Public Storage (PSA) Earnings Call Transcript & Summary

All right. Welcome to the 9:00 session of Citi's 2022 Global Property CEO Conference. I'm Smedes Rose. I'm here with Michael Bilerman. We're pleased to have with us Public Storage and CEO, Joe Russell. Everyone is Joe in Self Storage. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those joining us here today in person, to ask management any questions, please step to one of the mics that we have located in the center aisle of the room. [Operator Instructions]. Joe, I'm going to turn it over to you to introduce -- Tom, who's with you and a few opening remarks about Public Storage, and then we'll jump into some Q&A.

Okay. Great. Thank you, Smedes. Good morning. Thank you for joining us. Again, I'm Joe Russell. With me is Tom Boyle, our Chief Financial Officer. Tom and I have a few opening comments and then Smedes will turn it over to you for Q&A. But for those of you who aren't as close to the storage sector, it's yet again a great time to be part of the self-storage environment. We continue to see very compelling drivers to our business that we've been very fortunate not only to unlock in this environment, but also very positive about what we have ahead of us going into 2022 and beyond. Today, we own and operate the largest portfolio in the self-storage sector. That includes about 2,800 properties, 39 states, approximately 200 million square feet. In 2021, we yet again had a great year relative to not only operational performance, but we were fortunate to grow the portfolio and expand it by about 23 million square feet of additional investments, totaling $5.1 billion. We also uniquely have the only development platform in the self-storage sector. We continue to build and grow that platform. Today, the backlog we've got tied to development is approximately $800 million. We're also continuing to infuse technology into the portfolio. We'll talk a little bit more about that this morning. And for those of you who may not know us as well, we have a very efficient and ready-to-deploy capital structure that continues to serve us quite well. With that, I'll let Tom talk a little bit more about the financial perspective of the business as we speak.

Thanks, Joe. So as Joe mentioned, we deployed over $5 billion in acquisitions last year. In order to fund that, we issued $5 billion of unsecured debt. At the same time, we issued and redeemed $1.2 billion of preferred. In aggregate, we lowered the cost of our in-place capital from 3.9% to 2.7% over the course of the year. We have a uniquely strong balance sheet, as Joe mentioned, to fund accretive growth, combination of leverage at the low end of our 4 to 5x net debt plus preferred to EBITDA range and at the same time, expect $700 million retained cash flow this year. So we're positioned for another strong 2022, both from an operational standpoint and the balance sheet is poised to fund the growth initiatives that Joe outlined.

So with that, Smedes, Michael, I'll turn it over to you.

Great. So Joe, we've been starting each of these sessions asking each CEO to provide us 3 reasons why an investor should buy your stock over any other listed property company.

Okay. Great. Yes, Tom and I can outline 3 compelling reasons why we think Public Storage is uniquely positioned to capture the environment I briefly described. First of all, the overarching power of our brand. And what I mean by that, it includes a powerful combination of our platform, which I spoke to the size; the brand itself, as I just mentioned; and our management team. With that combination, we are digitally retooling the business as we speak. That includes a very deep-seated investment that's taken not only multiple years, but has multiple components going forward that will continue to serve us quite well. The digitization of the self-storage business is quite powerful if, in fact, you know how to retool operationally. And analytically what we have, which is a vast amount of data that comes into our environment each and every day. We transact on an annual basis, approximately 1 million transactions directly with our customer base, which today is about 1.7 million customers. And with that amount of data, it guides us into many deep-seated investments relative to not only our operational capabilities, but also our allocation of capital. We can definitely share more about that as well. Number 2 is our 4-factor growth. I mentioned, we had a very vibrant year in 2021 where we allocated and invested approximately $5.1 billion in the acquisitions, and we've also been expanding our development pipeline. More recently, we've also gone into third-party management, which also is growing the scale across our portfolio. Our third-party management platform grew by 79 assets in 2021 in 22 states. So we continue to see very good opportunity to grow that platform as well. And then the third area is our balance sheet. And I'll let Tom talk a little bit more about that.

Yes. The balance sheet is absolutely poised to continue to fund growth. As I mentioned earlier, a combination of low leverage philosophy over time, but at the same time, EBITDA growth that gives the company good capacity, year in and year out, to fund the business with unsecured debt and retained cash flow going forward.

Joe, on that first point, in terms of retooling the business, the digitization of your business, and you talked about it being a multiyear effort that's been underway that is going to have multiple components going forward. Can you talk about what changed organizationally for the firm to recognize the importance of these initiatives? Was it the sector moving to a point and then PSA realizing we need to be better? So just what changed?

Yes. No, it's a good question relative to one of the things that Tom and I have intention been doing, particularly in the last year or so is to be even that much more transparent around many of the things that have been, not only deep seated from a historical standpoint relative to our investment in optimizing the business. Much of that optimization historically has come from the amount of investment that we've made into our technology platform and the components of that. For instance, in 2018 and 2019, where we rolled out a platform system that we call Web Champ 2, which is our interface, not only to customers, but inventory management. It connects to our website. It's now been a tool we've been able to leverage into our PS app and also our call center. One iterative benefit of that investment also included a new technology that we rolled out operationally into the field 2 years ago, which is what we call eRental. So if you step back and think about what's been tried and true in the self-storage sector for decades. Ours included was a transaction with a customer has always been solely dependent on one connection, and that's a customer required to come to the counter at a property and do a lease transaction directly with that property manager. Over a number of years through our own surveys and our own view from what customers were asking for, we developed what we call an eRental platform where customers can now self-direct and self-choose a unit on their own, on their own time. The goal of that platform through our technology was to take that in-person transaction that takes anywhere from 30 to 45 minutes and be able to do it in 5 minutes or less online and again, self-directed. So through the -- not only the pandemic, which supercharged our ability to actually deploy this, today, over 50% of our customers are choosing to use that channel. Customers use it because it's fast, it's sufficient, it's self-directed and it really takes away the burden operationally on that property manager to each and every day be solely dedicated to that single function. Still have many customers who want a traditional experience, but that's an example of how the technology platform that we built actually facilitated that. And as I mentioned, we move in plus or minus about 1 million customers a year. So that's become a very vibrant and opportunistic channel. The other thing is it does, it gives us a very unique data trail. And what I mean by that is it actually begins with our platform relative to the beginning search to the ultimate transaction itself. And then post transaction, we have other technologies that we've also unlocked, which include something else that the self-storage industry has never had, which is actually customer usage once they occupy a space. So 2 years ago, we finished the rollout of a self-funded tool that's cloud-based that we now are able to analyze and monitor the amount of usage that takes place right down to a customer in and out of the property each and every time they visit. That, too, is a very different data trail than we've ever had before. So a couple of quick examples where our technology investment has allowed us to amplify and grow through our own innovation, the customer experience, very positive, the operational effectiveness. And by the way, it's also very efficient from a P&L standpoint, because the time and the labor component that was tied to that one function has now been supplemented by technology. And Tom can give you a little color on the quality of the customer that's coming through this channel, which we now have, again, very good data because we've been doing it now for well over 1.5 years, but we're very pleased by the quality. So Tom, do you want to talk about that?

Yes. The customers that are using our digital platforms are some of our best customers. And they generally -- with over 50% of the customers using eRental for instance, it's a wide cross-section of the U.S. population is choosing to use that channel. And that's intuitive because that's how customers are interacting with any number of consumer brands today, and self-storage is no different. We're trying to deliver the customer experience that, that our customers expect across how they manage their own day-to-day lives. So the customer base tends to be broad-based, but also skews a little bit younger, skews a little bit higher income, lower delinquency, so an attractive customer that comes through those digital channels. And then as it relates to the other digital components and their adoption, similar, but Joe mentioned the app that we rolled out has over 1 million downloads and continues to gain adoption within the tenant base. And that's really around allowing the customer to use that app to interact with our properties. So Joe mentioned the centralized access system that we developed with a technology partner several years ago. The real benefit to the customer in that technology is the ability to -- to not need to interact with the property outside of the phone. So that's a nice benefit to them. And from our standpoint, we get data and ability to optimize staffing, understanding the usage of the property.

If someone comes in through their contactless program, do they automatically sign up for sort of a monthly AutoPay? And have you seen that come up as a percentage of your overall tenant base? And does that help in terms of overall length of stay? I know it would for me.

Yes. No, we do have AutoPay as part of our eRental platform. We try to make that process as seamless as possible. And as Joe mentioned, less than 5 minutes, part of that is, is streamlining the choices that customers make and ultimately, AutoPay is a component there. AutoPay has a couple of benefits. It does -- you tend to see longer length of stay customers on AutoPay, but some of that is selection, i.e., customers that are willing to sign up for AutoPay tend to be willing to stay longer in any event. But there's also some delinquency benefits. I spoke about the delinquency benefit. You don't have to remind customers to make their payment, they're already on the AutoPay. And I would say delinquency over the past several years has continued to be a bright spot. Consumer balance sheets are in great shape, and we continue to see lower delinquencies than pre-pandemic levels.

And after -- and after transaction opportunity types of the PSA that Tom gave you a little color on, so we're still in the early innings of the robust nature that, that tool can continue to provide our customer base. We're soliciting feedback, but 2 or 3 of the most powerful tools that it's uniquely giving our customer base is it's, again, a contactless opportunity to access the site itself. You don't need to touch a keypad; you can do it from your car. It's very efficient and easy. You can do your own account or management, whether you are or aren't on AutoPay. And then it's going to give us a very vibrant communication channel with our customer base that continues to be very -- a strong, but actually giving us a lot of very good feedback. One of the things that we've seen over the last couple of years is our average length of stay continues to grow. Part of that has been driven by the quality and the nature of the analytics that we use to hopefully guide us to what we would consider the most opportune type of customer, long term. So we've, again, been able to unlock some pretty powerful tools around that. So today, our average length of stay is approximately 40 months. Now to put that in context, as many of you well know, we have 1 in -- only 1 lease structure, and that's a month-to-month lease. So even with the short-term nature of our lease structure, the tools that we're building around that and the environment that we continue to optimize through, the utility and the benefit of self-storage also is giving us some pretty commanding capabilities of actually -- pretty respectable length of stay.

Joe, I can remember a time where PSA would say, we don't want to continue to remind our customers because it could drive them to remember that they're paying all this money for stuff. It used to be in the closet that is now in the self-storage facility that you want them to forget about it, put them on AutoPay and not do anything. So are you -- that was the view before? So what changed in the calculus and is now, are you seeing the benefit where you're not increasing churn, but you're actually getting longevity out of it?

Yes. No, it's a good point, Michael, relative to not only the historical nature of -- and honestly, still the current nature of part of our tenants. Many of them don't want that active interaction, and that's fine. But what we clearly are also catering to is a growing set of our customer base who does want ease of use. They want some type of ease of connection to us, and we see the commensurate benefit of us being able to have a very different dialogue with them as well. So those customers who are much more comfortable being very traditional in that context where they'll move their goods into a unit and leave it there for a very extended period of time and basically want to keep the relationship that much of an arm's length relationship, that's absolutely fine. But we do see a growing number of customers that do want that level of service, that connection and that opportunity to engage with us. So we've put different tools as we've been speaking about into their hands with different ways of being much more customer-service oriented. The other thing that technology has enabled us to do is to do that in a very consistent way. Again, this is built around achieving higher levels of customer satisfaction. There's no question with the way any of us acquire any good or service, we want to be able to control the quality of that experience and the ability to direct it as much as possible. So our customer base is no different. What these tools continue to allow us to do is have that opportunity to not only improve the level of experience with us. But again, going back to that tried-and-true formula from a sector standpoint, you think about that relationship I mentioned that a property manager had the sole responsibility. And frankly, our industry, 90% of it or more, still works that way day to day. But what you're always burdened by as a customer to the good or the bad is the quality of that particular person's experience and/or what kind of service that they alone are prepared to provide. So one of the things that we can bolster on and improve the customer experience with the technology platform we've got, we can offer a much more consistent and much more pleasant experience whether, again, the channel is happening directly base to face and/or through the technology platforms that we have. Another area that we continue to bolster is something that is part of our system for a couple of decades is our call center. We no longer call it a call center, it's a customer care center. So before the pandemic, we had 2 call centers. One was in our headquarters location. The other one was in Arizona. Through our technology platform, we've expanded the nature of our customer care center. And now we close those 2 call centers, and we have 400 customer care centers around the United States, the technology platform that we have built allowed us to not only expand that from a size standpoint, but we have many more analytical tools to provide a higher level of customer interaction and customer care.

As you think about growth going forward, how are you guys -- I mean, obviously, price would be a consideration for acquisitions, but how are you thinking about which markets you want to be in? I'm thinking you talked a lot about what sounds like a lot of increases in investment in technology. And are you using -- we hear from other REITs that they're using these proprietary systems to figure out what markets are growing and kind of get ahead of the curve. Are you doing things like that? Or how do you think about where you want to be?

Yes. Yes, good question, Smedes. One of the things, again, it ties again to the data platform that we're able to uniquely blend into, even our allocation of capital and our market analysis, right down to a submarket basis is with the amount of data that we have, we can analyze and understand not only the competitive nature of a particular submarket, but what's ahead. And then from a macro standpoint, one of the things that is very powerful for the ultimate success of a self-storage facility is the amount of competition that either resides in that submarket today and/or what's ahead, coupled with the fact, what kind of movement may be taking place in a particular market that ties to demographics, that ties to the way any particular market is evolving. So from a capital allocation standpoint, we're using a very rich set of data, not only internal data but external data. Tom, you might want to give a little bit more color to that team reports into Tom's group. So you might want to give color on that, too.

Yes, I think the other thing I'd just amplify is because of the scale that Public Storage has had for so long, we have an immense amount of direct customer data. Meaning that -- so for instance, over the last 10 years, we've had 13 million unique customer journeys across the country, and that allows us to think about predictive analytics, demand drivers, what makes a particular submarket attractive for investment over time, long-term performance drivers, et cetera. And so the team is able to harvest that sort of data to understand and ultimately predict what we think local submarket performance will be, which gives us a leg up on capital allocation and then selecting those submarkets. Which feeds into our development business, which is probably an area that we can see where the puck is going from a demographics and demand driver standpoint and figure out where it is we want to select those sites even away from acquisition opportunities.

So one other thing statistically that has and continues to drive our business is, more often than not, a self-storage facility is fed by about a 3- to 5-mile radius. So that trade area dynamic is incredibly important. And the more you know about that specific opportunity set, the better serve you're going to be relative to many things, including, first of all, do you choose to either acquire or build in that particular location. Then, we use a variety of different analytics to tell us what's the optimum size of the facility itself and what's the internal optimization tied to the actual unit size within that facility, not only based on what historically has happened in the market, but where the market may be headed. So that, too, can be a very powerful way to optimize the amount of revenue and the success of a particular asset. It's not unusual, actually, as we even acquire properties, we'll go in and do some level of retooling relative to the internal mix and configuration of the unit sizes of the facility itself. With the amount of development that's taken place in the self-storage sector over the last 5 to 7 years, there's been a fair amount of high quality that's come with that. But some of that's come with the lack of analytics that we have. So again, in 2021, we acquired about 250 assets. Many of them have been built over the last 5 to 7 years, but we don't use that acquisition opportunity to keep them static necessarily. If, again, our analytics are pointing to some level of additional optimization. We've got the tools to go in and do that. And that, too, can be a very powerful way where we unlock value differently than an investor who does not know or understand the dynamics, not only of that specific trade area, but the kind of analytics that we're able to use, because we operate 2,800-plus facilities nationally each and every day.

You mentioned the average length of stay increasing, and we're seeing that across the industry. The other thing I was looking back over the last 15 years, occupancy has gone from 85% to about 95% now. And I know there's an expectation that occupancy will kind of come back to what's considered more normal levels. But it does seem like every time a new milestone is reached that was thought to be unattainable, that's the new level. And I'm just wondering, I mean, do you think that, that could be sort of an upside surprise this year, not necessarily just for you, but for the industry that people leave their stuff for longer as they tend to do? Why would that change?

Yes. I mean, I think from an occupancy standpoint, you hit on something there, which is occupancy within the sector has grown. I think there's a number of factors there. One of them is, I think the industry over the last 20 years has gotten more sophisticated in terms of how it manages inventory. And we've certainly done that ourselves and continue to. I mean, Joe mentioned Web Champ 2, there were elements of that platform that had nuts and bolts at the revenue management team in effect put into the system in order to better manage inventory and reduce the downtime associated with vacate activity. So that's just one example. And the industry continues to get more efficient in using yield management, revenue management techniques. I think away from that, speaking to this year and what we've experienced through the pandemic, we've seen a number of positive demand drivers as well as performance from existing tenants, which has allowed occupancies to move higher. We have seen in some markets, occupancies approaching truly frictional levels. And the market that I would highlight for that, in particular, is Los Angeles, which for us was a market where we couldn't move rents above a 10% limitation because of rental regulations within Los Angeles County. And so that was a good -- a test case for us to a certain degree as to what that true frictional vacancy would be within a market. And we were running at north of 98% occupancy for the past year or so in Los Angeles. Is that revenue maximizing? No, and we now have the ability to move those rents to market, and we're starting to see the occupancy come down as we anticipate in that market. So I think some of it is will be driven by revenue management in some of the markets and expectations for lower occupancies in order to maximize that revenue. But overall, customer demand remains strong and existing tenants perform well, which is supportive to overall occupancies across markets.

I wanted to ask you, too, you -- you're the only public storage company with the development pipeline on balance sheet, new development as well as expansion opportunities. And I mean, do you -- would you generally expect to have around $500 million or so, kind of, in the hopper for future development and opportunity -- expansion opportunities or new construction?

So in 2021, we held an Investor Day in May, and we outlined the trajectory that we're committed to put our development team on relative to elevating the level of annual deliveries for our platform. So the goal that we've targeted by 2026 is to grow our development pipeline to an annual delivery level of approximately $700 million. So with that, we are not only building and retooling the team to have even a deeper penetration nationally, but through the analytics that I spoke about and the unique capabilities that we have based on our scale and knowledge of markets, we're confident we continue to grow that pipeline. You saw it grow from a total standpoint over the last couple of quarters by about $150 million. So now today, our total pipeline is approximately $800 million. So behind that, we continue to bet and find very attractive land sites. One of the things that peaked in 2019 in the self-storage sector were national deliveries. Approximately $5 billion or so of deliveries peaked in that calendar year. Since then, it's continued to decrease, which is overall a good thing relative to the level of competition that we're seeing in the markets that we're continuing to grow the platform around. But the development business can be very complicated. I will tell you it's more complicated today than it's ever been. Part of the reason for that is the amount of city staffing that has yet to come back. And frankly, I don't know how soon it will come back from a timing and service level. I can't point to a single city across the United States right now that we're doing development and that's actually easier to do business in than it was pre-pandemic. So we're seeing elongated time frames. That's also an environment where we're seeing outstretched inflation in certain component costs, whether it's steel, concrete and in particular, market-to-market, the availability and the cost of labor. So if you're an individual developer, which is far more prevalent in our sector, you've got higher degrees of risk factors. With all that said, it's been a very good environment for us to actually go out and acquire a number of better land sites than we typically might see, with fewer competition or competitors. But also because we've got the scale and the depth and the size and the ability and the financial power behind them to continue to drive this part of our business, we're dedicated to do that. Without a doubt, development is the most pronounced capital allocation tool that we have, and it is and should be because of that -- because of the risk that is inherent in development itself. But we feel we have been and continue to build the best development and construction team in the business, and we continue to put the right resources around them, both analytically and financially to go out and find these prime opportunities expand the portfolio. Another part of the business that's in and within that team is the opportunity we have around expansions. So expansions can come from a few different ways: One, not only from existing assets; but it can also actually come through some of the acquisition activity we have on existing assets. So a quick example of that was in April of last year, we bought the ezStorage portfolio in the Washington, D.C. market. About 50 assets held by a family that had run and developed that portfolio over a 25-year period, they were a prolific and very skilled localized developer. One of the things that they had done is they had ceded expansion opportunity, about 10 of those assets. So once we acquired that portfolio in April, we actually put our development and construction team into those assets. And as we speak, we have expansion going on in those assets, in an environment where we can't wait to get them done. We need the space. We have the demand for it, and we're likely to see very good and outstretched returns based on that amount of investment.

So a few questions came here on the live QA. So the first one is what debt-to-EBITDA parameters are you sticking with? And are you concerned about the volatility in the European debt market?

Can you repeat the first?

Sorry, what debt-to-EBITDA parameters, guidelines are you looking for?

Okay. Yes. So the metric that we have communicated from a target standpoint is net debt plus preferred to EBITDA. Obviously, going back 5 years, the composition of that metric was almost entirely preferred. It's now shifted to be a majority unsecured debt as the company has grown. Adding that institutional capital source has been important. And if you look back at last year, we were able to access the unsecured debt market twice to finance the portfolio acquisitions in a smooth and seamless way. So we will continue to add unsecured debt as part of our capital structure over time, particularly for portfolio opportunities like we saw last year. So that target range of net debt plus preferred to EBITDA is 4 to 5x, we're at the low end of that range today and have capacity continue to use that source of capital. I think the second part of the question was on debt markets today. Obviously, with our balance sheet, we're well positioned with good access and cost of capital through cycles with A rating and that leverage profile. But nobody is immune to what's going on in the debt markets today, certainly seeing more volatility, both for base interest rates as well as spreads. But overall we feel good about our cost cut.

Right. And being at the low end of the range, when your EBITDA growth this year is going to be so strong, provides you the incremental leverage capacity to continue to add and grow and really drive cash.

That's right.

There's another question that says rents are up 30% above 2019 levels. This is according to this investor. When does the consumer pull back as a result of those higher rates? When is the cost to store your stuff?

Yes, that's a very good question. And I think it's one that we are monitoring and navigating each day, right? We've seen a level of rent growth that the industry hasn't seen over such a short period of time in the past. And associated with that has been a very strong demand environment for storage. Consumer balance sheets are in very good shape. But at the same time, we're in an uncertain macro environment with inflation at levels we haven't seen in decades. So we're monitoring that closely. I will say it's a core part of our competency to manage that rate optimization. In other words, there's no magic nominal number for a 10x10 that is just too much. One of the things that we're advantaged by is that, that rent for a 10x10 today, say $150, is a nominal component of someone's discretionary budget for a month. And so that's helpful as it relates to being able to pass through increases. At the same time, I'm not suggesting that we're immune to pressures around rate. In fact, the team spends -- one of my team spends their entire day trying to manage that optimization of rate versus volume, i.e. higher rate, lower move-in volume versus lower rate and higher move-in volume. And so there absolutely is a good bit of sensitivity there and it varies dramatically across the marketplaces.

One thing -- just for additional context. Believe it or not, a number of our customers, whether they're consumers or businesses, do make decisions around self-storage discipline and with some financial acumen as well, meaning they're looking at that as a sensible alternative to the elevated costs of both living and commercial space. So based on the fact that, from a consumer standpoint, self-storage is often looked at as an extension of home. So as you see elevated costs coming through in the rental and buying arena relative to homes, and certainly, on the commercial side with the elevated cost of industrial space today, self-storage can be a very financially sound addition to balance, not only that cost but with a high degree of flexibility. So that, too, continues to be a very strong driver for the utility of the sector.

30 seconds for rapid fire. Biggest growth opportunity PSA has that you don't believe the market is giving you credit for, one thing?

I think one thing that we continue to speak about what we've done today is the depth and the quality and the opportunity tied to our technology platform.

Same-store NOI growth for the self-storage sector in '23, the sector overall?

Tom?

Above historical averages.

So it will be positive? So a positive greater than 4. Is that fair?

Sure.

Okay.

[indiscernible]

10-year treasury, a year from now, it's 1-8 right now.

2.5%.

Property sector, will have more or fewer public companies?

Probably more.

More?

But we said that 3 years ago.

Thank you.

All right, thanks.