Changing Of The Guard

Posted by msmessenger on Jan 1, 2017 12:00:00 AM

A Transition To New Leadership

When Spencer Kirk joined Extra Space Storage in 1998 following a hugely successful stint in the high-technology world, self-storage must have seemed like a sleepy industry that was impervious to the rapidly changing world of technology.

Actually, that’s exactly how Kirk described his initial impression of the industry in a Mini-Storage Messenger article he authored in 2013. After all, Kirk lived life in the high-tech fast lane, where he co-founded Megahertz Corporation in 1985, which became the largest manufacturer of modems for laptop computers in the world. Megahertz went public in 1993 and was acquired by US Robotics two years later.

When Extra Space founder Ken Wooley approached him to join his expanding company, Kirk’s reaction was, “I was certain that I did not want to go from the world of high-tech to a world of no tech.”

That all changed when he joined the Salt Lake City real estate investment trust and implemented an innovative technology program that helped move a resistant industry into the 21st century.

Extra Space designed a cloud-based system that would connect the company’s point-of sale-system with its call center in real time. The system gives sales agents real-time information on availability, pricing, and customer history on a single screen.

Technology lets Extra Space capture big data about individuals to better understand customer behavior and preferences. As a result, offerings can be tailored to meet the unique needs of similar customers and predict which prices, discounts, and special offers are likely to lead to more sales.

The use of technology has helped propel Extra Space Storage to the second largest operator of self-storage facilities in the U.S., with over 1,400 properties in 38 states, Washington, D.C., and Puerto Rico. And now, even smaller self-storage operators can employ the Internet and advanced software to attract new customers and efficiently manage rates and inventory.

In With The New

As the new year begins, Extra Space is transitioning to a new CEO. Kirk has stepped down, and Joseph Margolis has assumed the top position. Kirk, who has been in the CEO position since 2009, will remain on the company’s board of directors and focus his attention on Kirk Humanitarian, a non-profit foundation.

Margolis, former chief investment officer and executive vice president, has held a position on the REIT’s board since 2005. Prior to becoming CIO in 2015, Margolis served as senior managing director and partner at Penzance Properties, an owner, operator, and developer of office properties in the Washington, D.C., metro area. A graduate of Harvard College and Columbia University School of Law, he also held positions at Prudential Real Estate Investors and Prudential Insurance for 16 years.

“Joe has been an integral part of our growth, evolution, and strategy for more than 18 years,” Kirk says. “He was instrumental in creating our first joint venture with Prudential, and he was on our board of directors for 10 years. He has strong real estate expertise, which clearly is important. However, what sets him apart are vision, leadership ability, and understanding of the culture of Extra Space.”

At least initially, Margolis is approaching the CEO’s job with a philosophy of, “If it ain’t broke, don’t fix it.”

“I’m lucky in that I’m taking over a company that is running really well now,” Margolis acknowledges. “We have a very experienced management team that has worked together for a long time. My main job is to keep the machinery running and focusing on what we’ve been focusing on for the past 15 years: a focus on property operations, technology, accretive acquisitions, growing the company, optimizing the balance sheet, and attracting and retaining great people.”

Technology Impacts Performance

Part of that machinery involves a heavy reliance on technology. Approximately 80 percent of the REIT’s customers interact online before completing a transaction.

Extra Space recognized in recent years that many more customers made decisions on the go, so the company redirected more funds on developing a better mobile device experience. As a result, more than half of consumers now find Extra Space through mobile search, according to the company’s 2015 Annual Report.

“We’ve just seen the lines cross where more people come from mobile than from laptops,” Margolis reports. “Now mobile is absolutely growing faster than the laptop.”

Just a few years ago, Extra Space Storage allocated the majority of its marketing budget to print ads. In 2015, 35 percent of its budget went into mobile, according to a Google report.

Aided by sophisticated data analytics, the company developed individual customer profiles by gathering background information from the U.S. Census, Google AdWords, and other sources. Extra Space now has the ability to offer customers real-time promotions optimized for them individually. Google says customers visiting Extra Space’s mobile site are given a unique click-to-call number, so the call center can tailor an appropriate response to the specific individual.

This focus led to 67 percent growth in mobile searches and ultimately a 53 percent increase in conversions from mobile calls.

“Spencer brought a focus on technology to Extra Space as early as 1998, and he believed the way to build and grow the company and develop and maintain competitive advantages is through technology,” Margolis says. “It corresponds with the rise of the Internet and the impact that’s had on our business, and it accounts for part of the outperformance we’ve been able to put up over the years.”

That performance was reflected in the REIT’s third-quarter report, which stated a 24.3 percent increase in funds from operations (FFO) as compared to the first nine months in 2015. This marked Extra Space’s 24th consecutive quarter of double-digit FFO growth.

Same-store revenue increased by 7.5 percent compared to the same period in 2015. Revenues for the first three quarters of 2016 increased due to higher rental rates for both new and existing customers.

Same-store occupancy stood at a robust 93 percent in September.

In 2015, Extra Space expanded its footprint by 24 percent, fueled largely by the acquisition of SmartStop Self Storage for $1.3 billion. This transaction added 122 wholly-owned stores and 43 managed stores to the REIT’s portfolio. The SmartStop portfolio gives the REIT a large footprint in California markets.

The company acquired another 51 stores during the year for approximately $450 million, bringing the total value of 2015 acquisitions to $1.8 billion.

During the first nine months of 2016, Extra Space acquired another 67 operating stores and five stores at completion of construction for $765.9 million. The REIT acquired seven stores at completion of construction with joint venture partners for an additional $131.5 million.

As of Sept. 30, the company had 611 stores under management, making it the largest self-storage management company in the United States. This platform not only generates management fees, but also is a valuable pipeline for future acquisitions.

As a result of the company’s significant growth and strong performance, Extra Space Storage became a member of the S&P 500 last year.

Stock Slide

While Extra Space’s financial reports generally have been upbeat recently, the company’s performance on Wall Street has been downright gloomy. Extra Space’s stock price—along with the other self-storage REITs—steadily declined over the summer and into the fall.

Extra Space’s stock price fell more than $20 a share between early June and late November, a decline of more than 23 percent.

It’s not entirely clear why self-storage lost some of its luster during 2016. Just a year earlier, storage REITs were considered the darlings of Wall Street because of their steady—if not spectacular—financial performance.

“We try to focus on what we can control and deliver the best FFO to our shareholders, and Wall Street does what it does,” Margolis says. “It was frustrating for us. We delivered 26 percent FFO YOY (year-over-year) growth and our stock went down 7.5 percent on the day we made the announcement. That’s difficult to understand.”

Margolis points out that Wall Street is concerned about the trend line of revenue growth in the industry. The storage REITs have been growing revenue at unusual rates, but it can’t go on indefinitely. “Real estate doesn’t grow by double digit rates forever, and it’s going to revert to more of a historical mean in revenue growth,” he says. “Wall Street reacted to the decrease in revenue growth and needs to see that it’s going to flatten out and maybe then they’ll have more faith in our stocks.”

Self-storage may be a victim of its own success. Some analysts believe the self-storage REIT sector has become pricey after delivering record returns for investors during the past two years. In addition, some investors question whether the current level of success can be sustained.

“Despite the tremendous performance of self-storage stocks the last few decades, there are some concerns about whether such a high occupancy rate can be sustained,” cautions Lawrence Hamtil of Fortune Financial Advisors, a wealth management company located in Overland Park, Kan. “Occupancy rates are much higher than they were in the first part of this century. Doubtless, the market could get overbuilt and saturated.”

The Orlando Sentinel notes there are more self-storage facilities in the U.S. than Starbucks and McDonald’s locations combined. Should consumer behavior begin to change and Americans learn to part ways with the stuff they seldom use but pay to store, then these facilities may face declining occupancy rates in the years ahead.

Others, however, like the sector’s fundamentals and believe investors will continue to be rewarded. “It is a widely-held belief by many industry experts and REIT management teams that self-storage still enjoys favorable supply/demand fundamentals in most markets,” says Seeking Alpha, a platform for investment research. “The industry continues to be fragmented with many small operators and is ripe for further consolidation.”

Seeking Alpha notes that Extra Space has been the top-performing REIT in any asset class over the past 10 years, with more than 800 percent price appreciation. Extra’s 2015 Annual Report says the company’s performance has increased shareholder value more than any self-storage company over the past decade. What’s more, the one-year, two-year, three-year, four-year, five-year, and 10-year total returns to shareholders were the highest among publicly traded U.S. REITs across all asset classes at the end of 2015.

“Extra Space Storage is pricey for a reason,” Seeking Alpha says. “It is the real deal when it comes to accretive self-storage growth, dividend growth, and total return track record. However, investors are going to have to pay up for growth in order to participate in the next decade of strong returns.”

Prospects For Future Growth

As a resident of a fragmented industry, Extra Space still has lots of room to grow through acquisitions.

“The large public companies own between 15 percent and 20 percent of the stores in the country. That tells you there’s still plenty of acquisition opportunities,” Margolis says. “We have great access to capital. We still can continue to grow. The only caution I would put on that is we’re not trying to grow for growth sake; we don’t want to achieve some number of stores or some growth target just to get big. If we can’t grow in an accretive manner, then we’ll temper our growth.”

The prospects for surging self-storage demand in the future is a question that’s up for debate. Margolis estimates demand has grown by 50 percent since 1998, but there’s no way of knowing if it’s going to keep growing at that pace. But Margolis is confident demand will continue upward.

“We don’t see any reason why product awareness and increased use of self-storage can’t continue to grow,” Margolis says.

Recent economic conditions have created favorable “tailwinds” for self-storage, but the question remains, can the good times be sustained?

“These tailwinds have helped propel operators to all-time highs in occupancy, revenue growth, and profitability,” Kirk says. “Some of those tailwinds will not be as strong as we begin to see more new supply come into the market and gradual interest rate increases. However, we are just scratching the surface when it comes to implementing technology into the storage industry. There is significant opportunity to increase efficiency in operations and customer acquisition through the use of technology and data analytics.”

Self-storage fundamentals remain strong and most experts see a promising future, especially for the REITs. But will the growth of the storage industry take smaller operators along for the ride?

“Storage is a fragmented industry, and smaller operators can certainly still succeed if they are well-positioned within their micro-market,” Kirk observes. “However, in an environment that is becoming increasingly competitive, it will be more difficult for smaller operators to thrive.”

Large operators like Extra Space continue to dominate the Web as they take more than their fair share of new customers.

“The advantages the big players have is going to get wider and wider,” Margolis says. “The Internet was supposed to be the great equalizer and in this industry; it’s turned out to be the great divider, and that trend is going to continue. You can still be very successful being a small self-storage operator, but over time you will be less competitive with the large, sophisticated operator.”

One way smaller operators may be able to remain competitive is to align themselves with a REIT through a third-party management program. “This allows them to benefit from the most sophisticated operating platforms in the industry, while retaining ownership of their property,” Kirk says. “They can profit from the experience of companies who operate hundreds of locations in markets across the country, which will increase both their income and their property value.”

Extra Space Storage appears to be well-positioned for whatever headwinds or tailwinds are thrown in the REIT’s direction. Outgoing CEO Kirk has played a key role in guiding the organization through turbulent waters and calm seas alike for nearly two decades. As he passes the helm to his successor, he sees a bright horizon for the company.

“It has been a privilege to have been a part of the company’s evolution over the last 18 years,” Kirk says. “I am proud of our accomplishments, and am confident that the best years for Extra Space Storage are before us—not behind us.”

Margolis admits he has big shoes to fill as he looks forward to the challenges and opportunities ahead. “I’m stepping into gigantic shoes to fill,” he says. “This transition is one of continuity. Extra Space’s success is due to the team we have here in place and now we’re going to continue with business as usual.”

David Lucas is a freelance writer based in Phoenix, Arizona. He is a frequent contributor to all of MiniCo’s publications.