Monday Morning Quarterback (03/01/2021)

March 1, 2021

SELF-STORAGE

Unseasonably High Occupancy

Across the board, all five self-storage REITs beat consensus estimates on the top and bottom line. Same-store (SS) revenues were driven primarily by unseasonably-high occupancy rates (historically, occupancy dips in the winter and rises into the summer) and growth in street rates. Due to the strict COVID business restrictions in some states, such as California, some self-storage owners were not and are still not allowed to raise rates on existing tenants nor auction off delinquent units. In response, the self-storage REITs focused on occupancy growth, rather than rental rates, to power top-line growth. In 2H20, Extra Space (EXR) hit record-high occupancy rates, ending 2020 at 94.8%. The combination of pandemic-related moratoriums and multiple counter-cyclical demands (discussed later in this report) have shortened lease-up periods for self-storage facilities, according to Public Storage (PSA) and CubeSmart (CUBE). Occupancy levels should return to normal in the back-half of 2021, assuming the pandemic’s diminished effects by then.

Top-Line Growth

4Q20 SS revenues blew through consensus estimates for each self-storage REIT. Life Storage (LSI) and National Storage Associates (NSA) led the group with SS revenue growth of 4.9% and 4.8%, respectively. PSA, the laggard of the group, reported a meager 80 bps growth, likely a consequence of its portfolio’s exposure to primary, urban markets, which have had the most stringent COVID-related business restrictions. While major MSAs tend to outperform secondary and tertiary markets during periods of strong economic growth, they are also the most vulnerable during downturns.

Same-Store NOI Growth

During the final quarter of 2020, LSI and NSA also led competitors in SS NOI growth of 6.8% and 6.1%, respectively. While all five self-storage REITs outperformed consensus, LSI and NSA saw the most significant growth due to its portfolio’s composition of mostly non-primary markets. Unsurprisingly, Public Storage also had the weakest SS NOI growth (+1.3% y/y) of the group, partly due to its concentration in primary markets. Looking ahead, the self-storage REITs, excluding PSA, who did not provide 2021 guidance, are all projecting at least 4% in SS-NOI growth for 2021. One considerable headwind to these forecasts is higher real estate taxes. NSA raised its 2021 guidance for RE taxes from a midpoint of 4.25% to 5.5%. EXR and NSA also have projected similar growth in taxes, with Life Storage projecting the highest increase (+7%) for this year. On account of higher taxes and delinquencies from debt, many sellers are coming to market with some level of reluctance to continue operating a self-storage business during these uncertain times. Interestingly, NSA reported that most institutional investors are becoming increasingly concerned with tax reform, while this issue has not been as big of a focus for “Mom & Pop” investors.

4Q20 and FY20 Transactions

During 4Q20, all five self-storage REITs expanded their year-over-year acquisition volume by double or more, collectively hitting nearly $1.7 billion in asset purchases. Compared to the same period in 2019, facility purchases skyrocketed by over four-fold, led by CubeSmart (CUBE) with $661 million in transaction volume, 10-times higher, year-over-year (y/y). Despite negative external growth in the three quarters preceding 4Q20, last year’s cumulative asset purchases jumped by 65% y/y, hitting $2.9 billion. With CUBE’s massive $540 million, eight-facility portfolio acquisition from Storage Deluxe, CUBE ended the year with $736 million in new assets. The amount the self-storage company spent on new property purchases for the full year nearly surpassed Public Storage’s (PSA) acquisitions of $796 million, despite being less than a fifth of PSA’s market capitalization.

2021 Acquisition Guidance

Looking ahead, cumulative 2021 external growth guidance for the self-storage REITs, excluding PSA (the company does not give guidance, but it already has $580 million in facilities under contract, after year-end), amounts to over $2 billion. After showcasing its economic resilience in 2020, the self-storage industry has been picking up in popularity, particularly with institutional investors such as Blackstone, who bought Simply Self Storage for $1.2 billion last October. In 2021, self-storage transactions will continue to benefit from high demand and favorable capital costs (implied cap rates of mid-4%). Nearly All MSA’s have seen cap rates decline by 100 bps from pre-pandemic levels, as self-storage fundamentals surpassed consensus expectations on both the top and bottom-line. With the industry’s proven resiliency, 4Q20 strong earnings results will probably result in further demand and capital chasing, elevating valuations further. However, with the flurry of recent transactions, there is an increased probability the industry could “suffer from success,” encouraging developers to add to an already backed-up, new supply pipeline.

Self-Storage Supply

Supply headwinds are a significant issue that each REIT mentioned on their earnings call. With most of its portfolio in primary markets, PSA will endure more supply pressure than its competitors, particularly in New York, Texas, and parts of Florida. Alternatively, National Storage Associates’ (NSA’s) facilities—predominately located in secondary or tertiary markets—completions have started to trend down, partly due to a rise in abandoned projects. According to NSA, 2021 supply headwinds will be formidable in Portland, Phoenix, West Florida, and Dallas. By year-end, new deliveries should amount to $3.5 billion+ nationally. In 2022, the supply pipeline is expected to drop noticeably, potentially creating a multi-year cycle of outperformance before developers realize it. By 2025, new deliveries will likely ramp up again.

With the pandemic’s spread deteriorating, nobody is sure which self-storage demand drivers will be permanent and which will be short-lived. The first factor to go as we enter a post-COVID world will likely be remote learning, particularly for grade-school children. As herd immunity grows, we expect a rapid return to schools and a drop in college students’ need for self-storage.

Self-Storage Demand

However, several demand drivers will likely remain after the pandemic and into a ‘new normal’ – the most significant being the recent trend toward working from home (WFH). During the pandemic, many adults began working remotely, and in some cases, work from the same space as their children. Because of this, many homeowners and apartment dwellers have had to convert a room into an office space, requiring extra storage space. Another significant driver of industry demand has been the booming housing market. Self-storage benefits from these transactions as homeowners need their furniture and other items stored between selling their house and moving into the next.

U.S. ECONOMY

10-Year Treasury Yield

On Thursday, the yield on 10-year U.S. Treasury’s briefly rose to a one-year high of 1.61%, before pulling back to 1.41%, as of Friday’s close. A month ago, the 10-year was yielding around 1.1%, and only two months ago, it ended 2020 sub-1%, while the year-to-date (YTD) rose by over 30 bps, a swift move for Treasury’s relative to historically low yields. The rapid rise in rates has unnerved some investors, who fear that the growth has not been from elevated economic activity but inflation.

Inflation concerns

Historically, long-term interest rates have increased during an economic recovery and should eventually return to pre-COVID levels. Although January consumer prices only grew by 1.4% y/y, recent indicators of service sector prices, retail sales, and durable goods purchases have exhibited inflation in the pipeline. During his testimony to Congress last week, Fed Chair Powell downplayed the chance of troublesome inflation. While a “surge in spending as the economy reopens” would certainly drive prices higher in the near-term, Mr. Powell reiterated that any growth in inflation would be short-lived and not “a persistent longer-term force.”

GDP estimates

Last week, the Bureau of Economic Analysis reported a +10 bps increase to its 4Q20 GDP estimate (4.1%). Upward revisions were made to private inventory investment, state and local government expenditures, and residential fixed investment, all partially offset by a downward revision to PCE (personal consumption expenditures). Following a month of solid economic reports, Morgan Stanley lifted its 1Q21 GDP growth estimate from an annualized rate of 7.3% to 8.1%.

Chart of Real GDP: Percent change from preceding quarter

Economic Calendar

February will likely show ongoing strength in economic activity. On Monday, the Institute of Supply Management (ISM) will release February’s Manufacturing ISM Report. On Wednesday, ISM will release the Services ISM report. SkyView expects new orders to pick up, employment growth, and increased input price pressures in both surveys. On Friday, the U.S. Labor Department will release non-farm payrolls for February. We expect a return of job growth after the soft patch in the fourth quarter and January. However, seasonal noise may obscure the unemployment figure.

COVID Update

New COVID cases remained under 500,000 for the second consecutive week. However, new cases lifted slightly on a w/w basis of 2%. From February 1-27, new COVID cases fell 58% compared to the same period in January – a significant decline. Last week, pandemic casualties broke above 500,000, ending the week at 512,000. Nonetheless, COVID deaths in February declined by 20%.

Chart of New Coronavirus Cases Reported per Day

Chart of New Reported Coronavirus Deaths per Day