Q3 2022 Extra Space Storage Inc Earnings Call
At this time all participants are in a listen only mode.
After the speaker's presentation, there will be a question and answer session.
To ask a question. During this session you will need to press star one one on your telephone you will then hear an automated message advising you that your hand is raised.
Please be advised that this call is being recorded I will now turn it over to Jeff Norman Senior Vice President of capital markets. Please go ahead.
Thank you welcome to extra space storage is third quarter 2022 earnings call.
In addition to our press release, we have furnished unaudited supplemental financial information on our website.
Please remember that management's prepared remarks and answers to your questions may contain forward looking statements as defined in the private Securities Litigation Reform Act.
Actual results could differ materially from those stated or implied by our forward looking statements due to risks and uncertainties associated with the company's business.
These forward looking statements are qualified by the cautionary statements contained in the company's latest filings with the SEC, which we encourage our listeners to review.
Forward looking statements represent managements estimates as of today November <unk> 2022.
The company assumes no obligation to revise or update any forward looking statements because of changing market conditions.
Other circumstances after the date of this conference call and with that I'd like to now turn it over to Joe Margolis, Chief Executive Officer.
Thanks, Jeff and thank you everyone for joining today's call.
We had another strong quarter with same store revenue growth of 15, 5% driven by strong rental rate growth, partially offset by lower year over year occupancy.
We felt expense pressure across many line items, resulting in total same store expense growth of 12, 6% and same store NOI growth of 16, 4%.
We continue to be busy on the external growth front, adding 40 stores gross to our third party management platform closing over $100 million and bridge loans and closing a number of acquisitions.
Notably the purchase of storage Express.
We view storage expense as a strategic opportunity to acquire not only an attractive portfolio with operational upside, but a remote storage platform. We believe this will unlock an additional growth channel for extra space to acquire and integrate smaller properties that.
Lend themselves to remotely manage model.
Our strong property NOI plus our external growth efforts resulted in core <unk> growth of 19, 5%.
<unk> includes an add back of five <unk> per share for estimated property damage and tenant insurance claims related to hurricane in.
We are happy to report that all of our people remain safe. During this storm. We are proud of the way our team has rallied around our employees and our customers in southwest, Florida to assist them with cleanup and restoration efforts.
Core <unk> in the quarter was slightly ahead of our expectations driven by stronger than anticipated interest income and non same store NOI, partially offset by lower than expected same store NOI.
In September we started to experience a return of seasonality, putting some pressure on occupancy and new customer rates, which were both modestly lower than our third quarter forecast.
As we evaluate our standard metrics to measure demand, we see the moderation. We are typically expected in the fall that did not occur in 2021.
Our traffic is lower year over year demand is in line with pre Covid levels Fund.
<unk> remain strong just not as off the chart strong as they have been in the last six quarters.
As a result, we have tightened our same store revenue NOI and core <unk> guidance ranges, eliminating scenarios that assumed only minor seasonality on the top end of the range.
As well as more bearish scenarios, which we do not believe will materialize.
This revision resulted in a five cent or 60 basis point decrease at the midpoint of our <unk> range.
We never like the idea of having to reduce our outlook, but we're also careful to maintain perspective.
Our 2022 implied same store revenue growth is the highest in the history of our company and this is on the back of 2021, which was our second highest revenue growth here.
Our implied 2022 <unk> growth at the midpoint is 21%.
Our balance sheet is healthy we have access to capital and our external growth platforms are positioned to grow on an asset light basis.
As we contemplate future potential economic landscapes, including additional inflation <unk> recession.
We are well positioned to continue to produce solid results.
Due to our resilient need based asset class diversified portfolio and best in class team and platform.
We are having a great year, and we look forward to finishing strong in the fourth quarter.
I'd now like to turn the time over to Scott.
Thanks, Joe and Hello, everyone.
We had a strong third quarter, a penny ahead of our own internal SFO projections, while same store revenue was generally in line with our expectations for the quarter. We did have higher than expected bad debt expense. The bad debt increase was primarily driven by lower collections from auctions in other words, our customers' ability.
To pay for storage doesn't appear to have changed as much as an auction buyers' willingness to pay for auction goods.
We experienced outsized year over year growth in most of our expense line items and I think some additional detail may provide helpful context in.
In the third quarter of 2021, we had same store payroll expense of negative, 9% and property tax growth of negative four 5%, which drove total Q3 2021 expense growth of negative 4%.
If we evaluate our third quarter expenses on a two year stack average payroll expense growth was approximately five 2% average property tax expense growth was three one and total and average total annual same store expense grew four 2% a year.
Turning to the balance sheet.
During the quarter, we completed an auction and accordion transaction in our credit facility, adding $600 million of unsecured debt across two tranches, we capitalized the storage express transaction with a $125 million in op units at an average price per share of $201 84.
With the remainder drawn on the revolving credit facility.
This resulted in a net debt to EBITDA at four six times at the end of the quarter without the benefit of the additional EBITDA from storage express given the late quarter close.
The revolver draws caused our variable rate debt to exceed our typical range of 20% to 30% of total debt at quarter end sub.
Subsequent to the end of the quarter, we swapped $200 million of our variable rate debt to reduce our floating interest rate exposure to approximately 35%. Additionally, our bridge loan balances provide a hedge against increases in variable rate debt effectively reducing the percentage to approximately 31% of total debt.
We will continue to take steps to reduce our variable rate debt further.
Our commitment to the investment grade bond market has not changed and we expect to utilize this market again once conditions normalize.
As Joe mentioned, we tightened our 2022 guidance given the outsized growth in unique customer trends, we have experienced over the past two years, we've had a wider than normal guidance range throughout the year to capture all of the different scenarios that we believe where possible as.
As we move through the fall the moderation has been more pronounced than we projected at the high end. However, it was also not as severe on the low end, resulting in a tightening in the tighter range.
The reduction in same store NOI guidance is partially offset by higher than expected interest income due to a larger bridge loan balances and higher interest rates as well as an expected later modification date of the next point preferred investment. We've also increased our forecast for management fees and other.
Income interest expense estimates have increased.
Has have increased due to data associated with storage express other acquisitions additional bridge loans and an increase in benchmark rates.
Our total investment activity year to date, we've increased our acquisition investment guidance to $1 65 billion, all of which is closed or under contract.
After these adjustments we have tightened our core <unk> range, which is now estimated to be between $8 30, and $8 40 per share and implied.
Increase of approximately 21% year over year.
We still anticipate <unk> <unk> of dilution from value add acquisitions as CFO stores in line with last quarter's estimate.
We're having a great year and we continue to be optimistic about our ability to maintain healthy growth in 2023, as we see storage fundamentals normalizing to historical levels.
With that operator, let's open it up for questions.
Thank you at this time, we will conduct a question and answer session. As a reminder to ask a question you will need to press star one one on your telephone and wait for your name to be announced please standby, while we compile the Q&A roster.
Our first question comes from Jeff Spector with Bank of America, Jeff Your line is open.
Great. Thank you. Good afternoon first question is on.
Just some of the comments on seasonality right.
I guess, Joe can you provide any other stats or any other details to give investors comfort that again. This is just normal seasonality, especially given you write your team.
Forecasts really well so clearly the market is somewhat surprised by.
Sure.
The.
Decrease at the top end of the guidance.
Sure.
Sure well. Thank you further complement we do normally take pride in our forecast I think it's important to understand we are in an environment, where customer behavior is very different we have no history of data about how customers react coming out of a pandemic and therefore.
<unk>.
We gave wider than normal ranges.
Because we had less confidence in.
Our ability to exactly predict how customers will perform.
What we see on fundamentals, though.
We do see slowing in in demand and rates and other metrics compared to the last six quarters or so, but if you look at pre pandemic numbers.
Things look very strong.
And we're very comfortable with.
State of the business, yes, Jeff maybe just to clarify one point the.
A slowing in demand as year over year, it's very clear that it is still as good as it was pre pandemic and very consistent with historical norms. At this time of year in terms of searches that our website calls that were receiving at the stores and our rentals on a monthly basis.
And to confirm this is.
Through October .
So what we have in October maybe just to give a bit of an update for October . Our October numbers are our occupancy is down about 30 bps from September so not significantly different from the end of September and our rates have been steady through the month of October .
Thanks, and then my second question.
Is.
Do you still stand by your comment that.
Youre, ending 22, strong, which bodes well as we enter 2003 or again to confirm are you seeing any negative sign post that would change that.
No.
Comment.
No I think if you look at our guidance range that will give you an indication of the range of where we believe we will end 2022 anywhere in that range is better than long term historical storage averages. So we still believe we're going to end the year strong in <unk>.
Set up well for 2023.
Great. Thank you.
Thank you Jeff.
Please standby for our next question.
Our next question comes from Michael Goldsmith with UBS, Michael Your line is open.
Good afternoon. Good morning, Thanks, a lot for taking our questions.
From our work your web exercises of web asking rates are street rates.
Have been down year over year through the quarter at the same time your occupancy rate, maybe hasn't had as much pressure as others. So clearly the goal here is that you are looking to maximize revenue, but how do you think about managing the pieces occupancy street rates in <unk> and <unk>.
How does your current position and strategy.
Allow you to maximize revenues kind of through this normal seasonality and into next year.
Yeah.
So your your statements are correct right, we're trying to maximize revenue by using all the tools available whether that occupancy rate discount mark getting expense days to reserve all the different levers, we can do and it's done on.
Hey.
Unit size.
In each store basis, not on a portfolio basis or market basis. So we're trying to maximize.
Revenue for whatever unit type and whatever store given the performance and data we have on that particular.
Unit type in the store when you roll all of that up together onto portfolio basis. We.
Certainly now favoring occupancy at the expense of rate. So, we're giving up a little bit of rate to have a little higher occupancy because we believe in the long term that will create the best long term revenue growth through the portfolio.
And by create long term revenue growth you mean.
Bring people and get them into the system.
And get them on the ECR program is that correct.
Certainly he cri is.
Is a very important factor there and it's also trying to attract as many longer term customers, who have a longer lifetime value than a customer who's going to going to come in maybe at a at a higher rate, but spin out after two or three months.
That's helpful. And then just my follow up question housing turnover has been under pressure for a number of different reasons do you see any impact of the housing market on your results.
Who are their increased interest from renters and then.
Does the impact of kind of housing turnover in the housing market is that does that have as much of an impact now or that have a larger impact kind of during peak leasing leasing season, when when people kind of start moving up again.
Overall.
A strong housing market is beneficial to self storage.
And we would prefer a strong housing market and a weak housing market that being said there is lots of different drivers of demand.
For storage and we see solid demand in good and bad housing markets and the Best example of that is during the great financial crisis.
As the housing market was.
<unk> in much worse shape than it is now and we didn't see any drop in demand because we had demand from other types of transitions other movements that made up for that.
This slowdown in housing transitions.
Thank you very much good luck in the fourth quarter.
Thanks, Michael.
Please standby for our next question.
Our next question comes from Todd Thomas with Keybanc Capital Markets', Todd Your line is open.
Hi, Thank you.
First I just wanted to follow up.
On the outlook.
And the re forecast here for the balance of the year can you talk about the occupancy decrease it sounded like that fell short in the third quarter relative to what you had budgeted previously.
It looked like average occupancy increased from two <unk> to <unk>, which which I think's, a typical seasonally so where was the shortfall specifically I guess, what fell short of budget and and then within the quarter. When did you start experiencing some of the softness that youre starting to say.
Yes, Todd it's Scott so.
I would tell you. It's later in the third quarter, certainly post labor day.
July and August were good for us.
Our forecast our post labor day, I think what changed is I think you saw that seasonal occupancy go back more to the norm, but what we've seen in the last two years and we've been saying this was a possibility for two years.
It came it came a little quicker than we were expecting when it did come and as a result, it impacted rates. So I think the thing that's impacted US most is the rate that we're going to charge new customers and the impact on the fourth quarter, so not necessarily occupancy, but much more new customer rate coming in and.
And a little bit of deceleration there in terms of our rate.
Okay, and then in terms of the.
Sort of heightened focus on occupancy relative to rate.
Is there still.
Are you still.
Okay.
Sort of throttling back on on move in rates in an increasing promotions in order to stimulate demand or has some of that stabilized.
So our promotions year over year were actually down slightly in the third quarter and we're not using promotions right. Now are we've used rate more as the conversion tool and our rates in October were.
Flat to slightly up from where they were in September so continues to be what we are seeing in September .
Okay. That's helpful. And then if I could just ask about storage express.
And the growth opportunity that you see by way of making acquisitions.
Through that through.
Through that platform.
What's the.
A couple of questions whats the timeframe to begin capitalizing on growth through new investments is this something that you.
We might expect to see you capitalize on in the near term.
Then as we think about that remote storage model, how much of <unk> portfolio today do you see the potential to roll that out across.
Yes.
So I would say the growth opportunity.
The external growth opportunity in store to express is not in the near term within the near term I think is.
Internal growth by getting them.
On to the extra space pricing Cri customer acquisition platform.
And we think we can improve the existing assets performance that is near term.
Until we can.
Do that get them on our platforms we won't.
<unk> pursue external growth so that's more of a second stage.
And I think that there.
There is a small number of extra space stores that.
Mostly things we run as annex is now that we may be able to improve the performance of using the storage Express model.
What may be more interesting is the ability to look at.
Modest size stores within our existing footprint that we don't really look at it now.
Okay great.
Great. Thank you.
Sure.
Please standby for the next question.
Our next question comes from one Santa <unk> with BMO capital markets. Your line is open one.
Alright. Thank you maybe just following up on Todd's question on stores Express it definitely seems like can you talk to you in your opening remarks about the strategic opportunity set.
To widen the opportunity set and maybe acquire assets that you otherwise wouldn't have.
But to what extent I guess do you way more secondary tertiary locations, where you can promote manage them and cut operating overhead do so.
Manage that against maybe a weaker demographics.
That are in place for your existing portfolio.
So.
Weaker demographics than our existing portfolio we wouldn't.
We wouldn't expect to have similar demographics in.
More secondary or tertiary markets.
We wouldn't expect to have the same rate growth, but we wouldn't expect to pay the same amount on a price per pound for the asset.
It's all about.
Proper underwriting getting compensated for the risk you're taking.
<unk>.
Uh huh.
I understand we look at our portfolio, which is about 10% in tertiary markets now we look at the performance of primary secondary tertiary market how their CAGR.
Compare over rolling 10 year periods every year, and we understand that to share markets can be more volatile, but they also can provide very good returns.
I think it's about.
Investing at the right basis.
I'm sure you're underwriting each deal properly understanding that in many of those market share the only REIT that we could be the only REIT that operates which gives you somewhat of an advantage.
The other thing I would emphasize as some of these remote assets will be in our core markets. So it's not just a tertiary market strategy. Here. This is expanding our existing footprint in what we kind of operate today as an annex and then running those much more efficiently.
And then just.
Any comments on supply I mean, I would assume that you seem to delivery delays this year and maybe the.
Whats coming on next year may be coming down as well, but just your view again going back to storage expressed between what the pipeline looks like and some of the secondary or tertiary markets that have been.
Arguably some of the hottest housing markets in some cases, and maybe getting outsized attention relative to history.
Now that risk reward is between the primary versus secondary and tertiary supply perspective.
Yes.
The first part of the question overall.
Yes.
Don't have any new information or data review is still that.
Storage deliveries are moderating not going to zero not dropping off the cliff, but they are moderating that theyre continuing headwinds in terms of costs and interest rates and entitlement issues and the availability of debt and thats going to be good for the industry.
We have not done a.
We study supply in the markets that we're active we have not yet done.
Tertiary markets supply analysis.
We're just not at that stage, yet when we're ready to start growing this platform, we'll find the right markets will have our guys do all the research they always do and we'll make sure we understand all the dynamics of the market before we put our investors' dollars into that market.
Great and if I can sneak in one quick one on the.
Third quarter, new customer right.
How did that trend throughout the quarter and if you could just give us the year over year changes software.
Hello.
Steve.
What changed kind of at what pace throughout the third quarter.
So in July we saw rates down about seven our achieved rates. This is achieved rates on new rentals. They were down about 7%, 8% in August and then low double digits in September . So we averaged about negative just about 10% negative in the third quarter.
Thanks, guys.
Yes.
Thanks Juan.
Please standby for our next question.
Our next question comes from Spenser <unk> with Green Street. Your line is open.
Thank you.
Back to the topic of demand for a second so you mentioned that demand is roughly in line with pre COVID-19 levels.
That work from home or the de Cluttering cohort, it's a relatively new demand driver for the sector.
This would seem to imply that the other more traditional demand drivers are contributing less than average am I thinking about that the right way.
So.
The kind of work from home deep cluttering demand.
That was more of the.
2020.
Summer 2020 to 2021, maybe.
Experience, we are back to more today, we're back to more traditional demand drivers for new demand.
For new demand correct, yes, but I'm just thinking so as we go I'm just looking at occupancy right across the sector.
We're starting to see occupancy returns.
Closer to the historic average that we've seen within the REIT portfolios.
For some time.
That would seem to suggest that that work from home.
Justin.
Decided to recall or their house right. So I understand that it may not be contributing to new demand, but as we think about where occupancy is trending.
There is arguably a new user base right within your portfolio. So I'm just wondering how you guys kind of think about the different demand stool Lagos.
Currently.
I think youre only partially right I think some of those worked from home folks have stopped using storage, but I think there is a cohort of them that continues to use storage and you can see that in our length of stay statistics, where during COVID-19 we have.
Had a.
Sharp increase in customers in our stores, who had been with us for more than a year more than two years lately, we've seen that decline a little bit, but we're still above historic averages. So that is telling us that some of those customers.
Just like some of every customer that comes in some small percentage of them.
That kind of terminate or quasi permanent customer and I think that happened during COVID-19 as well.
Yes.
That's what I'm, saying I guess, what I'm, saying is I think we're seeing the same thing so that it <unk>.
Portion of that new customer base rate work from home.
In Spain, which I think most of US would agree that that's the case then my point is that we shouldn't see occupancy fall back to the historic average, but shouldnt be somewhat elevated and I was just.
Curious if you either agree that moving forward.
Occupancy would be perhaps slightly higher than your historic average because of that new cohort using your facilities.
Sorry, if I misunderstood, but you are saying good I'm glad we're on the same page. So I think we can operate our stores or whatever occupancy we want great. We can we can adjust the other metrics to get there.
But I do agree with you I think we learned during COVID-19 that we.
We can.
Maximize revenue by operating stores at incrementally higher occupancy than we have historically.
Great. Thank you guys.
Sure. Thanks.
Please standby for the next question.
Our next question comes from Smedes Rose with Citi. Your line is open.
Hi, Thanks.
I just wanted to ask you a little more and I'm, sorry, maybe I misunderstood this but in your core <unk> you added back.
<unk> expense associated primarily with hurricane and uptick in tenant reinsurance.
Are the claims will you in turn get paid back for those claims or.
Is that sort of add back to get to your core.
Basically a claim on those earnings and you won't be recouping them I, just wanted to understand that a little bit better.
So $3 million of that is losses from tenant reinsurance. So those are claims made by our customers that will be paying out we're not getting it back we add it back because we don't think it's part of the core number and again, that's an estimate based on the data. We had obviously all of those claims have not been filed people are still kind of digging out down there.
The other piece of the loss of $3 2 million that is for property loss and our loss number is actually higher than that because that is net of the estimated tenant that <unk>.
Property insurance proceeds that we think we will receive.
And again those numbers have been best guess today.
Go ahead, I guess I mean, why would you include the I guess the profit from the tenant reinsurance program, but you wouldn't include.
The subsequent claims from that piece of business I mean isn't that just part of your business I mean, it's unusual rate and just I don't really get to add back.
Portion.
Just we didn't view it as core we didn't view it we viewed it as nonrecurring much more one time is the way we viewed it.
Okay, and then you talked about leverage being like a little skewed just because you have capitalized the storage express transaction.
But we don't have the earnings from that have you guys talked about what you expect the first serious contribution to be on that acquisition.
We haven't publicly we've said that it was a market cap rate, but going in was going to be lower we felt like it would stabilize around a six.
The first year, obviously lower than that but stabilizing around six.
And that and as that stabilization timeframe like two to three years or what's the.
Typical yet.
Two and three years.
It's an interesting one conceptually for me to try to understand yield right because what we're doing is taking the cost for an entire business platform.
Software people trucks, and office building et cetera et cetera.
Saying.
The existing stores produced a return on all of that and obviously, we didn't buy it for that we bought it for strategic region because that platform can produce what we believe is future growth for us. So that's how we came up with those numbers I wouldn't compare it to the acquisition of a building that.
Produces.
Yield we're because we're really buying more than just 100 607 buildings.
Okay. Thank you.
Sure. Thanks.
Yes.
Please standby for the next question.
Our next question comes from Samir Khanal with Evercore Sameer Your line is open.
Thank you.
I'm sorry, if I missed this but maybe talk about sort of changes in average length of stay that you may be seeing at this point here as we think about.
The ability to push rates on to their existing.
Existing customers.
Yes, we saw similar to what I think most storage operator saw and that is our average length of stay has gotten longer.
If you look at our tenants in our properties today.
35 ish 34, 35 months in terms of customers that are in there today. If you look at the tenants that have been in our properties over two years that number continues to grow.
<unk> of 60% so people continue to stay longer.
Okay got it.
Shifting to the.
I don't think we've talked about the transaction market, but maybe talk about sort of a levered IRR.
<unk> targets.
<unk> targets and how much maybe cap rates have moved.
Given higher interest rates.
So the transaction market has certainly changed.
Cap rates are expanding as interest rates rise, which is natural.
Fewer participants, we see lots and lots of deals that are not getting closed.
Including us.
Walk from over $526 million of deals that we had under LOI based on what we thought new pricing should be.
I don't think Theres really any way to say with any precision what new cap rates or how much cap rates have expanded.
It's very deal dependent you need to wait for a lot of transaction just not occurring.
We need to wait and see how it shakes out but.
Certainly the direction is clear.
Okay. Thank you.
Yeah.
Thank you Sir.
As a reminder, if you need to ask a question press star one one on your telephone.
Please hold for our next question.
Our next question comes from Ronald Camden with Morgan Stanley Ronald Your line is open.
Two quick ones.
You talked about sort of the pricing achieved pricing.
And <unk> and so far just with helpful. I'll have to move over to sort of the ECR I. Maybe can you comment on what you guys are seeing there are you still pushing it as aggressively of yours historically, what the tenant feedback has been.
So.
Covid and the restrictions the states put on.
Our ability to increase rents.
Coupled with the rise in street rates created that unusual situation of an extra large gap between what street rates were and what people are paying.
And we have largely made up that gap.
We will not see while we still will see.
Attractive ECR Ray.
Going forward, we're not going to see those outsized.
Increases that we experienced over the last.
Last year or so.
Great. That's helpful and then gone back.
Sorry did I cut you off.
No not at all.
<unk> gone back to the guidance.
Your opening comments.
I think you've talked about sort of the ranges bear case off the table Bull case off the table, but just sort of wondering because it's pretty unusual for you guys to do that what what changed over the past three months and so forth was there anything specific that caused the bull case to be off the table just just trying to figure.
What changed when you're redoing the numbers a little bit more color there would be helpful.
And I think Scott referenced earlier that after labor day, we saw.
Somewhat of a change in customer behavior, and a return to seasonality in our kind of a wider than normal guidance.
At.
At the top end at the bottom and had different assumptions about where that will occur and now that we've seen it begin to occur we can narrow that guidance with more comfort that we know how customers are behaving.
Great. That's it for me thank you.
Thanks, Ron.
At this time I would now like to turn it back to Joe Margolis CEO for closing remarks.
Thank you and thank you everyone for your time today your interest in extra space, if I could could leave you with a couple of thoughts. It's that 2022 is going to be another exceptional year even with.
Slowing growth in rates and very difficult comps revenue growth is very strong and we expect it to be solid in 2023 as well storage is better positioned than most if not all asset classes to endure future inflation or recession or what.
Type of economic slowdown we face so we are.
Very excited and confident heading into the future. Thank you very much.
Thank you for your participation in today's conference. This does conclude the program you may now disconnect.
The conference will begin shortly.
As Johan during Q&A, you can dial star one one.
[music].
Yeah.
Okay.
[music].
Okay.