Benzinga.com, savvy investors seeking the Holy Grail of growth and income hitched their wagons to the rising star of self-storage for the past two years. This demand has resulted in excellent returns, but somewhat frothy valuations based upon price to FFO (funds from operations) multiples, a key REIT metric.
During trading on October 14, Extra Space Storage, Inc (NYSE: EXR), Sovran Self Storage Inc (NYSE: SSS) and CubeSmart (NYSE: CUBE) all hit 52-week highs, while industry stalwart Public Storage (NYSE: PSA) continues to perform steadily for blue chip investors. Related Link: U.S. Industrial REITs: An Island Of Strength Within A Sea Of Red Ink
Timely Analyst Coverage
On October 14, Jefferies initiated coverage of most of these companies. Jefferies started CubeSmart at a Buy with a price target of $23, or ~20.6 percent above the previous close of $19.03 per share. During interday trading on October 14, CubeSmart shares rose to a 52-week high of $19.73, and closed up 3.15 percent for the day. After the bell, CubeSmart announced a 6.5-million share secondary offering, which resulted in the stock giving back the day’s gains in after-hours trading. Jefferies initiated Sovran Self Storage with a similarly bullish Buy rating and $89 price target, a 12.4 percent upside from the previous day close of $79.16 per share. Jefferies initiated Public Storage with a Hold rating and a $181 price target, a 7.5-percent increase from the previous day close of $168.31 per share. Jefferies Group had upgraded Extra Space Storage to a Buy on September 17, with a price target of $57, an 11.3-percent increase from the previous day close of $51.20 per share.
Self-Storage Supply And Demand
Since the Great Recession there have been relatively few new self-storage facilities constructed in the U.S. During a recent ISI Conference panel, Extra Space CEO Spencer Kirk characterized it as “a muted supply.” He elaborated that during the 2003 to 2007 time period there were ~2,600 storage facilities built each year. The self-storage industry is quite fragmented, with many mom and pop operators. Extra Space no longer develops new projects but was formerly the largest developer, accounting for only 15 new projects out of 2,600. Today it is estimated that there are more than 50,000 self-storage locations in the U.S., with only 300 to 700 being built.
Why So Few?
It typically can take from three to four years to lease a brand new facility to the point of stabilized occupancy of 80 percent or greater. Small local developers who historically had accounted for the vast majority of the newly constructed projects now face some significant headwinds, including:
Bank loans are difficult to come by, partially due to the long period of negative returns prior to stabilization of a property. There is no such thing as “pre-leasing” in the self-storage business.
Lending standards have tightened, which has resulted in less favorable terms for private developers who are able to get an acquisition and development loan.
The price of land has increased as the economy has improved.
Yellow Page advertising and drive-by traffic are no longer the primary means of marketing self-storage. The large public operators have sophisticated call-centers, spend millions on paid Google search, and can reach customers effectively on their mobile devices. The game has changed, with smaller operators effectively being forced to pay a 6 percent third party management fee to a national brand and give up the insurance proceeds to the operator as well.
Why Self-Storage REITs Make Sense
Self-storage demand drivers are not nearly as correlated to the health of the economy compared to many other REIT sectors such as office, retail, and lodging. However, in a similar fashion to hotels, self-storage can change pricing on a daily basis to respond to changes in occupancy and local market conditions. Assuming a facility is well located, demand has historically been a function of life changing events: marriage/divorce, death/birth, upsize or downsize in residence, both going to and returning from college, etc. Historically, approximately 80 percent of customers are consumers, while 20 percent of revenue is from businesses. On average, 6 to 7 percent of customers turn over per month. Not being locked into long-term leases helps self-storage REITs maintain leasing spreads between monthly rental income and the cost of capital — helping to offset the tendency for REIT shares to fall when 10-year Treasury Note rates are expected to rise.
Tale of the Tape
Based upon information provided by MLV Research for the week ended October 10, the REIT Industry is trading in the range of 17.1x 2014E and 15.9x 2015E funds from operations.
By way of comparison, the self-storage REIT sector trades at higher multiples, with $29 billion market cap Public Storage and $6.2 billion Extra Space Storage trading at premium valuations compared with $2.8 billion CubeSmart and $2.6 billion Sovran. Public Storage has a fortress balance sheet and an A investment grade rating; Extra Space Storage leads the sector in third party management and JV’s, which provides Extra Space a source of seasoned properties to fuel future growth. Read more: