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Extra Space Storage, Inc. (NYSE:EXR)

Q4 2007 Earnings Call

February 19, 2008 1:00 pm ET

Executives

James Overturf – IR

Kenneth Woolley – CEO, Chairman

Karl Hass – COO

Kent Christensen – CFO

Spencer Kirk – President

Analysts

Christine Mcelroy – Banc of America

Christeen Kim – Deutsche Bank

Michael Salinsky – RBC Capital Markets

Michael Knott – Green Street Advisors

Chris Pike – Merrill Lynch

Paul Adornato – BMO Capital Markets

Paula Poskon – Robert W. Baird

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Extra Space Storage Incorporated earnings conference call. My name is Lauren and I’ll be your coordinator for today. At this time all participants are in a listen only mode. We will conduct a question and answer session towards the end of this conference at which time you may press star one for questions. If at any time during the call you require assistance, please key star zero and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I’d now like to turn the presentation over to your host for today’s call, Mr. James Overturf with Extra Space Storage.

James Overturf

Thank you Lauren, welcome to Extra Space Storage’s fourth quarter and year end 2007 conference call. With us today are CEO and Chairman of the Board, Kenneth Woolley, President Spencer Kirk, CFO Kent Christensen and COO Karl Hass. In addition to our press release, we have also furnished unaudited supplemental financial information on our website. Please remember that management’s 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, SFO and guidance. We encourage all of our listeners to review a more detailed discussion related to these forward looking statements contained in the company’s filings with the SEC. These forward looking statements represent management’s estimates as of today. Extra Space Storage assumes no obligation to update these forward looking statements in the future because of changing market conditions or other circumstances. I would now like to turn the call over to Extra Space Storage’s Chairman and CEO, Kenneth Woolley.

Kenneth Woolley

Thank you James. Hello everyone, thank you for your interest in Extra Space and joining us with our call today we’ll have on the call today are Spencer Kirk, Kent Christensen and Karl Hass. I’d like to point out a couple of highlights for the quarter and then turn the call over to Karl and Kent to give you more details. Before an impairment charge on auction rate securities and development dilution, we earned $0.32 in FFO for the quarter and $1.13 for the year.

After the impairment charge and development dilution we actually earned $0.29 for the quarter and $1.09 for the year. Our FFO increase of 14.7% puts us solidly in the top 25% of all REITs, public REITs. And even with the impairment charge, our FFO was solidly within the guidance range that we gave at the beginning of 2007 and that we’ve given throughout the year of 2007. We also are confident in the accuracy of our future forecast and budgets that we’ll be talking about on this call. Our same store revenue and NOI growth for the quarter was again quite solid.

We finished the year with revenue growth of 3.9% and NOI growth of 5.3%. We also have a tenant insurance program which we last year decided to take out of our same store NOI and revenue growth. Many of our competitors leave it in, it is part of our operating activities. If we had included our tenant insurance program, our revenue growth for the year would have been 4.4% and our NOI growth would have been 5.8%. We in fact achieved those revenues in NOI but it was shown elsewhere in the financial statements. Our expense control at the site level was excellent if you look at the financial statements in detail. In 2007 we benefitted from a number of initiatives.

We had an intense capital improvement program at the property level which helped improve the quality of our properties. We continued to invest in technology systems and automate our processes so that our overhead activities became less expensive because of technology. We continued to refine our revenue management systems and we believe that that’s helping us and also we’ve improved the skills and performance of our personnel through extensive training.

We’re also continuing to benefit from our acquisition and development program. As you can see in 2006 and 2007 our acquisitions were above expectations. In 2007 we acquired interest in 50 self storage properties for approximately $385 million. 38 of those for $375 million were wholly owned properties, we acquired joint venture interests in 12 properties for about $10 million. The acquisition environment is changing with the change in the credit markets but seller expectations do remain high and we have to be careful to make sure that in our acquisition activities we are conservative in our budgeting and so in the future we do not expect acquisition to be quite as robust in the current year.

We also are continuing to develop properties in high barrier to entry markets. Our development program drives long term growth and ultimately earnings accretion. It also enhances our NAV and our overall portfolio quality. We completed the development of six projects in 2007 for $52 million and we have 12 more on tap for 2008, including, for about $103 million and 12 more in 2009 for another $126 million. Basically the company is in good shape, we’re performing well and we’ll get into the details about our performance as I turn the call now over to Karl Hass, our Chief Operating Officer who’ll give you more detail. Thank you, I’ll be back later in the call.

Karl Hass

Alright, thanks Ken [unintelligible], as Ken mentioned we had another good quarter. Our same store group of 181 properties had a 2.8% increase in revenue and a 3.6% increase in net operating income. For the year, same store revenue growth was up 3.9% and net operating income was up 5.3%. Occupancy as of the end of the year was at 84.1% and that compares to 85.1% the previous year. We once again had a very good expense control quarter as our same store expenses increased a modest 1.1%. For the year, expense finished up 1.3% which obviously is pretty good.

The lower expense growth certainly aided our bottom line net operating income growth. We did a good job on our controlled expense, however keep in mind that this quarter’s results are historically low increases and not necessarily the norm. We are forecasting same store growth for 2008 to be between 2.5-3.5% and we have seen some increase in snow removal costs and January 08, well above January 07 thanks to, can’t control Mother Nature. Revpav for the revenue, or revenue per available square foot for our same store pool was $12.14 which represents a 2.5% increase year to year.

Quarterly increase in revenue came from increased rents from our existing customers and a reduction in discounts at our same stores which were down, the discounts were down approximately 6% for the year. Revpav was mitigated by lower square footage [foot] occupancy which as previously mentioned was down 100 basis points at year end. During 2007, our monthly same store year on year revenue gross decreased from January through August, however we seem to have stabilized since August at about 3%.

Our pool of 589 stabilized properties that we manage had somewhat better results in our same store pool during the fourth quarter with a 3.1% increase in revenue and a 5.5% increase in net operating income. For the year, these properties had a 3.4% increase in revenues and a 4.3% increase in net operating income. Square footage occupancy for this group of properties was at the end of year was flat when compared to last year at about 84.1% which coincidentally is the same as our same store pool.

Our street rates for new tenants were down as of the end of the year when compared to 2006, however we continue to find traction with our existing customers with rental increases being given to approximately 30,000 customers on a monthly basis. As we have said in previous calls, our growth in 2007 was hampered by Florida which accounts for 10% of our overall net operating income. This is really a return to normalcy from the tremendous demand after hurricanes in 2005 for Florida.

Taking Florida out of the equation, our revenue for the same store pool for the year would have been higher by 100 basis points and net operating income would have been higher by 150 basis points. It appears that Florida as a whole is reaching the bottom with slightly improving year on year comparisons. The markets of Miami, Ft. Lauderdale, Tampa and St. P are faring better this year, however West Palm Beach continues to really struggle.

On the positive side our best markets for the year for revenue growth during the fourth quarter were Chicago, Columbus, Dallas, Detroit and Houston. These markets experienced year on year increases in revenue of between 7-13% and also were among our best performers for the year. Detroit has had a bounce back year and has felt the benefit of aggressive price decreases that we put into place in late 2006 and early 2007. For our largest net operating income producing MSAs, Boston, Los Angeles, New York-New Jersey and Baltimore-Washington, we showed increases of 2.5-4% for the quarter and the year. It’s interesting to note that there are ranges of performances within each of these MSAs.

For example, in Boston, the stores in the Boston central are outperforming those in the south shore and western suburbs considerably, with a revenue increase of nearly 8% for Boston central. In the New York MSA, Long Island is leading the way with growth over 9%. The south Jersey and Philadelphia markets continue to be one of our weakest. We attribute most of the weakness to new competition. [Better] new supply, according to our measurements, is low throughout the US, this particular market is seeing a significant increase in the supply with more scheduled to come online in the next year. As in other weaker markets in the country, we’re going into this year’s rental season in south Jersey-Philly with aggressive pricing to new customers in addition to being proactive with discounting.

The operations team is looking forward to 2008, which just happens to be my 20th year in the self storage business. Though many components of the business have evolved, operational success in self storage still comes down to preparation and a focus on good pricing and promotions, sales skills and keeping properties well maintained, we call clean and green here and controlling receivables. We are doing these things well. Goals for 2008 are well defined and we have the team and the tools to enable us to achieve them. Specifically we are training our people well and they are increasingly satisfied with their jobs and responding beyond our customer’s expectations.

We’re maintaining low turnover at the site and 75% of our employees gave us high ratings in job satisfaction in 2007 and that’s up from only 63% in the previous year for the same kind of survey. The executive team also conducted 40 town hall meetings during 2007 and met with over 1,400 of our employees. We are hearing good feedback from these meetings and overall we continue to further improve our processes in training. This year our online training program won major awards from the training industry.

We conducted over 150,000 training hours during the year, utilizing both our proprietary web based learning management system combined with face to face training. All of our site personnel is required to achieve a base level of certification before managing one of our properties and we’re continuing to raise the competency, ah it’s a tough word to say, competency bar throughout the organization. So, thank you and now I’d like to turn the call over to Kent Christensen who hopefully will be able to pronounce his words a little bit better.

Kent Christensen

Thanks Karl. As we disclosed in our press release this morning, our FFO per share for the fourth quarter came in at $0.32 per share before an impairment charge on our auction rate securities and dilution from our development program, compared to $0.26 in the same quarter last year. Taking into account the $0.018 from the impairment charge and the eight-tenths of a cent in drag from our development properties, our fully diluted FFO per share for the quarter came in at $0.29 compared to $0.26 a year ago.

Driving our growth was 25% increase in our property rental income and significant growth in our insurance program. We did an outstanding job with our G&A which rose just 2% over the same quarter last year and fell to 14.2% of our revenues from 17.3% a year ago. For the year our FFO came in at $1.13 per share before the non temporary impairment charge and the development drag compared to $0.95 last year. After consideration of the impairment charge and development program, our FFO for 2007 was $1.09 per share which was what Ken stated earlier, which was the budget we had set for the beginning of the year.

Regarding the impairment charge that effected the fourth quarter and the year, we decided it would be prudent at this time to write down our investment in our auction rate securities. We are working with the broker dealer managing this investment for us and we feel we will come to a mutually beneficial outcome in this matter. The permanent impairment charges recorded as a non operating loss in other income which impacted our FFO by $0.018 for the quarter. We also recorded a temporary impairment charge of $1.4 million which is recognized as an unrealized loss in shareholder’s equity.

Moving on to our acquisitions and development, we had another good quarter of acquisitions and finished the year on a high note, adding several properties during the fourth quarter. We acquired interest in 19 self storage properties for an aggregate cost of approximately $79 million. Seven of the properties acquired are wholly owned and 12 are owned in various joint ventures. The properties acquired during the quarter are high quality, well located assets in the states of California, Connecticut, Florida, Illinois, Massachusetts, New York, Rhode Island and Texas.

For the year, we acquired interests in 50 self storage properties for an aggregate cost of almost $385 million. As we started in the 2008, not much has changed on the acquisition front. We remained conservative as we see little to not decrease in seller expectations. We still have the capacity to grow but we are being very careful with our capital allocation. To this point in our guidance we have no included any acquisitions at this time for 2008 but we are still looking for good accretive acquisition opportunities. During the fourth quarter our development team completed a joint venture project in Sacramento for $7.1 million and a wholly owned project in Laurel, Maryland for $8.7 million.

For the year, the team completed six projects for $52.1 million, three of these projects were wholly owned and three of them are in joint ventures. Ken already spoke a little bit about our development program for this year and what we anticipate completing in 2009. The properties that we have that are in our development program right now are located in high barrier to entry markets in California, Florida, Chicago and the Baltimore-Washington DC area. The total outlay for both years is between $25-$35 million. The debt markets are still very favorable and are still open for us for our development program.

In order to illuminate the effect of our development program, we have several tables in our supplemental package posted on our website. You can see by looking at the analysis that although it is extremely valuable in the long term, the development does have a short term impact on our earnings. For modeling our FFO and our NAV, we estimate that our drag from our development program will be approximately $0.06 in 2008 and if all of the properties that we have developed in 2006, 7 and 8 were open and fully stabilized today and using the rents today, their contribution to our FFO would increase from the negative $0.06 to a positive $0.09 or a $0.15 swing.

Our balance sheet is in good shape. Our debt is manageable at a total debt to market capitalization including OP unites of 57% at year end. The total debt outstanding as of yearend was approximately $1.3 billion and our fixed rate debt which comprises 90.5% of our debt has an average interest rate of 5% and the maturity of our debt is well staged. Our variable debt at the end of the year had an average rate of 5.9, however, because of the trough in the LIBOR rates is now currently at a 4.48% and our fixed charge coverage for the fourth quarter was 2.4 and averaged 2.3 for the whole year.

For the three months ended December 31, 2007, the CCS CCU calculation outlined in our IPO prospectus allowed for the conversion of an additional approximately 455,000 additional shares in units. Total CCS CCU shares converted to date is approximately 1.9 million. G&A net of our development fees was $9.2 million for the quarter and $36.7 million for the year. Management fee income for the year from our joint ventures and our third party managed properties came in at $20.6 million. When you take our management fees and net them against our G&A, the cost to manage our wholly owned properties is $16.1 million.

In terms of our outlook, we estimate at this time that our fully diluted FFO for the first quarter to be between $0.27-$0.29 per share before the development dilution and $0.26-$0.28 after consideration of the development program. I’m sorry the numbers I just stated were incorrect, there’s $0.27-$0.28 before the development dilution and $0.26-$0.27 after the development program. For the year we estimate our fully diluted FFO to be $1.23 to $1.27 per share before the development dilution and $1.17 to $1.21 after consideration of the dilution. The assumptions behind that guidance are listed in our earnings release but I will highlight that it assumes as I said no additional acquisitions and also no further impairment on our option rate securities. With that, I’d like to turn the call back to Ken.

Kenneth Woolley

Thanks Kent, our outlook for the coming year for same store growth is similar to what we achieved in the current year. I think that’s prudent given what we’re seeing in the economy. Given our estimated range of guidance, we’ll see FFO per share before development growth dilution grow between 9-13% which will be an excellent performance given that it assumes no new acquisitions. We do however expect we will be doing acquisitions and that could cause a better result. As we continue to grow, we believe that we will continue to harness economies of scale which have been very helpful to us in achieving our cost control and excellent revenue growth.

It also reflects the continued contribution of earnings of our acquisition and development properties. In all I feel Extra Space is in a very good position in our industry and is one of the premier operators. I’d like to kind of speak to Self Storage for a minute. We’ve had a lot of investors and analysts talk to us about the relationship between Self Storage and the housing difficulties in our economy. We are not seeing much relationship between the two. Storage demand arises because of life changes. It can be a wedding or a graduation or a death or a birth or some other or a divorce.

But those types of life changing events occur whether or not the economy is going up or the economy is going down and in fact in some cases if the economy is in some stress and people lose their jobs or there’s a foreclosure, it can actually give rise to demand for self storage. Also there’s a significant part of storage demand that relates to small business and business activity that has nothing to do with housing, it is all about business activity in general. Of course if business activity slows, there’s an anticipation that that market would slow slightly. Also there’s a stickiness about the storage business.

When people store, once it gets there, there’s a tendency for people to forget it and not want to remove it from storage and so it’s one of the reasons that we’re able to get reasonable rental increase to our existing customers because it’s a big, big job to undo the storage, get rid of their stuff. Storage, there is an addictive nature to storage, people like to hold onto their material goods and there is something about, there is an emotional aspect to keeping them. All these things are unrelated to housing. Certainly in some of the markets where we’ve seen very active new housing formation and that new housing formation has slowed, we’ve seen a slowing of self storage activity, but those markets are not very big in terms of the overall of Extra Space.

Those markets would include parts of Phoenix and Las Vegas and the Inland Empire and parts of Florida, but much of the rest of the country, we believe, has been unaffected by changes in housing value. And it’s one of the reasons that we continued to see excellent demand. A year ago, or approximately a year ago on our call, I mentioned that we were seeing slowing rental activity and that did occur in October, November, December, January, February of last year.

But currently, our rental activity is actually up over the previous year and it is doing fine. So we’re not seeing anything negative with respect to rental activity. Karl did mention, however, that our achieved, that our asking rents are down slightly and that is true. We are being more competitive on an asking rent price basis and in order to maintain our rental activity. However, he also mentioned that our discounting was down versus the previous year which is also true so we’ve been a little less aggressive on discounting but we are a little bit less aggressive on our asking rents.

Our occupancy is actually, we believe, going to be moving slightly to the positive relative to the same time at the same year. I think most of you know that our year end occupancy for our large same store portfolio and our stabilized portfolio was 84.1%, that of course will achieve a peak of 3-400 basis points higher in the summertime and then will fall back again next year. But our own internal goals is to actually increase occupancy during the year slightly. But to continue to operate our business based upon maximum growth in income. I can say without hesitation that the self storage business is just an excellent place to be.

Extra Space is a unique company in that business because we are active developers of self storage, number one, which are competitors are not and number two we have a substantial joint venture business that gives us experience in operating with institutional partners and will give us as time goes on, excellent return on investment through promoted interest with our joint venture partners. We believe that sets us apart as a company. We also have achieved as a company the highest rent per square foot of any of the self storage companies and that really is a result of the quality of our properties and the markets that we’re in. And we expect to continue to be the leaders.

Our acquisition activity continues to be careful and prudent. We bid on more than $1.8 billion worth of properties during 2007 as you know, we bought $385 million. The reason we didn’t buy the rest was because we, in many cases, underbid our competitor by 15-20% because we weren’t willing to pay what the market was serving up. We think that’s going to lead to higher shareholder returns over time. Anyway, with that, I’m going to turn the call over to questioning and we’ll answer any questions that you have.

Question-and-Answer Session

Operator

Ladies and gentlemen, if you wish to ask a question, please press star one on your touchtone telephone. If your question has been answered or you wish to withdraw you question, please press star two. Questions will be taken in the order received so please press star one to begin. And your first question comes from the line of Christine Mcelroy with Banc of America.

Christine Mcelroy – Banc of America

Hi, good morning, regarding your same store revenue growth forecast of 2.5-4%, you mentioned occupancy but can you quantify the expected upside there and what do you expect rent growth could look like? So essentially how much of the revenue growth are you expecting to come from rent growth and how much from occupancy upside? And are you forecasting any change in concession activity in 08?

Karl Hass

We are, our goal for 2008 is to improve our delta on square footage by about 1.3% from October 07 through December 08. So, about a percent we hope to get from occupancy gains. We do not see any dramatic change in our discounting. I will say though the reason that our discounting has kind of flattened out here in the latter part of 2007, really two things. One, we had experimented and were doing some three months half off promotions in late 2006 and part of 2007 and we stopped doing that. We determined that it just didn’t get us a better answer, but it did result in higher discounts.

And the other thing that we’ve done is we really have tightened up the discounts, kind of the discretionary discounting that our managers can do. We have found that you know that wasn’t always used in a way that really got us to the best answer. So while we actually have done some, changed some parameters that could increase discounting, we’ve been able to offset that by reducing the discretionary discounting and reducing the three months out half off.

Christine Mcelroy – Banc of America

Okay and Ken, can you expand on your thoughts on the tighter credit environment and as it plays out, what impact do you expect to see both on kind of the demand and supply of self storage? Do you see the potential for larger well capitalized storage companies to take advantage of an environment like this and if so, how?

Kenneth Woolley

Well let’s talk about the supply side first. The credit crunch, we believe and have been talking with people in the local communities and people in the self storage association, it appears that less capitalize developers are having a more difficult time getting loans from banks just because of the more conservative nature of the banking environment and the lending environment. That works well for us because it’s going to I believe decrease the new supply of properties. Now there’s always a lag time in this business because the supply that’s coming on this year is mostly properties which were all the way under way last year. So it’s really going to affect supply probably in late 2008 and 2009, we’ll see a decrease in new supply. That will help us.

On the demand side, there’s no question that self storage, if we have a recession in our economy as a whole, self storage is, you know it’s a business, it is related to the business world. We’ve seen less, it is a business that seems to have less ups and downs with the cycle of the economy than other businesses and so I don’t see a lot of decrease, you know you might see a slight dampening of sort of revenue growth on the demand side but I think if you look at our numbers, you look at the excellent results we’ve had in places like Detroit, where we have I don’t know 12 or 13 properties and yet we would all agree I think that Detroit is sort of in a recession as a place or you know Michigan if anyplace.

And yet we’ve had increases in self storage activity and so it’s, we don’t see a lot of correlation there. So I think we’re going to benefit because, where we have the most trouble in self storage is when there’s too much supply. As we mentioned, in south Jersey and Philadelphia areas and other areas of the country where there’s just too much being built, we really, that hurts us. So we think on the whole the credit crunch isn’t going to hurt the operating statistics much and may in fact help it.

Now on the other side of the credit crunch is the supply of funds to companies like Extra Space Storage. Clearly Extra Space, we are trading, we at a value currently that we believe is under our NAV and I think most of the analysts who rate us would also say that and that means it would be unwise for us to tape the equity markets to get new equity. Also our debt ratios are high enough that that it is unwise for us to increase our debt by very much because we don’t want to get over leveraged or get into any kind of financial condition.

That’s leading Extra Space to be very conservative on its acquisition activities and also is leading us toward looking at more joint venture possibilities for further acquisition activities. We do as you know have good relationships with our joint venture partners and I suspect that in the future we will be doing more activities with joint ventures because of the state of the capital markets. If the capital markets open up, we’ll go back to growth using the conventional capital markets.

Christine Mcelroy – Banc of America

Great, thank you and just really quickly my last question, with regard to your new development pipeline, are you buying the land ahead of time and holding it on your balance sheet or is all of your land under option until you’re getting ready to start the project?

Kent Christensen

This is Kent, we try to balance that activity you just described and have in our agreements with the sellers as much time as we possibly can to get the project ready to as close as we can to starting construction. There are, however, instances when the land and the property that we’re acquiring is so valuable and the seller knows that, that we’ve had to buy the land before we’re ready to start construction. But as a general rule, we will not acquire the land if we know, unless we can confirm that the entitlements and what we would like to build on the land is, the city will allow us to do. So we try to push that to get as close as we can but in some instance we are acquiring the land before we’re ready to start construction.

Kenneth Woolley

[Overlay] I think at year end we had raw land on our books of about $50 something million dollars in our assets.

Kent Christensen

Right, I’m sorry, Christy what?

Christine Mcelroy – Banc of America

That was what I was going to ask, thank you.

Operator

And your next question comes from the line of Christeen Kim with Deutsche Bank.

Christeen Kim – Deutsche Bank

Hey, Ken, you mentioned seeking out joint ventures or using your current partners to acquire assets, given where the stock price is and where your debt levels are, what are you guys seeing in terms of the institutional appetite for self storage at this point, has there been any changes?

Kenneth Woolley

The appetite appears to remain robust, but to be very honest we have not yet gone out actively to pursue a joint venture partner in this activity so we don’t have first hand experience with the current marketplace.

Christeen Kim – Deutsche Bank

Okay, great and then in terms of your guidance, your core guidance assumptions for this year, what have you assumed for Florida? Have you assumed going back to positive growth there or flat or negative?

Karl Hass

Uh, flat.

Christeen Kim – Deutsche Bank

Okay, great, thank you.

Operator

And your next question comes from the line of Michael Salinsky with RBC Capital Markets.

Michael Salinsky – RBC Capital Markets

Good afternoon guys, real quickly Ken, can you touch on your investment capacity you have on balance sheet right now under the unencumbered asset pool.

Kent Christensen

This is Kent, we have about $250 million of properties that are unencumbered that if we were to tap the debt markets on those properties that we could get financing that would allow us to be able to do acquisitions.

Kenneth Woolley

Let me clear that up, we have $100 million line of credit which is untapped and we have properties worth more than $250 million to which we think we can borrow $250 million. So that’s $350 million total if we were wanting to leverage up.

Michael Salinsky – RBC Capital Markets

Okay, secondly in terms of the debt markets right now, I mean where is pricing for debt product essentially in the self storage market relative to maybe this time a year ago, where, how much is it up on a year over year basis basically?

Kent Christensen

Well the spreads that you get as far as a CMBS quote, over the last two months have ranged anywhere from 200 to 400 basis points, just depends on the week that you’re calling and the information that we’re getting from our lenders. But obviously with treasuries dropping and the pricing that we were getting before the credit crunch that occurred in the middle of last year was about 100-125 basis points over the applicable treasury.

So, you know, you’re somewhere between 75 basis points higher to 275 basis points higher on the spread, but then the treasuries are lower and so that’s where you’d, adding those numbers up would give you what the rates would be. There are, appears to be some interest in the non CMBS markets on book deals that could be done for us to be able to obtain financing, smaller amounts of financing, not large amounts, but smaller amounts of financing that companies are wanting to do on book loans and those would be more variable rate loans and would be somewhere between 200-300 over the variable rate [unintelligible] 200 standard over LIBOR.

Michael Salinsky – RBC Capital Markets

So the insurance companies and some of the other financial institutions are still out there lending?

Kent Christensen

Yes.

Michael Salinsky – RBC Capital Markets

Okay and then finally in terms of recurring cap ex for 2008, I know you’ve got some work you’re doing on some of the 5A rent a space properties, you know could you describe what your outlook is for recurring cap ex and how much you plan to spend just on portfolio improvement stuff?

Kent Christensen

We’re doing the budget for this year is about $0.35 per square foot and which that does include, that does not include the 5A, the 5A stuff, we’re able to, we had budgeted about $10 million and about $2 million of that was completed by the end of the year and we still need another $8 million or so to be done this year. So in addition to the $8 million on the 5A we’re planning on about $0.35 for the rest of the portfolio.

Michael Salinsky – RBC Capital Markets

Great, thanks guys and congratulations on the good quarter.

Operator

And your next question comes from the line of Michael Knott with Green Street Advisors.

Michael Knott – Green Street Advisors

Hey guys, wondering if you can just give us a little color on what buyers are underwriting today in the market for self storage, what types of unlevered returns or cap rates?

Kent Christensen

We haven’t seen a lot of transactions close so we’re not, we know that we’re still getting outbid on the transactions that we’re bidding and we’re bidding between 7.25-7.50 and we’re still getting outbid and that produces you know a 9-10% IRR depending on what kind of inflation factors and other assumptions you make on your equity. So those are the kind of the underwriting numbers that we’re using and as I stated we’re getting outbid. So that implies that people are coming up with numbers that are lower than those.

Michael Knott – Green Street Advisors

Okay and then could you guys give us a little assessment of your 07 acquisition activity given that it was pretty sizable and given the negative comments about the state of values in the for sale market today?

Kenneth Woolley

Let me characterize it a little bit, there were 38 wholly owned properties that we purchased. I don’t know, ten or 12 of them were the [nuppy] 5A rent a space properties that was one transaction that was sort of, didn’t really have competition on that, it was a privately negotiated transaction off the market. The rest of the transactions, all but one were transactions where we purchased the properties either through existing private relationships or from our existing partners, where we either managed or had a joint venture interest before in the property.

Only one property of the 38 we bought that was widely marketed. This means that the average cap rate that we achieved for properties that we purchased in 2007 was in the range of 7% in actual numbers. The properties that we bid on that I told you about $1.8 billion worth that we didn’t get, we were typically outbid by as much as, you know 10-15% and sometimes even more which implied that the cap rates were really happening in the market were in the low sixes, not really in the 7% range. The only reason we were able to achieve that higher cap rate and something that was accretive to us was because of kind of the way we went about it. We continue to hope that we’ll go about it, we will go about it in the same way this year.

As you noticed in our guidance, we’re not showing any guidance for acquisitions. We will be doing acquisitions, we are active, but where we sort of moved up our cap rate number, just based upon our, the financial markets, but we haven’t seen the properties come up yet in cap rate or down in value.

Michael Knott – Green Street Advisors

Okay and then earlier you said you’re not forecasting any acquisitions but you are continuing to look for accretive deals, can you help us understand whether they were primarily focused on earnings accretion or value accretion?

Kenneth Woolley

Both. We’re focused on value accretion without earnings dilution, which means that we’re not going to be buying very mean lease up properties that could be value accretive but earnings dilutive. So unless we find a joint venture partner to do that with, so we want to have both value accretion and earnings accretion.

Michael Knott – Green Street Advisors

Okay and then my last question, Kent, can you just help us understand whether you still have capital invested in the auction rate securities or whether you’re out of that now? Can you just help us understand that?

Kent Christensen

Right there’s $24 million of cash that we had used to buy auction rate securities that those all started to [fail] in August of last year and so we still have, this $24 million that’s tied up in our auction rate securities. To date, all of those auction rate securities are, our auctions rate securities are held or are investments from insurance companies, none of them are backed up by any kind of CMBS loans or subprime loans. There’s only one, two of the 13 securities are backed up by the companies that insure these products, companies called MBIA and Ambac, but otherwise the other 13 are all securities that are held by insurance companies. Currently all of our loans are currently paying their interest payments.

We get an interest payment every 28 days. They’re all current and for the most part they’re double A or triple A rated. But because of the illiquidity of the product, obviously none of them are, there’s no transactions occurring today, that’s why there is a suspect as to what the value of these is. There’s not any question that the principal is in, that we have a problem with the principal is whether or not because of the liquidity aspect what the value is.

Michael Knott – Green Street Advisors

Okay, thanks.

Operator

And your next question comes from the line of John [Clowny] with Merrill Lynch.

Chris Pike – Merrill Lynch

It’s actually Chris, good morning everybody. Can you hear me? Okay good, Ken you talked earlier about the performance of storage through a recession. You know some will contend that we’re actually there already in many ways. Can you talk about what type of timing lag, if you’ve historically seen one given your experience in the sector, between when let’s say when the NBER officially calls a recession and any downside inflection in operating fundamentals.

Kenneth Woolley

I don’t know that I could give you that information and this is really anecdotal not analytical.

Chris Pike – Merrill Lynch

Exactly, that’s all I’m looking for [overlay].

Kenneth Woolley

My anecdotal experience would be there isn’t a timing lag, that it’s concurrent, it’s not a lagging indicator, it’s a concurrent indicator if there is any. Recognizing that we’re running, if you take Florida out, same store revenue growth in the range of 4%, during this, if we are in a recession, that’s pretty good. That’s just where it is right now for us.

Chris Pike – Merrill Lynch

Okay and I guess the question for Spencer, I don’t know if he’s there, you know last time we did meet at [nary] you talked about revisiting some of EXR’s best practices and some of the innovations that the company has brought forth over the last few years and trying to actually identify to what extent there is value there relative to the cost. So I guess here we are, 90 days plus after having that meeting, just wondering how that project is proceeding and are there any preliminary observations you guys could share with us on that.

Spencer Kirk

I appreciate the chance to respond Chris. I have been vigorously working internally on something that you will be hearing more about called enterprise content management. There’s a lot of information about our customers, their behavior, their purchasing decisions and as you look at taking the data that is proprietary to what we’ve learned about how customers go about using self storage, we think that there is tremendous opportunity in revenue management, in cost containment, in web marketing and design to pull together a competitive advantage that gives us integration of the information that will allow us, we believe, to in an agile way, more quickly respond to real time pricing demands in the marketplace and further enhance our ability to serve up to the customer exactly what he or she desires at the point of purchase.

If I could further expand that, many people look at the concept of a customer from cradle to grave and we’re thinking outside of the box that at Extra Space, there is a lot that goes on even before the customer acquisition where it’s really from first glance or first inquiry to grave. And my efforts with what I would consider a significant and capable technical prowess within Extra Space, I think it will allow us to take the enterprise content management and drive our results to a level that has not been seen within storage. Because we’ve put technology and automation to our advantage. We will invest aggressively. My desire is to support, complement and enhance what Karl and the operational team is doing so well already and give them further energy and information to outmaneuver the competition.

Chris Pike – Merrill Lynch

So is this using data that EXR has accumulated on existing preferences with respect to current customers and extrapolating that over a larger opportunity set or you know or is it just looking proactively at potential trends and you know customer tastes and expectations coming in as a new user?

Spencer Kirk

The answer is yes to both of those.

Chris Pike – Merrill Lynch

Okay and I guess just a last question, I don’t know if there’s any and if you can remind me, the update on the external call center, I know quite a few were in beta and just wondering how you guys are thinking about that and maybe how that call center would work its way into some of these initiatives that Spencer is working on.

Karl Hass

Well it’s one of our key initiatives this year to upgrade our call center and we are working with an outside consultant and also an outside call center. We really haven’t made a decision on which direction we’re going to go although we are confident we will end up with a call center either operated by us or operated by a third party in Salt Lake City, near the end of the year.

Chris Pike – Merrill Lynch

Okay, thanks a lot folks.

Operator

And your next question comes from the line of Paul Adornato with BMO Capital Markets.

Paul Adornato – BMO Capital Markets

Hi, could you talk about the performance of the development properties, specifically the lease up, the discounts, promotions and street rents that you’re asking and if that provides any insight as to the state of the economy or the industry?

Karl Hass

What we’re seeing in the rent ups is pretty much consistent with what we’ve seen in the past. California properties rent up a lot faster than properties in the east and it really depends, we’ve had some that are performing great even in the east and we’ve had some that have had you know slower rent up. The rates are pretty much where we had projected them when we did our original projections and you know all in all there, if you take the whole package and wrap it together, it’s pretty much performing where we would have thought they would be performing.

Paul Adornato – BMO Capital Markets

And what’s your appetite for new developments, looking out perhaps 2009, 2010.

Kent Christensen

This is Kent, we’ve, our development team has constantly and continuing to work on new opportunities in the development area. Ken mentioned the 24 that are possibly opening this year and next year. In addition to those 24, we have another between 25 and 30 properties that are in our pipeline of openings in either 2009 or 2010 or 11. So that’s a program that’s still going full speed ahead.

Paul Adornato – BMO Capital Markets

And does switching to insurance, you mentioned that the tenant insurance program had some nice growth, is that just because of the larger pool of properties under management or is that greater penetration, greater sales on the part of [overlay].

Karl Hass

This is Karl, it really has been as a result of greater focus and which has resulted in much higher penetration.

Paul Adornato – BMO Capital Markets

And do you feel that you’ve plateaud there or do you have more to go in terms of penetration?

Karl Hass

We feel we have more growth, it won’t be at the same rate that we grew in 2007.

Paul Adornato – BMO Capital Markets

And what percentage of new customers get the insurance?

Karl Hass

It’s in the 60-70% range.

Paul Adornato – BMO Capital Markets

Okay, thanks very much.

Operator

As a reminder to ask a question please press star one. And your next question comes from the line of Paula Poskon with Robert W. Baird.

Paula Poskon – Robert W. Baird

Thank you, most of my questions have been answered, just a couple of follow ups. As you consider acquisition opportunities, do you see any difference in the seller’s expectations between those selling stabilized assets versus those selling lease up opportunities?

Kent Christensen

This is Kent, still to date we’re still, that would be an area where we would think that the expectations would change but starting about two years ago, a lot of properties came to market with the expectation of even though they were in lease up, sellers were expecting full value. And for the things that we are bidding on, once again these transactions haven’t closed, but we’ve been outbid on them. We’re putting a discount on properties where they’re in lease up but we’re being outbid and so that’s we’re, we still have not seen seller’s expectations change there. You would think that that would happen but we haven’t seen it yet.

Paula Poskon – Robert W. Baird

Thanks and then lastly, just to follow up on your commentary about the demand drivers and the stickiness of storage et cetera, to the extent that you are tracking this, are you seeing any bumps in demand from households combining in the swelling housing markets or from owners downsizing that are moving from homeownership back to rental.

Kenneth Woolley

I would say there’s so much noise in the data that it’s very difficult to separate that out. So you know it may be there but the noise is too great so I can’t answer that.

Paula Poskon – Robert W. Baird

Okay, thanks very much.

Kenneth Woolley

The one thing I can say is that we’re not seeing extraordinarily high move outs, we’re not seeing any change in move out rates than a year ago or two years ago.

Paula Poskon – Robert W. Baird

That’s helpful, thank you.

Operator

And your next question is a follow up from the line of Michael Knott with Green Street Advisors.

Michael Knott – Green Street Advisors

Hey guys, can you just touch again on the capital strategy. Let’s say in a poor case scenario the public market doesn’t reflect any change in values 12 months from now and debt markets are still challenging, how do you fund the development pipeline for 09 and 10, how would you strategize in that type of circumstance where equity is not appealing and debt is still challenging.

Kent Christensen

Well the, to answer your question, this is Kent again Mike, the capital needs for our development program for the next two years is as I said in my script, between $25-$35 million. So with the availability we have on the line of credit plus the properties that are unleveraged, it would cause our debt to total market cap to go up slightly but we could easily fund all of the development programs that we have in place right now.

The debt, and that assumes that we can get 80% leverage on those properties and as I also stated the appetite for the banks to do our development programs is substantial. We have numerous banks that would love to do our development program. We’re not having any push back. In fact we just closed on some loans in the last two weeks on our development program at the kind of rates that I’m talking about, very aggressive and very good terms on our development program. So that’s why the cash that we need to do this is very limited to the $25-$35 million which we have today.

Kenneth Woolley

But you know to further talk about that, that’s one of the reasons that we’re being very modest in our expectations for acquisitions this year. We view the development program as being much more important to our long term viability and growth as a company than the acquisitions and we can turn acquisitions on and off but once you get development going it’s harder to turn it off and if you turn it off, it’s harder to start it again. And it’s much more accretive in the long run for us than acquisitions.

Michael Knott – Green Street Advisors

Okay.

Operator

And your next question is a follow up from the line of John [Clowny] with Merrill Lynch.

Chris Pike – Merrill Lynch

Hey it’s Chris again, Kent sorry if I missed this earlier but with respect to the ARS position, so I guess from reading and understanding things right, the combined 1, 2 and 1,4 that is really with respect to Q4, correct?

Kent Christensen

What occurred is that the auction rates fell in August, by the end of December the brokerage house that we’re using to trade in these sent us a statement where they had determined that the securities had gone down in value as of December 31. We then subsequently received another statement from the brokerage house as of January 31 further showing a further reduction in the value of these securities.

Of those securities, we reviewed them with our auditors and with the brokerage house and determined that some of them might have an impairment that should run through the income statement while others of them should have only a temporary impairment and that’s why the total amount of the statement that we received from our brokerage house as of January 31 has been written down, part of it through earnings, part of it as a temporary impairment. This is a very fluid issue, the accountants and Extra Space and I think everybody is trying to deal with what it is, is actually happening here. This is our best assessment right now as to where the market is today.

Chris Pike – Merrill Lynch

Okay because I guess, just in thinking about it, it’s really come to the forefront of economic news headlines within the last few weeks or so and I just want to make sure that we’re thinking about all future expectation with respect to any further write downs. And I guess did this impact the P&L, is it an other income, through the other income line item? Where exactly does it hit the P&L?

Kent Christensen

It’s in other income.

Chris Pike – Merrill Lynch

Okay, so once again, so this 1, 4 of temporary charges or temporary impairments, that could get reversed or what [overlay].

Kent Christensen

If we’re ultimately able to liquidate this security at face value, then everything that we’ve just recorded would be unwound, the $1.4 million would be re-reversed off the balance sheet and the $1.2 million would be reversed back through the income statement, if we’re able to come to a resolution and we’re able to somehow unwind these securities. Not knowing how the ultimate outcome of that’s going to be cause us to make the entries that we did.

Kenneth Woolley

Let me emphasize that we wrote them down on December 31 to the January 31 value, not the December 31 value.

Chris Pike – Merrill Lynch

That’s what I was trying to get to Ken, so to the extent there’s any other write downs between Jan 31 and now, that’s just a wait and see [overlay].

Kenneth Woolley

Well yeah I mean we don’t have a new number from January 31 so we wrote down everything we knew as of the end of the year.

Chris Pike – Merrill Lynch

Okay, okay sir, thank you very much.

Operator

And this concludes our question and answer session, I’ll now turn the call back over to Mr. Ken Woolley for closing remarks.

Kenneth Woolley

Thank you everybody for joining our call, we appreciate your interest in our company and we look forward to talking to many of the analysts and our investors in the coming months. And we’re also kind of looking forward to the new year. It’s staring out well for us and we’re happy about that and we do appreciate the support of all of our shareholders to our company. And we’ll end with that comment, thank you.

Operator

And thank you for your participation in today’s conference, this concludes the presentation and you may now disconnect. Good day.

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Source: Extra Space Storage, Inc. Q4 2007 Earnings Call Transcript
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