Extra Space Storage Inc. Q3 2009 Earnings Call Transcript

Extra Space Storage Inc. (NYSE:EXR) Q3 2009 Earnings Call November 3, 2009 1:00 PM ET

Executives

Spencer Kirk – President
Kent Christensen – EVP & CFO
Karl Haas – EVP & COO
James Overturf – Director Risk Management

Analysts

David Toti - Citigroup
Christy McElroy - UBS Securities
Todd Thomas – KeyBanc Capital Markets
Mike Salinsky - RBC Capital Markets
Ki Bin Kim - Macquarie Capital Market
Paul Adornato - BMO
Smedes Rose - Keefe, Bruyette & Woods
Paula Poskon - Robert W. Baird
Michael Knott - Green Street Advisors

Presentation

Operator

Greetings and welcome to the Extra Space Storage third quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. James Overturf of Extra Space Storage.

James Overturf

In addition to our press release we have also furnished unaudited supplemental financial information on our website. Please remember that managements’ prepared remarks and answers to your questions contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements address matters which are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include statements related to Extra Space Storage’s development and acquisition programs, revenues, NOI, FFO and guidance.

We encourage all of our listeners to review a more detailed discussion related to these forward-looking statements contained the company’s filings with the SEC. These forward-looking statements represent management’s estimates as of today, November 3, 2009.

Extra Space Storage assumes no obligation to update these forward-looking statements in the future because of changing market conditions or other circumstances.

I’d now like to turn the call over to Spencer Kirk.

Spencer Kirk

Hello everyone, thank you for joining us. With me today in Sault Lake City are Kent Christensen, our CFO and Karl Haas, our Chief Operating Officer. In the third quarter we earned $0.23 of FFO which was in line with our estimate. We narrowed our same store properties variance throughout Q3 as vacates decreased materially and new rentals were flat compared to last year.

Also our asking rents have come back nicely from their lows in February and March. In October positive rental activity and pricing trends have continued which is a good sign for the business and gives us a sense of guarded optimism as we finish the year and head into 2010.

Extra Space continues to be a company committed to growth. We opened eight development properties in California, Florida, and Oregon and we are on track to open seven more before year-end. These properties are an excellent source of future earnings growth for Extra Space.

Our management program, marketed S3 Plus, continues to make progress attracting third party owners to the Extra Space brand and operating platform, adding 47 properties this year with many others in the pipeline.

The addition of these development and management properties has helped us increase our scale by 10% since Q3 of last year. During the quarter we also continued to strengthen our balance sheet by closing on $114 million of secured financing.

In October we closed on another $13.1 million and we expect to close an additional $67 million by the end of the quarter for a total of $80 million in secured financing in Q4. At this time we have current cash on hand and credit line availability to repay all debt maturities through the first quarter of 2012.

I’d now like to turn the time over to Karl Haas, our COO to discuss operations in further detail.

Karl Haas

Thanks Spencer, when looking at our operational performance for the fourth quarter we see signs that our business is stabilizing where same store occupancy ended the quarter at 84.2%, which is only 1.4% below last year.

At the end of the second quarter our same store occupancy variance was 2.7%. So we were able to improve the year over year delta by 130 points and the variances continue to improve even through October.

During the quarter our same store revenue and net operating income was impacted by the low asking rates from earlier in the year. Same store revenue decreased 4.5% and net operating income decreased 6.2%.

In the past three months our same store revenue decrease though has decelerated and flattened out. Expenses were again held in check and decreased by 1.2%. Our controllable expenses notably payroll, have been consistently below last year.

Most of this reduction is due to what we call right staffing or becoming more efficient in how we staff our properties and limit our overtime hours. Our average street rate for asking price has rebounded from February and March. Though we’ve seen improvement in street rates, it will take a while for lower rates to burn through the system.

How fast they do depends on a combination of the strength in ongoing street rate, the new rental activity and the stickiness of our existing customer rate increases. We feel better where our business is now then in early August, and much, much better then we felt in April.

A couple of interesting operational data points from this year that I’d like to share. The first is a turnaround in move outs. From July, 2008 through March, 2009 vacate activity was up by 5% to 10% per month when compared to the previous year.

In April the trend reversed and has been moving lower. In Q3 move outs compared to last year were down 6.5% or approximately nine per property. Now we don’t think this is a long-term trend, that would be nice, but simply a return to more normalized levels of move out activity.

This move out trend combined with rentals holding their own continues to have a positive impact on occupancy. The second data point is our percentage delinquency and bad debts. These numbers remain at historically low levels and have decreased annually since 2007.

This experience is in stark contrast to what we’ve heard many other real estate companies discussing during the recession. A lot of this has to do with management of problem accounts but mostly its due to our customers’ financial and emotional attachment to the items they store.

The attachment that our customers hold for their items that are stored at our properties is a key element to driving length of stay as well as the ability to pass along rate increases. Now we believe that staying on top of technology and innovation is one of Extra Space’s differentiators.

Our national sales continues to improve both in the areas of call quality and the close rate. We believe there is still room for improvement but we are happy we made the move to an internal call center.

We have seen similar improvement on the internet on both paid and organic search. The major search engines are constantly changing their bidding logic and search algorithms so we have to react quickly or risk losing out on potential opportunities.

We consider the call center and the internet perfect environments in which to dynamically test pricing and marketing strategies. This testing has proved invaluable to us this year. It doesn’t make this year any less painful, but the learning will greatly enhance our ability not only to weather the remainder of this and any future downturn but to capitalize on increasing opportunities throughout the recovery.

With that I’d like to turn it over to Kent Christensen, our CFO.

Kent Christensen

Thanks Karl, in the third quarter we achieved $0.23 of FFO including $0.02 per share of development dilution. Year to date we’ve earned $0.76 of FFO. Adjusting to exclude the charge for winding down our development pipeline of $0.22 per share, the gain from debt repurchases of $0.30 per share and then adding back $0.02 from non-cash interest related to our exchangeable notes, we have earned $0.71 of adjusted FFO.

During the quarter we paid back $126 million of loans and closed seven loans equaling $114 million. Our 2009 total new financing now stands at $290 million. I’d like to recognize our treasury, finance, and legal team for all of the hard work in getting all of these loans done.

As of today we have $108 million of cash, $50 million of capacity on our undrawn credit line with Banc of America, for a total of $158 million. We anticipate closing an additional $67 million worth of loans by year end and would leave us an estimated $225 million of capacity.

We continue to put new loans on our unencumbered properties to address our remaining 2012 maturities and beyond. We currently have about 53 unencumbered wholly owned properties on which we can place loans.

The total estimated loan amount we could get on these properties is $190 million assuming the 70% loan to value in the 7.5 cap rate. Our next large maturity is $100 million CMBS loan due in August of next year. Again it is important to note that with the exception of one covenant on our undrawn $50 million line of credit with B of A, none of our debt has any corporate level covenants.

We completed eight development projects during the quarter at a total cost of $91 million. We anticipate opening another seven properties in the fourth quarter and then seven properties in 2010. Our development properties will yield $0.20 to $0.25 of incremental earnings.

As a hole, lease up activity on these properties has been in line with our historical averages though the rental rates are less then what we originally projected on many of the properties. We continue to work on the loan assumption for our Harrison Street joint venture and still anticipate this transaction getting completed in the fourth quarter.

Though acquisition opportunities are scarce at this time, our acquisitions team is keeping their pulse on the market. Due to our record of successful acquisitions, experience and financial flexibility we believe we will be able to execute when strategically attractive opportunities arise.

At this time we estimate earning between $0.19 and $0.22 for the fourth quarter and between $0.89 and $0.92 for the year. We are forecasting same store annual top line growth to be between negative three to negative four including tenant insurance.

For further assumptions on our guidance please refer to our earnings press release. And with that I’d like to turn the call back to Spencer.

Spencer Kirk

Thanks Kent, before we begin Q&A, I’d like to make a few closing comments. This year has been very challenging to say the least. Our guidance reflects our limited visibility into the future but we are starting to see stabilizing in the operating trends.

The worst case scenario that was not out of the realm of possibilities in August failed to materialize. It appears our operating fundamentals are on the mend. Through all that has happened in the previous 10 months we believe we have made the right decisions to maximize the performance of our properties, maintained financial flexibility and even grown the portfolio.

On the operation side of the business we have priced and marketed our properties to maintain occupancy and maximize revenues, we have implemented and brought to speed an industry leading call center and we have done an excellent job of controlling expenses.

On the financial front we have strengthened our balance sheet, we have repurchased debt at a discount, and we have made the difficult move of terminating our development program. And we have continued to grow our national footprint through opening best in class development properties and adding properties to our 3 Plus management program. There have been many analyst notes lately discussing the bottoming in property performance fundamentals of different REIT sectors. Though we are reluctant to call a bottom in self-storage, we are seeing signs of stabilization including a turnaround in move outs, improved rental activity and strength in pricing.

These are all positive signs for the business. The entire Extra Space team is focused on capturing every sale, being diligent on cost control and looking for ways to intelligently grow the business. We look forward optimistically to the end of 2009 and what the future holds for Extra Space and the self-storage industry.

With that, we will field any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of David Toti - Citigroup

David Toti - Citigroup

My first question relates to some of your regional concentrations and I was wondering are you seeing any trends in performance relative to stabilization as it could be connected to housing improvement or overall economic stability of the region, or is there still a pretty big disconnect between those two trends.

Karl Haas

On the negative side, there is some correlation. Certainly San Bernardino, LA, Florida, the markets where the housing is and Phoenix and Las Vegas where the housing has been a real problem, we are having, we are seeing a lot of stress in those markets and Boston and the Baltimore, DC area, New York continue to do well.

I’m not sure it’s a turnaround in housing that’s driving it one way or the other though.

David Toti - Citigroup

Can you share the terms on the construction financing, I’m not sure if I missed that.

Kent Christensen

I didn’t give any details about that. What we’re seeing on the construction financing are terms that have floors, they’re LIBOR based but generally have floors. The floors are between 5.75 and 6.5. The terms are anywhere from three to four years, three years with a one year extension.

We’re getting 65% loan to value. And the appraisals are coming in as far as establishing the cap rate, appraisals are coming in and then we’re having to negotiate what each of the individual banks as to what the cap rate might be. But we’re in the high seven’s low eight’s on cap rates, on the negotiation with banks.

There’s obviously no sells to be able to really tie appraisals to, so it’s a negotiation with the bank.

David Toti - Citigroup

And then are there any plans to push rents in the existing customer base, I know you’d sort of held off on that for a bit.

Karl Haas

Actually we have, we’ve continued to increase the existing customers all through the last, through the whole recession. We did have, we still do have some governors where if the existing customers’ rate gets too far out of line, the street rates, that we might not increase those tenants. But overall we continue to increase existing customers and as mentioned in my narrative, that we are seeing actually reduced vacates.

So we haven’t seen a negative reaction to existing customer rate increases.

Operator

Your next question comes from the line of Christy McElroy - UBS Securities

Christy McElroy - UBS Securities

Just another question on the rents, you talked about existing customer rents but I think you mentioned in your comments that you’re seeing an improvement in street rates, can you sort of quantify what happened with street asking rents in Q3 versus Q2 and what percentage of your assets would you say that you raised asking rents versus lowered them sequentially.

Karl Haas

I’m not sure I have a breakdown of what we raised. In general we raised almost everywhere. We felt that we had some opportunity, as we seen the positive move in occupancy we had felt better about being able to more our street rates up. We are being flexible as far as giving some off that rate if we need to to get the rentals.

But in general we found that we’ve been able to push the rates and continued to make occupancy gains.

Christy McElroy - UBS Securities

How much have you been able to push them by.

Karl Haas

Three to four percent.

Christy McElroy - UBS Securities

Over Q2.

Karl Haas

Yes.

Christy McElroy - UBS Securities

And then just focusing on your tenant reinsurance income, this has obviously been a growing business for you for a couple of years now since you started pushing it more proactively and it continues to have a pretty meaningful impact on your same store growth numbers, what percentage of your customers now buy insurance from you and what do you see as sort of a frictional level such that you could see a leveling off of that line.

Karl Haas

Its north of 50% and we, certainly the rate of growth has slowed down. We have north of 90% of our customers, new tenants coming in take it. But some of those people cancel out after some period of time, possibly after the first month.

And so we don’t see the rate of growth to be, we’re starting to hit, I think we’re starting to hit the stabilized rate level.

Christy McElroy - UBS Securities

You increased your guidance for the year for that line, why do you think its coming in better then expected.

Karl Haas

Because of the trends, we’ve grown it throughout the year and so we’re still well above the prior year. We just don’t see it, it’ll be above the prior year but the gap will get smaller and smaller.

Christy McElroy - UBS Securities

And then just your same store NOI guidance for the full year is for a decline of negative 4 to negative 6%, that’s a pretty wide range for an annual number given that you already have about basically 10 months under your belt, can you frame that forecast in the context of sort of best case and worst case scenarios for Q4 and what could potentially go wrong between now and year end that the bottom end of that range is a possibility.

Kent Christensen

If you look in our press release most of our numbers are rounded to whole numbers, four to six, so the negative 6% for the calendar year was a rounding of a worst case scenario from our perspective that got you to a negative six. It would be pretty dire set of circumstances that would allow us to get to a negative six which is the number that we put in our theme.

The more realistic probability is between a minus four and a minus five, rounding up to a minus six. And to get to a minus five, you’ve got to be down in the negative five for the quarter, have your expenses 3% increase for the quarter which puts you at a negative nine for the quarter and that puts you at about a little over a 5% for the year, 5.3 or 5.4.

That’s kind of our, what we envision today to be our worst case scenario and that means our expenses have to go up 3% for the quarter which right now as you’ve seen for the first nine months of the year we’ve been able to hold them pretty flat. So that reflects that we don’t know what’s going to happen with property taxes exactly and that’s our wildcard in the fourth quarter, is our property taxes.

Christy McElroy - UBS Securities

So realistically its more like a 4 to 5% decline.

Kent Christensen

That’s correct.

Operator

Your next question comes from the line of Todd Thomas – KeyBanc Capital Markets

Todd Thomas – KeyBanc Capital Markets

On the expenses you’re starting to anniversary on some of the more difficult expense comps, how much room do you think you have to cut expenses further and what areas would you focus.

Kent Christensen

You mean starting into next year or for this quarter.

Todd Thomas – KeyBanc Capital Markets

Yes going into, well this quarter and then into 2010 mostly though.

Kent Christensen

Its probably a question Karl and I’ll both answer, for this quarter we would see the continued trends that we’ve seen for the year. Obviously our property insurance costs are going to be down from what they were a year ago. Our utility costs are flat. Our payroll costs we continue to see them being down this year.

So for this, as I said in the last answer, what the wildcard is tenant property taxes and we are not aware of any, we have not been given any notifications for many of our jurisdictions of any substantial changes in property taxes. We just don’t, that could happen, and so that’s why we’re unsure as to what the property tax number will be. With that I’ll let Karl speak to what he sees happening next year.

Karl Haas

I think we’ve had especially in the last four quarters, is some very aggressive controlling of expenses. Nothing that would negatively, I think repairs and maintenance we’ve held at really normal levels. So we haven’t impacted the assets but certainly have squeezed payroll through our right staffing which we think was the right thing to do and we were in the process of doing it no matter what.

We think we, but we really don’t see a lot more opportunity to squeeze those expense dramatically. This year we’ve and year over year, we’ve really had a benefit last year we got hit hard with utilities and this year we’re back to, we’ve kind of gotten it back which is good. But I don’t see us, I think we’re down in this quarter like 8 or 9% on utilities and the year 3 or 4%.

We’re probably not going to repeat that next year. So its going to get tougher and tougher and as I said before and our way out of this is through revenue. Not going to be, there’s only so much we can do with expenses.

Todd Thomas – KeyBanc Capital Markets

And then regarding your development properties, you increased the expected dilution by about half a million for the year, and I was just wondering if you could talk about the lease up strategy at some of those properties to get them stabilized. I notice that some of the projects that were completed in 2008 they’ve increased occupancy from 2Q, and seemed to be doing well. But a number of the 2006 and 2007 developments seem to be going backwards perhaps and I was just wondering if you could talk about the different vintages and what’s going on.

Kent Christensen

Our development properties I’d have to characterize as the ones that are opening now and leasing up are all exactly the same as what has been going on for the 10 years that I’ve been in the self-storage business. We’re seeing lease ups at properties that are by far exceeding our expectations. We have a property in California that opened in Santa Clara that’s rented 250 units in four months.

But then we have properties that are way behind our expectations which is as I stated similar to what we’ve seen on the 10 years I’ve been in self-storage. We have some that go fast and some that go slow. But as I said in my prepared remarks it appears that on balance they’re all leasing up at about the same pace in total as what we’ve seen historically.

We’re not seeing any substantial change in that. The rental rates that we’re getting are down from what we had anticipated so we are charging less. So the NOI’s on these properties if they lease up at the current pace will be behind what we had originally anticipated but that reflects the current market conditions and we think that long-term we’re going to be in a really good spot on these properties because nothing else is opening up anywhere in the United States.

So once the economy does turn around, we’re going to be able to get rental increases on these properties that are probably going to outpace many of our other properties because of them being, they’re brand new properties that are in great locations and long-term I think they’re going to do very well.

So other then that I specifically talked about the different pools, it would be a property by property discussion about what’s happening but I think its better on this call just to characterize everything in general and total which is what I think what I said is, I think we’re on pace to doing on average what we’ve seen historically.

Todd Thomas – KeyBanc Capital Markets

And just lastly can you talk about some of your markets a little bit more, you say Northern California and Texas where your properties seem to be outperforming within your portfolio and do you attribute the performance to your specific assets in those markets or just the geographies in general.

Karl Haas

I don’t think it’s the assets, I think it is markets and there’s certain markets that and I don’t think we’re any different then anybody else, Phoenix, Atlanta, West Palm Beach, are certainly the worst markets and they’re definitely, the Atlanta is the one that’s kind of snuck up on us a little bit and there’s seem to be a lot of things going wrong in Atlanta right now.

But I don’t really think it relates to the assets because we have managed assets that are also struggling there. LA is a big market for us and its one that we haven’t, we don’t know that its hit bottom yet. Some of these other markets we feel like we’ve hit bottom and we’re really starting to rebound, I’m not sure, I wouldn’t bet on LA and really when you get out and Northern California you’ve got a little bit of that too, especially when you get further out in Central Valley and those areas, they’re still struggling.

The good markets, we’re really pleased with what we’re seeing in the Baltimore, DC market, Boston is going in the right direction, and kind of the whole Northeast. We’re really pleased in those markets. Hopefully that tells you what you were looking for.

Operator

Your next question comes from the line of Mike Salinsky - RBC Capital Markets

Mike Salinsky - RBC Capital Markets

I apologize if I missed this, did you mention how the portfolio performed in October.

Karl Haas

I alluded to it. We don’t want to overreact to it but we have seen sort of a bottoming out in August and September and October got better and we’re seeing, we’ve very pleased with what we saw in October.

Mike Salinsky - RBC Capital Markets

Can you maybe be a little bit more descriptive, was it rental activity picking up, was it rates stabilizing, or was it a combination.

Karl Haas

Rentals were actually positive but there’s a quirk in the months in that it had five weeks, five Saturdays this year versus four so we don’t want to get too carried away with that. But we’ve been seeing rentals being flat and vacates are continuing that same trend of being well below the prior year.

Really since April, I guess since May, we’ve had positive net rentals, that our net rentals have been improved over the prior year every single month consistently and pretty significantly and we’ve, as we’ve said earlier we bottomed out in April at about minus 3.1% negative delta in occupancy and we’re getting pretty close to being even with last year.

Its getting better.

Mike Salinsky - RBC Capital Markets

You talked a good deal about renewals, what is the mark-to-market right now on new leases signed versus out of expiring.

Karl Haas

There’s still a negative gap and there probably will be for a while. We’re more interested in making sure that we’re getting the rentals and moving occupancy and we’re going to continue to do that and at the same time we’re increasing existing customers so there’s going to be that phenomena of the existing, but the gap is closing because we’ve been able to move street rates.

Mike Salinsky - RBC Capital Markets

Any estimates as to the size of that right now, any numbers behind that.

Karl Haas

Its below what it was at the end of the second quarter.

Mike Salinsky - RBC Capital Markets

Then finally I guess more of a little bigger picture question, with the down sizing of the joint venture there can you talk about how you feel about the overall leverage of the portfolio and where you expect, whether you expect to deleverage that further or you’re comfortable with the leverage at this point.

Kent Christensen

The overall leverage right now is at a level that we think is sustainable meaning that we don’t think our balance sheet is at risk. We feel that way because of all of the loans we’ve been able to get accomplished this calendar year and one of the, what could be characterized as one of the most difficult credit environments that we’ve all seen and we’ve been able to roll our debt.

So we think that from the perspective of our balance sheet being, having a problem because of the debt that’s rolling we think we’ve taken care of that so now it’s a discussion about what the right level of debt should be.

And when we look at the different alternatives of delevering, many of those we think have a lot of negative consequences to them and so at, from a long-term perspective we would like to bring our debt level as a percentage down but we want to do that in a form and fashion that seems to make sense for the long haul and for the long-term.

So at appropriate times we’ll be taking steps to bring the debt levels down but it won’t be big chunks and it won’t be dramatic actions. Its going to be small little steps to help us bring our debt level to a smaller amount.

Mike Salinsky - RBC Capital Markets

Then finally, you’re still out of the acquisitions markets, correct.

Kent Christensen

We have not acquired, we’ve done one acquisition this year and we’ve got possibly one acquisition of a joint venture or a partner that we have that we might be buying a property but as far as third party acquisitions out on the street, we’re not seeing any activity of any distressed properties at all.

Operator

Your next question comes from the line of Ki Bin Kim - Macquarie Capital Market

Ki Bin Kim - Macquarie Capital Market

Just going back to you comments about property taxes, could you just remind us why is there some vagueness between what you expect to pay.

Kent Christensen

Generally what happens on the property taxes is that in the second half of every calendar year is when we get most of the statements from our jurisdictions as to what the property taxes are going to be and that’s when we get the notification as to actually what the number is.

Not all jurisdictions are that way but the vast majority of them come in the second half with the majority of them being in the fourth quarter. And so that’s we always are a little hesitant to say what our fourth quarter numbers are going to be based on those estimates, based on those actual numbers that we get.

So we know we’re going to be getting notifications from the different jurisdictions in this quarter and when that happens we have to adjust our actual property taxes for this calendar year based on the number that we actually get. And so that’s why there are generally true ups that occur in the fourth quarter and then it gives us the indication of what we’re going to be projecting for next year.

So that’s why we’re a little hesitant to say exactly what it is.

Ki Bin Kim - Macquarie Capital Market

And is there typically a lot of volatility in what you pay one year versus the next.

Kent Christensen

There can be, yes. Historically there has been some volatility and that’s why we’re a little hesitant to say that there won’t be any this year and this year with the overall economy it would make sense that there are going to be cities and counties and jurisdictions out there trying to find ways of getting property tax increases.

So we would be expecting those kinds of things to happen but as I stated earlier, we have not seen anything yet.

Ki Bin Kim - Macquarie Capital Market

More broadly speaking given your positive commentary about your rentals being flat versus last year and traffic improving versus last year, so why aren’t we at a bottom in self-storage fundamentals. What keeps you reluctant from, I guess what’s the risk in calling a bottom.

Spencer Kirk

The risk in calling bottom is we have a really nice data point in October and I would not want to prognosticate and say that that is a trend that is rock solid today. We are guarded in our optimism and we think that what we have been doing is making a difference and that the life changing events that drive demand for storage continue to happen.

Just in Q3 of this year we’ve rented 75,000 spaces to 75,000 new customers and that leads me to believe that the demand for the product is there. The discretionary user has left but to say that is has bottomed out when we’ve only got a solid data point from August forward is probably a little premature.

Ki Bin Kim - Macquarie Capital Market

On the [inaudible] JV capital, any, can you provide any additional color there, are you seeing more activity and is refinancing, re a JV is that a more likely possibility a going forward.

Kent Christensen

With our current joint venture partner, Harrison Street, the reason we are continuing on the process with Harrison Street is because they do have cash and they want to do more acquisitions and so as opportunities come up, we think that they could be a partner that we could use some of their cash in doing appropriate acquisitions.

That being said we are continually getting phone calls from people to do joint ventures but I’d have to characterize most of those individuals who call us as very opportunistic kind of money. They’re expecting very high rates of return and anticipating substantial amount of distress in the self-storage space.

And without seeing that kind of stress in the self-storage space the kind of joint venture, the people who are calling us I don’t imagine we’re going to be doing many joint ventures with those kind of people because I don’t think we can generate the kind of returns that they would expect.

So there is money out there but its expecting to get a pretty high rate of return.

Operator

Your next question comes from the line of Paul Adornato - BMO

Paul Adornato - BMO

You mentioned that you were able to rein in personnel costs by right staffing the properties and I was wondering if you could talk about that especially in the context of the increasing importance of the internet and your call center, I guess the question is what are the responsibilities now of the folks on staff and how has that evolved over the last year or two.

Karl Haas

I’ll let Spencer maybe follow-up on this but we still believe that our local store manager is as critical as ever. The only thing that we’ve taken from our local store manager is the first call response. They’re not answering the call goes, the initial call goes to the call center and the call center because they’re professional call takers, they handle 40 to 60 to 80 calls a day, every single one of them, they’re great at that first initial cold call handling.

And great at closing and its great from the standpoint of us being able to measure effectiveness of their closing and handling the call and also us being able to better measure traffic and those are all very very positive things.

However, ultimately everybody that rents a self-storage unit eventually comes to the site, or almost everybody and those people want to deal with somebody that’s pleasant, that feels good about who they work for and that can deal with, that’s good with dealing with the public. And so our focus is still on having the best quality managers, people that are motivated.

We put a lot of effort into it and you can’t lose sight of the fact that somewhere around 40 to 45% of the people don’t go to the internet, don’t go to the call center, but first come to the site. And we can’t lose sight of that. That’s a big part of our business. And so we’ve, very much involved our local people in the process and they’ll continue to be involved in the process.

And what we did with right staffing was not really in response to the call center, but rather just a rationalization of staffing to make sure we had the right level of staffing at comparable stores.

Spencer Kirk

A comment that I would make is there is a high degree of enthusiasm out in the field for both the call center and the internet because those are two devices we’re using to drive traffic to the sites and once the traffic arrives at the site, we have an enthusiastic, well trained, happy, motivated employee that is skilled in closing the sale and making sure that that customer doesn’t have any reason to go anywhere else.

And so the call center and the internet aren’t supplanting the job of the site manager rather they are augmenting and providing additional traffic so the individual at the site can do what he or she does best and that’s take care of the customer need.

Paul Adornato - BMO

So just to review if you will, the savings that are coming at the site is coming from simply fewer hours or perhaps turnover—

Spencer Kirk

Let me clarify that for you, the right staffing was simply this, if you have two properties that have similar demographics, equal number of units, comparable spaces, and one property is staffed at 80 hours a week and the other one clear across the country is staffed at 88 hours a week, why the difference. All we’ve done is rationalize what it takes to operate that site intelligently and where we could cut hours we have cut hours and that’s the right staffing.

We just need to make sure that we’re consistent across the platform.

Operator

Your next question comes from the line of Smedes Rose - Keefe, Bruyette & Woods

Smedes Rose - Keefe, Bruyette & Woods

I just had a couple of points of clarification, you mentioned $0.20 to $0.25 of FFO from new developments, is that from the eight facilities that are already opened or is that including properties that are going to continue to open next year.

Kent Christensen

That includes the properties that continue to open next year.

Smedes Rose - Keefe, Bruyette & Woods

And then you said for the new properties that are, they’re leasing up at a pace that you would have anticipated but at a lower rate, what sort of gap are you seeing relative to what your initial expectations were.

Kent Christensen

Somewhere between 3, some are very close to what we thought, 3 or 4% down. Some are 10% to 12% down. I’d say the overall average is probably 7, 8%.

Smedes Rose - Keefe, Bruyette & Woods

And then I think you answered this before, but I just want to be clear, your street rates are currently less then the in place rents, is that correct.

Kent Christensen

That’s correct.

Smedes Rose - Keefe, Bruyette & Woods

And then finally you mentioned something about the discretionary customers you think have left but it sounds like you’re getting some strength in the customer base, so what are you seeing in terms of the customer mix, who is replacing the more discretionary spend customers.

Karl Haas

I don’t think the discretionary customers have left, we’ve probably lost a larger portion of discretionary customers then non-discretionary customers during that period last year and early this year when we saw higher vacates.

There was a lot of stress, all consumers were feeling stress and so obviously if you’re a discretionary user, you’re probably more likely to vacate then non-discretionary. We still have lots of people that are discretionary users and we will continue to have those.

Smedes Rose - Keefe, Bruyette & Woods

So you mentioned you’re not seeing, besides the supply that you are adding, you’re not seeing any additional supply in your markets.

Karl Haas

No, its probably, there are sporadic properties being opened here and there, but in general its probably, this is probably, I’ve been doing this for 20 some years and I would say this is probably the lowest level maybe with the exception of 1989 to 1990, probably the lowest level of new properties coming on line that we’ve had in a long time.

Operator

Your next question comes from the line of Paula Poskon - Robert W. Baird

Paula Poskon - Robert W. Baird

I just want to get at the expense question in a different way, I know its been talked about quite a bit on the call, how would you characterize as you face tougher expense comparisons heading into next year how would you characterize that versus the opportunity for productivity gains whether that be as the call center stabilizes or leveraging the fixed costs around growing the 3 Plus platform.

Karl Haas

The call center, I think we charged, the properties pay a set amount per month for the call center. We think our call center, we did a pretty good job of estimating what the costs were going to be and its probably going to be pretty comparable next year. I just, I think that the good thing that’s going on is that we don’t have a lot of vendors feeling that there’s strength enough to increase their prices.

And in some cases we’ve actually been able to identify opportunities where we can squeeze the prices of some of the people providing us services a little bit more. We’re also continuing to look for opportunities, there’s mailings that we do that we feel and we’re seeing some opportunities to reduce our mailing costs by getting, taking different approaches.

We’re continuing to explore on utilities. There’s a lot of things on the utilities that where we’re retrofitting properties with, I’m not going to bore you with details, but there’s the T-12 bulbs and T-8 bulbs and the skinnier bulbs that use a lot less electricity and we’re going to see hopefully some improved, trying to reduce our consumption of kilowatts and so we’re working on all angles.

But its going to be tough to make a dramatic impact in reducing our expenses and its, we’re trying to run our business more intelligently but we don’t want to make cuts that are going to actually negatively impact the quality of our customer experience.

Paula Poskon - Robert W. Baird

And can you talk a little bit about the appetite that you’re seeing among the independents for the 3 Plus program, is it waning, is it increasing, is there no real change.

Spencer Kirk

I think the answer is the interest is growing. The message is getting out. We’ve been travelling the country talking to people and as they’ve seen the performance we’ve been able to produce not only in a downturn but just over the last 14 quarters, as we’ve been able to talk about the efficiencies of the internet and the web and call centers and national accounts, I think enthusiasm is growing, interest is growing and the bulk of the growth that we’ve had over the last 12 months, the 10% increase in our national footprint, the bulk of that has come through the 3 Plus program.

And we’ve got a lot of activity in the pipeline and we’re very optimistic that its going to continue to be a growth vehicle into the future.

Paula Poskon - Robert W. Baird

And some of your peers have pointed to the rapidly rising pricing of the internet search costs, are you seeing that as a driver among the independents to consider a third party management services.

Spencer Kirk

I think it’s a factor and for us as we look at the rising costs of being on the internet obviously if we can grow the denominator over which we spread the costs it gives us a greater advantage even with rising prices.

Paula Poskon - Robert W. Baird

And can you just give some magnitude about what those rising prices have been recently.

Spencer Kirk

I can’t, I don’t know. I just know that they are up significantly.

Paula Poskon - Robert W. Baird

Housekeeping question, what is your expected amount of capitalized interest for the year.

Kent Christensen

I’ve got a schedule right here, I think its about, I’ve got to pull up a schedule, so go on to your next question and then I’ll answer that.

Paula Poskon - Robert W. Baird

On the remaining construction pipeline is that fully funded.

Kent Christensen

Yes it is. Well we say fully funded, there’s not very much more actual costs that we have to spend and we have the cash right now to be able to fund those developments and we’re still trying to get construction loans on those properties, but irrespective of getting any construction loans, we have the money we need to fund those development projects.

Paula Poskon - Robert W. Baird

And just to follow-up on the earlier question on development dilution, given what’s happening with the early vintage properties versus the properties that are still expected to come online next year, how long do you think we’ll still be talking about development dilution. Is it 2013, 2014.

Kent Christensen

Well when we talk about dilution right now its because the properties that are opened are actually dragging down our earnings. We anticipate that in, by some time the end of 2010 into early 2011, that flips and those properties, the older properties are generating enough net operating income to offset the negative aspect of the ones that are open.

So that its effectively at least break-even if not starting to be accretive. So the dilution is because its negative. At some point we expect it to be positive but then we’ll be talking about the extra amount of FFO that’s not in our earnings and that will be there once the properties can get leased up.

But that’s going to be for another three to four years before we get the properties that are open fully stabilized. Back to your other question the number that we have in our projections is between $3.8 and $4 million.

Operator

Your next question comes from the line of Michael Knott - Green Street Advisors

Michael Knott - Green Street Advisors

Question on the gap between street and in place rents, you mentioned that it had improved compared to 6/30/09 which I think as I recall it was around 15%, could you just maybe give us a sense, is it 10% now, is it just slight improvement.

Karl Haas

Its 2 to 3%.

Michael Knott - Green Street Advisors

So its really narrowed a lot.

Karl Haas

Its gone down 2 to 3%.

Michael Knott - Green Street Advisors

So its about 12% now. So it was 15 last quarter.

Karl Haas

Yes, its probably more like about 12%.

Michael Knott - Green Street Advisors

And earlier in the Q&A you mentioned you had pushed street rates about 3 to 4% over 2Q, can you just comment on what the normal seasonal pattern is on that so we can put that in context.

Karl Haas

Yes, we’d actually be lowering rates in this timeframe.

Michael Knott - Green Street Advisors

And I think earlier in the year you had mentioned during the phase when move outs were much heavier you had mentioned that tenants were very fixated on rates more price sensitive then you had ever seen before, has that changed with the improving move out statistics.

Karl Haas

Yes, I guess, I don’t remember saying that it was, well we obviously really early in 2008 got much more aggressive on rates and we’ve continued to be aggressive on rates and even now our rates are still below where they were a year ago. So its, we’d like in normal situation we would expect to be having rates higher then the prior year not less then the prior year.

So customers are still sensitive to rates. However we’re finding that we might have been a little bit cheaper or less expensive then we needed to be and we’ve really worked on trying to push rates and at the same time getting the balance to make sure that we’re not hurting our goal of increasing occupancy or improving the occupancy delta.

Michael Knott - Green Street Advisors

And then just to go back to my last question can you just remind us what that street and in place gap would have been a year ago, at the end of third quarter 2008. It was still slightly negative at that point in time right.

Karl Haas

The, if you’re talking about the in place versus street.

Michael Knott - Green Street Advisors

Yes, that’s right.

Karl Haas

Yes it would have been about $13 to $14 and now its more like about $10, $12 to $11.

Michael Knott - Green Street Advisors

And then I have a question on the Harrison Street deal—

Karl Haas

Just to correct my percentages, I was probably more, it probably dollars not percent, what I’m saying of the decrease.

Michael Knott - Green Street Advisors

On the Harrison Street deal, any inferences that you drew from that whole process of essentially getting re traded in terms of what it may mean for storage values or just appetite for institutional capital with reasonable return expectations.

Spencer Kirk

My response on that would be a lot changed in the marketplace between early 2009 and fall of 2009. For me yes, some operating fundamentals have decreased and that obviously has some impact but the story of storage extrapolated over a three or a four year period is still very compelling and I think that as we looked at the Harrison Street transaction, there were several reasons to continue to do this transaction, one of which as Kent alluded to is it gives us a nice joint venture partner.

It validates the price point of properties in the market and it gives us an ability to further expand our footprint in the future. So for me the Harrison Street takeaway is an awful lot changed in a very short period of time but we need to stand back and look at the bigger picture.

Michael Knott - Green Street Advisors

And then if you can just tie up some comments you had made on the sales market, I think you had mentioned you had seen a little bit of activity, can you just maybe give us a little color on what you’re seeing and do you expect any opportunities to emerge that you might be able to capitalize on in say 2010.

Kent Christensen

The, I said earlier there’s been very limited activity on the acquisitions front. The extend and pretend comments of what’s going on with CMBS loans, the same thing is taking place with banks, banks and the CMBS lenders are finding ways to extend loans.

Its clear that the self-storage property type is still one of the lowest default property types out there so there are not a lot of distressed opportunities. There have been a few here and there. There have been a few banks that have called us with wanting to sell paper which we have evaluated and made bids on.

But once again they are very hit and miss, few and far between. So going into next year we would expect to see a little more of that kind of activity, some distressed properties, some loans that are for sell. The majority of the distressed properties that we’re seeing are lease up properties, properties that haven’t reached their stabilization yet but yet the loan is coming due and so the debt service, the NOI is not able to service the debt yet.

And so we’d expect to see some more of that next year but we’re not seeing or not anticipating seeing a substantial lots of self-storage properties that are going to be what we think are going to be hit and miss.

Michael Knott - Green Street Advisors

What would be your appetite for taking on leasing risk given that you have some of that already in your development portfolio.

Kent Christensen

Obviously we’re a company that can take on leasing risk but its got to be at the right price that meets the objectives of what our cost of capital is and so it would have to be at a purchase price, what makes sense, but if the purchase price makes sense then yes, that would be something that we would be willing to accept in the right markets and for the right locations.

Michael Knott - Green Street Advisors

On that same topic how would you underwrite that, what kind of return would you expect, not obviously cap rate but sort of a total return underwriting expectation.

Kent Christensen

Well in today’s market we would, that number would be much higher then what it would have been a few years ago. So we would [pro forma] expect to get a much higher rate of return knowing that if the property that you’re talking about is in a distressed situation then that means we should try to buy the property at as good a price as we can get.

And so we would be trying to buy and try to get the best deal we could get so that would be a very high expectation as far as rate of return.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Spencer Kirk

We appreciate everyone’s interest. Obviously we look to the forward positive conclusion of 2009 with some guarded optimism and we believe that the fundamentals are beginning to heal and mend and we believe that 2010 will be a solid year for Extra Space. With that I’d like to bring the conference call to a close and say thank you for your time today and we’ll look forward to our next earnings call. Thank you.