommend investing in NSA. Number one is really applicable to the whole self-storage sector, especially as we're looking right now at a situation where we may be going into a difficult economic time, potentially recession, later this year with the fears of the coronavirus. Self-storage has proven to be very resilient in a downturn. It's certainly not recession proof, but it is recession resilient. So our whole sector, I think, will be one of the stronger performers if that happens. Secondly, NSA has been the strongest performing of all of the self-storage REITs since we've gone public with the highest same-store NOI growth, highest FFO per share growth, highest total organic growth. And highest stock performance for that entire time. So that's a second reason. And the third reason, which I think really relates to that second reason is that our PROs and our management team are highly aligned with shareholders. Our PROs and management team that run the company combined, own $1 billion of NSA equity, and they are totally focused on the success and performance of the company.

Great. Joe, let's go over to you. Same thing.

Sure. Thanks, Smedes. Thanks, Arlen. That was very good. Joe Saffire, CEO of Life Storage, been CEO for just over a year now. I'm here with Andy Gregoire, our CFO; and David Dodman, our Head of Investor Relations and Corporate Strategy. We manage and operate and own over 850 properties in the U.S. and as of last year, Canada as well. Going to kind of jump right into the 3 points. I think one reason really to invest with us is we've proven to be innovators in technology, namely our Rent Now platform, which is pretty unique to the industry. We're the only ones that can provide customers the opportunity to skip the counter. And also our Warehouse Anywhere platform, which is tailored towards the increasing business users who are using self-storage for last-mile delivery. But right now, in particular, it's been a game changer for us, in particular, it's allowed us to really control our OpEx. And if you've seen our guidance, you've seen what we've put out there for 2020. It's also allowing us to attract millennials who are actually a very big user of self-storage. And it's also allowed us to grow our third-party platform. Owners are really liking what they see about the Rent Now, and we're one of the fastest-growing third-party platform providers out there. Second reason is, we're anticipating some meaningful growth. Put on our guidance, about 7% FFO growth this year. But despite that, our multiple still, or FFO multiple, is one of the lowest in the sectors despite us expecting to have one of the highest growth rates in 2020. And the third reason is really a lot of talk about supply. Well, ours -- our markets, in particular, we've shown that we're kind of past the peak of our major markets, in particular, Houston, Dallas, Chicago, our top markets. Even our New York region, we're not really in the boroughs, our New York region is one of our top 5 markets, but we're outside of the boroughs. We have one store in the boroughs. The others are in Long Island, Mid Hudson and so forth, and doing very well, and not a lot of new supply in those markets.

Okay. Thanks. We're opening up these sessions with the same question for each CEO. So our first question is -- yes, Arlen, we'll start with you. The ESG is taking on increasing importance for all company stakeholders. What is one thing your company is doing to improve your overall ESG score over the next 12 months?

Yes, I think, Smedes, one of the things about ESG in particular, we've had very very good corporate governance really since going public because we are a relatively new public company, and that was an important part of our design. But on sort of the ES side of that, self-storage, in general, has very low impact environmentally and has a lot of positive impacts from a social standpoint. And so what we've been failing to do at NSA is really communicate that. And so this year -- this past year, we formed a committee that's focused on just gathering the information of all the things that we do. We do tons of things to support our local communities from the social side. We have a major initiative for energy savings underway, those kinds of things. But we haven't publicized it very well. And so that's one of the things we're going to try to do better this year.

Okay. And Joe, how about for you?

Yes, ditto. No, in seriousness, there is a similar situation. We've actually been doing a lot of great things related to ESG, LED lighting, solar, we have a truck fleet. We've been turning those over, getting more efficient trucks. We've been doing more with management of our utilities. But the one thing we haven't really done well has been communicating. And that's actually something that's also changed as of last, I would say, 12 to 18 months. We have an executive committee that's reporting to me that reports to the Board. You're going to see much more on our website in 2020. And we're also going to be -- we're working through the process of being rated by GRESB. So you'll hear more from us. We're going to do a much better job of articulating and communicating what we have been doing already and what we'll continue to do to improve our ESG scores going forward.

Okay. Thank you. Arlen, do -- I actually will ask both of you. I mean, no conversation about storages goes anywhere without a little discussion about supply. Arlen, in your markets, which tend to be smaller, secondary, it's part of the strategy. I think, overall, you have noted less supply growth relative to some of the larger markets. On the last call, I think you said 45% now are under some sort of competition. So is that just -- are there still just fewer new units being built in your markets? Or is there more of a catch-up from developers as they discover these markets?

I'd say, in general, there are fewer or less overbuilding, I'll call it. What we are seeing, and I think Joe would concur with this is that we are seeing demand growth everywhere in the United States. But we are seeing supply growth in a lot of markets at faster than demand growth. And so that's the issue, sort of trying to match those up. In general, we have only about 1/3 of our properties in the top 20 MSAs, so 2/3 are in smaller MSAs. And we find in the smaller MSAs that we don't have as much of the overbuilding, partially because of the fact that the economic drivers are less. We have the lowest average rent per square foot of any of the public REITs, and that's because of the markets that we're in. And that lower rent per square foot makes it a lot less economically attractive for a developer to go in and build a lot of properties. And so what we tend to see in our markets are more the mom-and-pops or the local developers building as opposed to the big, more Empire build -- Empire type builders that go into larger MSAs. And so it's not that we don't have any competition because we certainly do, but it's less than some of our peers. And I think Joe has a similar situation with a lot of his markets.

Yes, for sure. I agree with Arlen, supply demand has been growing, especially on the business side. And there was concerns about millennials and we're seeing millennials. I mean, they are moving all around for new jobs. And they are definitely a user of self-storage. I would say, from supply, our 2 biggest markets, Houston and Chicago, were really early on in the cycle of new supply, and we haven't seen -- and they're past their peak of new supply, and you're starting to see that in some of our results. And then, surprisingly, some of the other cities in Texas, like Austin, despite a lot of new supply having come on last year and probably this year, it's been very, very strong, a lot of new demand for storage in Austin. And similarly, with Dallas, Dallas is kind of a little bit behind Houston, but it's been remarkably, very strong, and this seems to be stabilized a bit. And then there's been some talk of Miami, and I think all of the -- the REITs who are exposed there, also said that things look a little bit better in Miami. So we feel pretty good about where we are. We are also in some smaller markets, and there isn't a ton of new supply, like Buffalo is one of our -- obviously, our headquarter is in Buffalo, we kind of own most of that market, but it's been very good from a top line perspective. And there's not a lot of new supply hitting those secondary tertiary markets. I don't expect it either for the reasons Arlen pointed out.

Any kind of lesson learned and your view since you've been -- you're newer, I guess, as the CEO of the company, of exposure to markets like Houston, which -- typically high-growth -- job growth centers that have really no barriers to entry and were really a drag on LSI for a long time. How do you think about exposure in these markets going forward?

Yes. We love Texas. I mean, obviously, it's a very strong market. You have a lot of job growth there, a lot of opportunity and demand is quite high in Texas. But you're right, we're probably a little bit concentrated, I'd say a little bit because we're a pretty diverse company across the U.S. But you saw us last year, we did a bit of a recap and sold off some properties and some of them were in Texas. So we derisked a little bit in Texas. We're not buying any new in Texas. So you're seeing us kind of improve that -- our diversification with much of our focus on external growth is in some other markets that we think we should have a little bit more weight. We entered Seattle, which is a great market, last year, the Mid-Atlantic. I think we could do more in New England. So we love Texas. It's -- yes, we had -- we had some pain a few years ago, but that seems to be subsiding, and there's not a ton of new supply coming on. There's always going to be new supply, but it's not like it was in the past.

I have a question from the audience, Arlen, for you. Can you comment on the recent internalization transaction? What changes from a cultural and strategic perspective for NSA? Who fills the void created by your departure from the C-suite as other execs are all talented but lack the founder-entrepreneur DNA that you possess?

It's a long question. So for those of you who weren't aware of this. SecurCare self-storage was the predecessor company to NSA. That was the company that I was cofounder of over 30 years ago. And so when we formed NSA 6 years ago, NSA -- the predecessor was SecurCare and SecurCare became one of our participating regional operator PROs. We set up a mechanism to make sure that PROs would stay in place for at least a 5-year time period after the IPO. And so that time period is now up this year. And so we recently announced that SecurCare would be internalized and merged in and no longer be a PRO, but would be completely merged in, and the employees would join with the employees of NSA. What that means from a culture standpoint is very little because as the predecessor company, the culture has pretty much been similar all along. I think from a C-suite standpoint, my move to Executive Chairman is really meant to allow me to focus more on long-term strategic objectives, looking at larger transactions, recruiting of new PROs, just sort of directionally, that kind of thing. And and Tammy and Brandon, who are here, will continue to run all of the day-to-day as they've been doing. And so I don't think there will be a lot of change from that standpoint. I do think that we'll see more PROs retire over time. In the next 5 years, my guess is probably another 3 or 4 will retire. And what that means is it opens up slots for new PROs. There's -- from a practical standpoint, you can't have too many people together, it's somewhat hurting cats, if you will, of trying to keep everyone working in the same direction. And so this is a very important part of our growth forward to allow this to go together. And fundamentally, the part that's internalized at NSA really looks like all of our peers. So about 40% or so of our properties now are internally managed by NSA, and that looks exactly like our peers like Life Storage and everyone else. And the other 60% is managed by the PROs.

As more PROs start to internalize and I guess, potential PROs can see the wealth that's been created, I mean, do you think that you get more interest going forward? Because it seemed like for a while, you're having trouble adding PROs at the speed that you thought you could. So what do you think that happens over the next few years?

Yes, it's true. It means that adding new PROs has gone slower than I anticipated. We are at 10 PROs right now, will drop down to 9 with SecurCare's internalization. But it will definitely help us to be able to recruit additional PROs, and I think that will speed that process up somewhat. But also, we're just getting a lot bigger in terms of territories, and we try not to overlap PROs within the same territory, so that as we got bigger, that made that slower. One of the things that has been a challenge is that we went public at $13. We've traded as high as $38 recently. So the PROs that didn't join our -- potential PROs that didn't join us early, one of the common objections I get is, well, why I could have joined when you were $13? And I'm like, well, why didn't you join when we were $13, that would have been fine. But what we look at is, there's still a lot of growth opportunities for us, a ton. I mean, almost 80% or over 80% of the self-storage properties in the United States are still owned by small private owners. And so there's a huge roll-up opportunity, consolidation play remaining, some of that through PROs and some of it through just acquisitions in the territories that the PROs operate in and has been really successful for us.

Okay. Maybe a question for both of you. Just -- Arlen, you noted in your opening remarks that you thought the U.S. may be go into a recession over this COVID stuff. Do you think small -- does that present an opportunity for both of you with small or private operators? Can you be more active, more -- grow your pipelines more in that environment?

I'll let Joe answer for him. But for us, we definitely think it does. And in particular, what I saw in the last recession, the Great Recession, because I've been here so long, I've been through a number of recessions. But in the last one, what we saw is that the stabilized properties with highly diversified portfolios did really well through the downturn. We saw very small revenue declines, and it wasn't painless, but it was very, very minimal. Whereas, the problem properties were the guys that were trying to fill up. And so if we go into a recession, what I believe is that we are going to see a huge number of these properties that are new recently that are going to have real financial distress, and that may present some real buying opportunities. It's one of the reasons why we keep a very low debt level. Our debt to enterprise value is in the 20s percentile-wise and that's so that we have dry powder to take advantage of a time like this.

How about on your side, Joe?

Yes, I mean, I wasn't here for the first recession. I -- but I know that in our 30-plus years of being in the business, we only had one down year of revenue, and that was in 2009. So it is a very resilient sector. Those stabilized stores will continue to do well. I don't believe we're going to be in a recession anytime soon. I'm more focused on Prop 13 in California as an opportunity for consolidation. I think that's a big risk for those operators out there, but it's also opportunities for operators who want to expand their presence in California. I think with significant property tax, potentially increasing for operators who have been there for many, many years, I think there will be opportunities to be a buyer. I think some of the smaller operators will be looking to sell. So I'm really more focused on that risk in terms of finding ways to take advantage and do some more consolidation. Because Arlen is right, there's a ton of players out there. And I think they've proven that they don't want to sell, and it's quite hard to find the smaller operators to sell. But that's one of the risk factors, I think, that's going to provide an opportunity. And then also, the second is just what's going on with technology and CO, and it's becoming harder for those smaller companies to compete today. And they'll probably move more towards third-party management and then sell.

Okay. So is it fair to say, California is the market that you most want to see yourself expand in over the next few years?

Yes, we're just in the process of closing in on 6 stores in California. It's a very hard market to find properties, but we have room to grow there, especially Southern Cal. So we'll keep looking. We're buyers. But we're also pretty disciplined, and we're not going to overpay either.

You guys were able to provide your 2020 same-store guidance on your third quarter release, typically earlier than most companies do. And a fair amount of it was driven by efficiencies that you've talked about across your portfolio on the cost savings side. Could you maybe just talk a little bit about -- with LSI just under-managed before and inefficient in it -- or do you really feel like it's more to do with some of your initiatives around the Rent Now program that are driving the cost savings?

Yes. No, absolutely, I was hardly in the role for a blink of the eye. A lot of this stuff was set in motion before I arrived. I think the majority of it is really the technology and not just Rent Now, but other technologies that we're using to embrace efficiencies in the industry, whether it's -- online auction is a good example. Anything that can reduce the amount of time, you need to have your counter staffed, and that's what we're focused on. We're focused on how do we improve our store margins. Rent Now has been great. We're already seeing 10%, and who knows where that will go, of our customers self-serving. So that means they're not spending an hour at the counter, 10% of our customers are booking at home and going straight to their unit and they're not bothering the store manager, with the exception that maybe they want to go ask questions or maybe move the unit, but they're not having to do the contract work. And that actually amounted to real dollars in payroll savings for us, and we actually achieved them sooner than we would have thought. Actually, our fourth quarter was even better. So we had to tweak our guidance a little bit for expenses because we'll have a harder comp in the fourth quarter. But honestly, Smedes, it's a number of things that we're doing. I would say the majority of it is because of the new technologies that are out there, and we're looking for other technologies. It's not all our own proprietary stuff. There's some really good stuff that's going out there, that I think it really help us all control our costs.

Okay. And just to clarify, you said 10% of customers. It's 10% of incoming customers? Or...

Yes, 10% of our move-ins are self-serving.

And where do you think that can go over the next -- over the next few years?

We're working on strategies to see how we can improve it. It's tough to say, could it be like the airlines, I don't know. I think we're much different that customers use us more infrequently than something like airlines or car rental. So they do need some handholding. But I do see it continue to go up. I just don't know how quick or how far.

And when you look at Warehouse Now and -- or Warehouse Anywhere, sorry, and Rent Now, what is the sort of the longer-term better profitability profile for you?

Yes, I think -- well, the Warehouse Anywhere is -- as that grows, it's strictly really fee income. We've already done all the investments in technology. So those margins will improve as we can scale it up. It's more of a longer sales cycle. And then Rent Now, I think we could see another 50 basis points in NOI margin improvement in 2021. We'll see where it goes in terms of how many people use it and where that goes at 10%. If it goes to 30%, I think that you'll see some more improvement on the bottom line. But technology in general is going to help all of us going forward. And I think the Warehouse Anywhere is still relatively small. It's about $6 million in fees. But with the emphasis on last mile and more and more companies trying to get products closer to the end user, self-storage has always played a part in commercial business. It's just becoming more important as everyone needs to compete with Amazon, and they'll have to get their goods closer and they can't afford to do what Amazon does.

You mentioned, I think, in your opening remarks that LSI is cheaper relative to the other storage names, which it is, and it typically trades at a discount to the group. What do you attribute that to? And how do you think you can close that gap going forward?

Well, it's close significantly since probably a year ago. And I think the word is catching on that what we're doing is real, that we have a lot of different things that we're doing that our peers don't yet. And it's hitting the bottom line. We're working really hard. We've got a great brand. You're starting to see our third-party platform, pickup speed. I mean, it's -- we're almost over 300 stores with management fees and that's tripled in the last 3 years. So we've got a lot of good things going in our direction. There was probably some concern, Smedes, I would think, even a year ago today about Texas and Houston. And I think as that continues to show quarter-after-quarter of improvement, that gap will continue to close. And I would expect, with our technology, that we should probably be trading at a premium to our peers.

Arlen, how about on the technology side for you guys? It's not really something you have emphasized at least on public calls. Or how do you think about technology and storage in the sectors that you're in?

Well, technology is an important part of what the whole founding premise of NSA was because we have platform tools that are pretty much all technology-based that we can share across multiple PROs, private operators wouldn't have been able to afford those kinds of technologies by themselves, and those relate to the things in call center type operations, revenue management, Internet marketing, those kinds of things. So it's definitely an initiative that we've had as an important one, but I will concede that there's still quite a bit of opportunity for us there because one of the things that we don't force our PROs to do is we don't force them to adopt all of the technology platforms immediately. We let them decide based on the economic drivers that they see the benefits of that. And they all have to use our management information systems right away when they join. But other than that, they get to pick and choose. And frankly, they don't all use them as fully as possible.

So do you think that's a mistake on their part? Or you think...

I think it's a mistake on their part. Yes, because if we look at the PROs that have performed the best, we compare PRO against PRO, it's all the ones that adopted the platform tools the fastest. So ultimately, people are people, and they can be either quick or slow to adapt to change. And we like our PROs. We think they've been tremendously successful as entrepreneurs. They really know their local markets. That's a huge advantage that they give us. But some of them are faster to adopt change, and some of them are slower. And despite the fact that they're not all adopting it as fast as possible, we still have had the highest and fastest same-store NOI and revenue growth of anyone. And we have had, by far, the fastest FFO per share growth of anyone. So we'll continue to do that. And I just think what that really means is there's just more upside ahead.

As they adopt.

Right. Right.

And presumably, they'll see the numbers and want to keep going.

Have either of you heard or seen any kind of disruption on the construction supply side out of China with -- on steel supply and things like that, that might slow the supply growth in the industry?

We actually have seen some, yes. And we're not in the development business. Our PROs, some of our PROs do development, though. And we've seen some slowdowns on certain key components, not necessarily as much direct steel, but some of the other things. But it's definitely having an impact. The supply chains are important in almost every industry these days.

How about you?

We don't build either. So I mean, we participate in new development with our JV partners, we haven't heard any major issues yet.

Okay. How do you think about JV growth going forward, Joe. I mean, is that going to be a more important component for LSI? Or would you prefer to do wholly owned?

Yes. No, there's always a mix, Smedes, of wholly owned JV, obviously, for the CO part. We took some dilution last year with our recap and asset recycling. We have never developed. So it's harder for us to do development now with the dilution that's involved. So no, we like the JV structure. It allows us to take part in new development and CO deals. And that's primarily what we'll be doing JVs partnerships with. We've expanded a number of partners that we have. I think it's a great use of capital. You typically can get some nice fee income from it, acquisition fees and that sort of thing. So we'll continue to do more JVs. But at the same time, we're in a position where our cost of capital is much better than even a year ago. So we're also very good at acquiring properties. And I think the priority will be the REIT in 2020.

And you -- I mean, you completed a number of large acquisitions, dispositions last year. Do you feel like pretty good with where the portfolio is now? Or do you feel like you need to do anymore?

Yes. No, we're done with the dispose, there may be 1 or 2 here or there if somebody comes with a crazy offer for -- to put up multifamily or something. But no, we're not -- we're focused on acquisitions and using other means of capital than selling stores.

Okay. And just in terms of looking at acquisitions for both of you, have either of you seen any significant changes in private market cap rates? Or quality of assets that are on the market? Or anything changed around there?

I would say that cap rates, surprisingly have not gone up, they have kind of leveled out. And so partly, I think that cap rates would go up because of the slower growth in the same-store NOI performance, but that's been offset by the lower interest rate environment. And so I think right now, cap rates are pretty low and they're staying there.

Yes, I would think they would -- they've been staying low, especially really attractive markets and properties will get a good price, and they'll probably keep compressing with where interest rates are going.

Okay. Yes. So it sounds like supply for both of you, you feel like it's probably peaked. It's definitely outsized in some markets but pricing isn't changing at all.

We are a little more favorable on pricing than we were a year ago. When we compare year-over-year on our Street rates, we started the year with average Street rates 3% to 4% below the prior year, and we ended the year with them about flat to the prior year. So at least we're gaining a little bit on that. And I think we've definitely hit the peak on new deliveries of supply, but you've got this cumulative effect of the last 3 years of supply as it fills up. So we do see 2020 being the bottom. We're going to bounce along the bottom in performance. Our projected -- our guidance this year is a pretty low, same-store NOI growth in the 2% to 3% range, which is by far the lowest we've ever seen. But I think that will be the end of that, and then it will start to get better by 2021.

Okay.

Unless we go into a recession.

Unless you go into a recession, all right. And when do you think it will be then?

Unfortunately, I think I -- my personal opinion is that we probably will enter a recession by the end of this year. Not a major recession, but I see enough disruption from the COVID-19 issues with travel, supply chain issues. This is a global economy that we're in, and those things will have a bearing on it. It means I believe GDP will probably go negative by the end of the year. But I don't see it as a huge downturn.

Well, that brings us actually to one of the questions we have as our closing questions for the session. So Joe, maybe we'll go to you, and we're going to ask you the following 4 rapid fire questions. First, will your property sector have more or fewer public companies 1 year from now?

Same.

What will same-store NOI growth be for the self-storage sector in 2021?

2021?

Yes.

That's a good one. I would say between 1% and 2%, but we'll be north of that.

What will the 10-year treasury yield be 1 year from today? It's about 1.1 now.

It'll be higher.

Do you want to give us a number?

1.5.

And in what year will the U.S. go into a recession?

I can't change my answer from last year. So I'm still saying 2028.

Okay. Arlen, more or fewer companies from a year from now?

I agree with -- the same.

And same-store NOI growth in 2021 for storage?

I think '21 will be a little better, probably in the 2% to 3% range.

The 10-year, 1 year from now?

Probably 1.0.

And what year -- well, you sort of answered this, but what year the U.S. go into a recession?

As I said, late this year, I think we'll enter a recession.

All right. Thank you, guys. Appreciate it.

Thank you.

Thanks.