REIT Rankings: Self Storage

Apr. 12, 2017 1:02 PM ETPublic Storage (PSA)CUBE, EXR, IEF, IYR, LSI, SPY, VNQ30 Comments

Summary

  • After an uncharacteristic down-year in 2016, the perennial outperforming Self Storage sector has regained its 'mojo' in 2017. The sector has gained 6% this year, outpacing the REIT index.
  • Self-storage was the worst performing real estate sector in 2016, declining 13%. Our "Dogs of the REIT" study published earlier this year theorized that the sector would outperform in 2017.
  • Q4 earnings were generally solid. Demand remains healthy, but rent growth has decelerated as supply growth has exceeded 2-3% of inventory.
  • Across the sector, NOI growth has declined from roughly 8% in 2015 to 6% in 2016. Guidance projects roughly 4% growth in 2017. Occupancy remains near peak levels.
  • We update our “REIT Rankings,” and use various metrics to compare the self-storage REIT sector against other REIT sectors and recap recent developments and performance over the past quarter.

REIT Rankings Overview

In our "REIT Rankings" series, we introduce readers to one of the 13 REIT sectors. We rank REITs within the sectors based on both common and unique valuation metrics, presenting investors with numerous options that fit their own investing style and risk/return objectives. We update these rankings every quarter with new developments for existing readers.

We encourage readers to follow our Seeking Alpha page (click "Follow" at the top) to continue to stay up to date on our REIT rankings, weekly recaps, and analysis on the REIT and broader real estate sector.

Self-Storage Sector Overview

Self-storage REITs comprise roughly 8% of the REIT Indexes (VNQ and IYR). Within our market-weighted self-storage index, we track the four largest self-storage REITs within the sector, which account for nearly $60 billion in market value: CubeSmart (CUBE), Extra Space Storage (EXR), Public Storage (NYSE:PSA), and Life Storage (LSI).

Above we show the size, geographical focus, and quality focus of the four self-storage REITs we track. "Quality" is determined by the average value of the self-storage facilities within the portfolio and the REIT's use of leverage, among other factors.

Roughly one in ten Americans currently rent space in a self-storage facility. These 30 million Americans park their possessions in one of 55,000 self-storage facilities throughout the country. Proximity to one's home is cited as the most important feature of these 100 square feet of space. 70% of customers are residential, with the other 30% split between businesses, students, and the military. Nearly half of self-storage customers rent their unit for more than two years.

The robust demand for space in these facilities has been accelerating over the past decade as homeownership rates dip to record lows. Self-storage demand is driven by change: moving houses, going to college, having kids, changing styles, and getting older, to name a few.

Americans have been going through more "change" than in the past. The "rent-by-choice" preference that began after the housing crash of the recession shows few signs of reversing and homeownership is currently near multi-decade lows. While homeowners can use their garage and basement for their storage needs, renters rarely have that luxury. Rental rates for small storage units are often cheaper than their cable bill, so for constant movers, it makes economic sense to store furniture and valuables that are casualties of a slightly smaller apartment unit but may see new life at the next rental unit.

While demand for self-storage units over the past decade has been robust, supply had lagged considerably until 2014. Investors in self-storage REITs have enjoyed this supply/demand imbalance as market rental rates for existing units have increased by over 10% per year in many major markets.

Supply has been increasing considerably over the past three years, though. Roughly 600-800 facilities were built in 2016, with another 1000 coming online in 2017 and 2018. New supply growth is estimated to be 2.5% of existing supply per year over the next two years and as high as 3% of existing supply through 2020.

Finally, investors should note that self-storage REITs own just a tiny portion of the total self-storage real estate market, leaving open significant potential for growth via acquisition. Self-storage REITs exhibit significant franchise or "brand" value, which is atypical in the REIT universe. Brand-name facilities like Public Storage and Extra Space tend to command higher rents than off-brand facilities.

Recent Developments and Performance

Storage REITs have been among the best-performing REIT sectors so far in 2017. Storage REITs are up 6.4% over the past quarter, outpacing the broader REIT index by 4%.

Q4 earnings were generally in line with or slightly better than expectations. Of the four self-storage REITs, one beat consensus expectations, while three were in line (CUBE, LSI, PSA). While most other REIT sectors reported disappointing guidance, storage REITs were generally slightly better than expected.

NOI growth continues to decelerate from double-digit levels in 2014 but remains at relatively high levels compared to other real estate sectors. CubeSmart reported the highest NOI growth at 8.1%, followed by Extra Space at 7.9%, Public Storage at 5.1%, and Life Storage at just 3.7%. NOI growth for 2017 is expected to average 4% across the sector.

On conference calls, several key themes are being discussed. First, the supply pipeline has heated up considerably, which has put downward pressure on rental growth. The lack of new supply in the storage sector was the driving force behind the sector's significant outperformance in recent years. Unlike the apartment sector, supply growth data in the storage sector is scare, so visibility is limited. We expect about 2.5% per year of new supply growth through 2020, given our expectations for higher construction costs. We believe this would be a healthy growth rate that would allow storage REITs to continue to grow FCF 5-9% per year.

Second, rent rises for new customers have softened, and many storage REITs have been forced to offer discounts to these new customers. Turnover remains very low, though, as the price sensitivity of existing customers remains relatively constant. Frankly, customers are slow or outright unwilling to recognize a sunk cost. After paying hundreds of dollars to store their belongings, storage customers find it difficult to take the loss and clear out their storage unit.

Below is our REIT Heat Map, showing the quarterly performance in relation to other sectors. As we mentioned, storage REITs have outperformed the broader REIT index over the prior quarter. We also highlight the strength in the S&P 500 (SPY) and the decline in the 10-Year Yield (IEF).

Valuation of Storage REITs

Compared to the 12 other REIT sectors, storage REITs appear fairly cheap, trading at slight discounts to the REIT averages. Storage REITs are the fifth cheapest sector on both current and forward Free Cash Flows. When we factor in two-year growth expectations (expected to average roughly 5% per year), the sector appears more attractive.

(Hoya Capital Real Estate estimates, Company Filings)

Storage REITs traded at premiums to the broader REIT market for much of the past seven years. The premium expanded considerably beginning in early 2015 and swelled to almost 5x FCF. This premium, along with a 30%+ premium to Net Asset Value, allowed these REITs to acquire smaller storage portfolios accretively, which helped fuel their outperformance in recent years. This premium entirely vanished after the sell-off in late 2016. Storage REITs are currently trading at a slight discount to the REIT sector despite their above-average growth expectations.

Within the sector, all four names appear fairly attractive at these levels relative to other REIT sectors. We see CUBE and LSI as the best value at these levels.

Sensitivities to Equities and Interest Rates

Followers of our research know that we put a lot of emphasis on factor analysis, specifically looking at how REITs have historically responded to changes in the broader equities market, interest rates, and to movements in the REIT index itself. We believe it is critical that investors understand how their investments will respond in different economic environments.

Using our Beta calculations, we see that self-storage REITs tend to trade very much in-line with the broader REIT average. As a whole, they are neither bond-like nor equity-like and fit into what we call the "Hybrid REIT" category.

Within the sector, we classify the four names as either Yield, Growth, or Hybrid REITs based on our calculations. CUBE, PSA, and EXR show more equity-like properties and fall into the Hybrid REIT category, while LSI exhibits more bond-like qualities and falls into the Yield REIT category.

Dividend Yield and Payout Ratio

Based on dividend yield, storage REITs rank right in the middle, paying an average yield of 3.8%. Storage REITs pay out 80% of their available cash flow.

Within the sector, we see that Life Storage pays the highest yield at 4.5%, but is also expected to see the slowest growth over the next several years.

Bottom Line

Earlier this year, we published a study which examined a contrarian approach to REIT investing. "A Contrarian Strategy To Crush The Index."

The "Bottom 4" sectors of 2016 were Self-Storage, Retail, Residential, and Healthcare. Three of these four sectors have outperformed the index in 2017. An equal 25% weighting in each sector would have produced an average return of roughly 3%, topping the REIT index return of 2.4%. We will continue to monitor this hypothetic portfolio throughout the year.

After an uncharacteristic down-year in 2016, the perennial outperforming Self Storage sector has regained its mojo in 2017. The sector has gained 6% this year, outpacing the REIT index. Q4 earnings were generally solid. Demand remains healthy, but rent growth has decelerated as supply growth has exceeded 2-3% of inventory. Across the sector, NOI growth has declined from roughly 8% in 2015 to 6% in 2016. Guidance projects roughly 4% growth in 2017. Occupancy remains near peak levels.

We aggregate our rankings into a single metric below, the Hoya Capital REIT Rank. We assume that the investor is seeking to maximize total return (rather than income yield) and has a medium to long-term time horizon. Valuation, growth, NAV discounts/premiums, leverage, and long-term operating performance are all considered within the ranking.

We currently view CubeSmart as the most attractive REIT within the sector, followed by Life Storage and Public Storage.

Please add your comments if you have additional insight or opinions. Again, we encourage readers to follow our Seeking Alpha page (click "Follow" at the top) to continue to stay up to date on our REIT rankings, weekly recaps, and analysis on the REIT and broader real estate sector.

This article was written by

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Disclosure: I am/we are long PSA, EXR, CUBE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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