Storage REITs: Keep The Change

Summary

• Self-storage REITs - once the darlings of the real estate sector following a half-decade-stretch of relentless growth - stumbled into the 2020s with challenged fundamentals and a strained outlook.
• Storage demand is driven by "change", and there's been no shortage of that amid the pandemic. Self-storage REITs have delivered notable outperformance relative to other real estate sectors this year.
• With rent collection above 95%, self-storage demand has proven to be quite "sticky," consistent with trends of the prior Financial Crisis. Rents are essentially "collateralized" by a renter's possessions.
• Supply growth, which had weakened self-storage fundamentals over the last half-decade, is poised to finally cool considerably. Acquisition and consolidation opportunities should be plentiful over the next decade.
• Leasing volumes slowed amid the pandemic with a plunge in “move-ins” offset by similarly low “move-outs.” With limited visibility or precedent, the next quarter's earnings results will be especially consequential.
• This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

REIT Rankings: Self-Storage

(Hoya Capital Real Estate, Co-Produced with Brad Thomas)

Self-Storage REIT Sector Overview

"Change" is proving to be a good thing for self-storage REITs, which stumbled into the 2020s with challenged fundamentals and a strained outlook but have delivered notable outperformance amid the coronavirus pandemic. In the Hoya Capital Self-Storage REIT Index, we track the five largest self-storage REITs, which account for roughly $60 billion in market value: Public Storage (PSA), Extra Space (EXR), CubeSmart (CUBE), Life Storage (LSI), and National Storage Affiliates (NSA). While we focus this report on these consumer-focused storage operators, we also track business storage REIT Iron Mountain (IRM), which also operates a small portfolio of data centers.

There are roughly 50,000 self-storage facilities in the United States, and proximity to one's home (generally 3-5 miles) is cited as the most important feature. Roughly, one in ten US households rent a self-storage unit, and 70% of self-storage customers are residential, with the other 30% split between businesses, students, and the military. While all five REITs own fairly well-diversified portfolios across the country, we note the geographic and quality focus of the five REITs below. The three largest REITs - Public Storage, CubeSmart, and Extra Space - operate relatively high-rent portfolios in primary markets, while Life Storage and National Storage Affiliates operate facilities with generally lower rents in secondary and tertiary markets.

Who paid the rent? While self-storage REITs were quiet when it came to providing pre-earnings updates, ultimately, nearly all current renters paid their April and May rents. With rent collection above 95%, self-storage demand has proven to be quiet "sticky," consistent with trends of the prior Financial Crisis. As the popular reality show Storage Wars has highlighted, rents are essentially "collateralized" by a renter's stored possessions, and unpaid rents typically result in the repossession and auction of the goods contained within the storage locker. During the Financial Crisis, self-storage occupancy levels declined roughly 2-3% compared to the 6-8% average declines seen in other more economically-sensitive REIT sectors, including retail, industrial, and office.

However, as we'll discuss in more detail below, rent collection may only tell part of the story, and we caution that there were some moderately unsettling developments below the surface that introduce near-term uncertainty. Leasing volumes slowed considerably during the pandemic with a nearly 25% plunge in "move-in" rates during April even as self-storage facilities were considered "essential" businesses in essentially all U.S. jurisdictions. This decline in move-in rates, however, was mostly offset by a 15% decline in move-out rates, but the net direction of the "pent-up" activity remains a question mark. Storage REITs have again been quiet in providing updates, and with limited visibility or precedent, the next quarter's earnings results will be especially consequential.

Deeper Dive: Self-Storage Industry Fundamentals

As we'll discuss throughout this report, while near-term risks remain, our longer-term outlook remains favorable as we see opportunity amid the recent industry struggles as these REITs can begin to assert their competitive advantage in access to equity capital to fuel accretive external growth. The storage industry remains a highly fragmented industry, and these five REITs own roughly 20% of the total square footage in the US, and we believe that industry consolidation is one of the key potential drivers of self-storage outperformance in the next decade. Revenue management technology, brand value, and cost of capital have historically given these REITs a competitive advantage over private market competitors and smaller brands.

Importantly, self-storage REITs operate with some of the most well-capitalized balance sheets across the real estate sector. As discussed in our recent report, Cheap REITs Get Cheaper, consistent with the persistently "winning factors" exhibited by the REIT sector over the last decade discussed in the prior report, higher-yielding, higher-leveraged, and "inexpensive" REITs have declined nearly twice as much as their lower-yielding, lower-leveraged, and more "expensive" counterparts. All five consumer-focused storage REITs operate with debt ratios that are below the REIT sector average of 43%, led by Public Storage, which operates with perhaps the most conservative balance sheet within the REIT sector with one of the few, coveted "A-rated" long-term bonds.

Additionally, the operating efficiency of the self-storage business is second to none in the real estate sector, commanding some of the highest NOI margins in the real estate space at over 70% while requiring minimal ongoing capital expenditures to maintain the facilities. A double-edged sword for asset owners, including REITs, the ease and efficiency at which operators can enter the market have resulted in a wave of speculative supply growth coming online over the last half-decade, a large chunk of which has come from developers with limited previous experience in the self-storage business. For this reason, we believe that acquisition and consolidation opportunities should be plentiful over the next decade for these storage REITs as the weaker operators are "shaken out" by potential dislocations resulting from the coronavirus crisis.

On the demand side, self-storage units are the "Hotel California" of the real estate sector: once you're checked in, "you can never leave." Nearly half of renters stay longer than two years, and about a quarter rent for at least a decade. Demand is driven by growth in household formations and underlying change within these households. Boomer downsizing, an increase in moving rates, and demographic-driven demand in key age cohorts have been demand catalysts that we expect to continue well into the 2020s, regardless of the course of the pandemic. Often viewed as an extension of the residential sector due to high correlations with multifamily and single-family fundamentals, self-storage REITs comprise roughly 5-8% of the broad-based "Core" REIT ETFs and also comprise roughly 3-4% of the Hoya Capital Housing 100 Index, which tracks the performance of the United States housing industry.

Self-Storage REIT Stock Performance

The darlings of the REIT sector from 2010 through 2015, self-storage REITs were perhaps the best-kept secret within the REIT investment community in the immediate post-recession period, but have fallen on tougher times over the past half-decade as developers and new operators have flocked to the sector and added new supply at a furious rate, weakening fundamentals and resulting in relatively disappointing performance. A little "change" may have been exactly what the doctor ordered for the self-storage REIT sector, which has proven to be an unexpected leader this year following a half-decade of lukewarm performance. Self-storage REITs are lower by just 8.4% so far in 2020 compared to the 17.7% decline on the broad-based commercial Real Estate ETF (VNQ) and the 1.7% decline by the S&P 500 ETF (SPY).

Low balance sheet leverage, high operating margins, and limited economic sensitivity of rental demand have been in-demand attributes within the REIT sector amid a time of immense economic uncertainty. Below, we present a framework for analyzing the REIT property sectors based on their direct exposure to the anticipated COVID-19 effects as well as their general sensitivity to a potential recession and impact from lower interest rates. Within the COVID-19 sensitivity chart, we note that storage REITs are among the four sectors with the lowest direct COVID-19 sensitivity (along with cell tower, data center, and industrial REITs), and are also one of the least sensitive sectors to general economic conditions. As mentioned above, self-storage demand has proven to be quite "sticky" even during the depths of the prior Financial Crisis.

Performance this year has followed a near-perfect correlation with market capitalization - and balance sheet quality - as sector stalwart Public Storage has led the way, followed by Extra Space and CubeSmart. Over the last five years, however, small-cap National Storage - which focuses on secondary and tertiary markets which have seen more muted supply growth - has been the top-performer in the sector with average annualized returns of 16.6% since 2016, followed by Extra Space with average returns of 5.5%. The other four REITs in the sector, however, have trailed the 4.8% average annualized total returns of the NAREIT All Equity REIT index.

Investors willing to forego some upside potential but capture a relatively steady stream of income have the option of going the "preferred route." Two of the six REITs offer preferred securities, tracked in our new iREIT Preferred REIT & Bond Tracker. These include a suite of thirteen preferred issues from Public Storage (PSA.PB, PSA.PC, PSA.PD, PSA.PE, PSA.PF, PSA.PG, PSA.PI, PSA.PW, PSA.PX) and one from National Storage (NSA.PA). All of the issues are standard cumulative redeemable preferred securities that currently trade with an average yield of roughly 5.1% and trade at modest premiums to par value. These fourteen issues are roughly flat on the year, outperforming their respective common issues by an average of 7.8% in 2020.

Fundamental Performance of Self-Storage REITs

Heading into the coronavirus outbreak, self-storage fundamentals were among the softest in the REIT sector but showing some signs of stabilization. Charting the same-store NOI performance against the broader REIT average, we note the meteoric rise and subsequent sharp dip in NOI growth in the self-storage sector. After producing REIT-leading NOI growth above 10% in late 2016, same-store NOI growth has underperformed the REIT sector average in two straight years. While the self-storage REIT sector has historically shown a high degree of correlation with the residential REIT sector, the performance of the two categories has diverged since 2018 with residential REITs now seeing some of the strongest same-store NOI growth across the real estate sector.

Record levels of self-storage construction spending from 2015 to 2019 - translating into a roughly 25-30% rise in total self-storage supply over this time - has led to intense price competition among operators. The lack of new supply in the storage sector was the driving force behind the sector's significant outperformance early in the decade, and while supply growth appears to have peaked in 2018, deliveries are expected to remain elevated through at least 2020. A slowdown in self-storage supply growth should be expected during and in the aftermath of the COVID-19 outbreak by suppressing speculative development, which may help to alleviate some more acute oversupply issues in the self-storage sector over the next several years.

As mentioned, there may be opportunity amid this period of disruption for the self-storage REIT sector, which has historically been more active acquirers among REIT sectors. External growth via acquisitions has explained a significant percentage of FFO growth over the last decade, and with minimal same-store organic growth, investors will look to external growth to shoulder even more of the "growth burden" in the early part of the next decade. On recent earnings calls, even before the coronavirus pandemic, REIT executives had discussed the expectation that many of the weaker operators and more opportunistic developers will be willing sellers over the next few years given the intense competition, allowing these REITs to scoop up assets at attractive valuations. Self-storage REITs acquired $2.3 billion in net assets over the last twelve months, one of the few REIT sectors that remain "net buyers."

Core FFO growth, which rose by more than 13% from 2013 to 2016, continues to decelerate across the sector, but the extent of the decline is not as significant as once feared. Boosted by this accretive external growth, core FFO rose by 2.6% in 2019 and was expected to rise by roughly 2% in 2020 based on pre-COVID-19 guidance. Before withdrawing guidance, National Storage and Life Storage projected the strongest rates of growth, reflecting the limited supply pressures in lower-tier markets. We continue to see industry consolidation as a key long-term growth opportunity for self-storage REITs, which we believe command competitive advantages through their brand value, operating efficiency, and superior technology platforms.

Valuation & Dividend Yield of Storage REITs

Once exclusive to the realm of "Growth REIT" investors, self-storage REITs have increasingly caught the attention of yield-oriented investors as dividend yields have swelled, while valuations have come back towards the REIT sector average. Relative to other REIT sectors, self-storage valuations are roughly in line with the REIT sector average based on forward AFFO. Storage REITs pay out roughly 70% of their available cash flow, leaving a decent-sized buffer before potentially being required to cut dividends in the event of a significant coronavirus-related negative impact.

Speaking of dividend cuts, self-storage REITs have been one of the only property sectors that have been completely unscathed by the wave of coronavirus dividend cuts. We have now tracked 58 equity REITs - primarily retail and lodging REITs - out of our universe of 165 that have now announced a cut or suspension of their common dividend, roughly a third of the equity REIT sector. Absent a second-wave of widespread economic lockdown, we believe that the five consumer-focused self-storage REITs can continue to pay dividends at current levels, but payout levels will likely be further stretched.

Within the sector, among the consumer-focused storage REITs, we note that CubeSmart pays the highest yield at 4.7%, followed by National Storage and Life Storage at 4.6% and 4.4%, respectively. Business storage REIT Iron Mountain pays a yield of 9.4% but does so with a payout ratio at-or-above 100%, and thus is at the highest risk of a dividend reduction. In our recent report, "The REIT Paradox: Cheap REITs Stay Cheap", we discussed our study that showed that lower-yielding REITs in faster-growing property sectors with lower leverage profiles have historically produced better total returns, on average, than their higher-yielding and higher-leveraged counterparts.

Reasons to Be Bullish & Bearish on Self-Storage REITs

Below, we outline five reasons why investors are bullish on self-storage REITs.

Below, we outline the reasons why investors are bearish on self-storage REITs.

Key Takeaways: "Change" Can Be Positive Catalyst

Storage demand is driven by "change", and there's been no shortage of that amid the pandemic. Self-storage REITs have delivered notable outperformance relative to other real estate sectors this year. With rent collection above 95%, self-storage demand has proven to be quite "sticky," consistent with the depths of the prior Financial Crisis. Essentially an extension of the residential sector - perhaps the most "essential" of all property sectors - the demographic-driven demand in multifamily and single-family housing bode well for a continued recovery into the 2020s once supply growth returns to "normal" levels a trend that should be accelerated by the pandemic.

Near-term risks remain, however, as leasing volumes slowed considerably amid the pandemic with a plunge in "move-in" rates offset by similarly low "move-out" rates. With limited visibility or precedent, the next quarter's earnings results will be especially consequential and potentially volatile. Our longer-term outlook remains favorable as we see opportunity amid the recent industry struggles as these REITs can begin to assert their competitive advantage in access to equity capital to fuel accretive external growth.

If you enjoyed this report, be sure to "Follow" our page to stay up to date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Manufactured Housing, Student Housing, Single-Family Rentals, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Hotels, Billboards, Office, Storage, Timber, Prisons, Real Estate Crowdfunding, and REIT Preferreds.

Disclosure: Hoya Capital Real Estate advises an Exchange Traded Fund listed on the NYSE. In addition to the long positions listed above, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. Real Estate and Housing Index definitions and holdings are available at HoyaCapital.com.

Analyst’s Disclosure: I am/we are long HOMZ, PSA, CUBE, EXR. 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.

It is not possible to invest directly in an index. Index performance cited in this commentary does not reflect the performance of any fund or other account managed or serviced by Hoya Capital Real Estate. All commentary published by Hoya Capital Real Estate is available free of charge and is for informational purposes only and is not intended as investment advice. Data quoted represents past performance, which is no guarantee of future results. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy.

Comments

[TagHoyer]

The move in/move out data seems to suggest a reduction in the demand for self storage which goes against the conventional wisdom that during downturns, people need to store their belongings as they downsize. Yes, but....if they can afford to.

How long will this will crazy craze of building and leasing self storage units go on until the excess profits are arbitraged away by building more of them. When the occupancy goes up, then the self storage units send you a letter raising your rent...when the occupancy goes down, then rents go down for newcomers, so established tenants/renters still pay the higher rent or move their belongings to a new unit, even in the same building to obtain the new rate. I have heard of people successfully complaining and having their rent reduced to the new rate without having to move their belongings.

I am thinking about other growth stories that ended and there really isn't one that is similar to self-storage. Maybe something will come out of the blue in which self storage units can no longer use the renters' contents as collateral, and they have to go through eviction process like other landlords which would really undermine the business model. Or zoning problems will come up as municipalities will figure out self storage provide very little employment for the amount of land they use up.

As years go by, and people store more and more paper records in the cloud, that might reduce demand, however surprisingly that has not had an impact yet as best I can tell.
I am a renter for a storage unit, and love the convenience of not having clutter in my residence, and belongings in a climate controlled nice place, however I consider it a luxury that I am grateful I can afford. However, it is a 'luxury' and I do wonder from an investment standpoint, how long purchasing stocks in this segment will be so profitable.
I do like investments that are NOT labor intensive, such as self-storage, royalty streaming companies, IT companies (Twitter/Facebook), come to mind as labor exposes a company to health insurance liabilities, lawsuits from employees, etc. However, market efficiencies may make stock prices in these areas already reflecting these realities of reduced labor exposures. Maybe there should be a mutual fund that concentrates on low number of employees per earnings per share.

[rcsam]

Americo (UHAL) is becoming a storage REIT. They are spending $1.3B/yr on storage facilities. The Uhaul franchise is a feeder for storage. It is closely held company but will one day spin out the storage facilities into a REIT. They are already big enough to do that.

[TagHoyer]

@Rcsam
Does seem like a natural for UHAL to be in self storage business; ? synergy. Thank you for the idea.

[jsmjsmjsm]

Thank you for writing such a great article full of useful insights!
I do have a question regarding your analysis, "how was COVID sensitivity analyzed?"

[Hoya Capital]

Thanks, @jsmjsmjsm.

While the Economic and Interest Rate sensitivity were quantitatively-driven (Beta), naturally the COVID sensitivity was a more qualitative approach that considered things like lease structures and "social distancing" factors.

We created it right at the outset of the pandemic and has proven to be pretty foretelling. We did make one adjustment to Casino/Gaming upon further review of the sector (we hadn't previously covered the sector) which was noted in our Casino REIT piece this week.

[jsmjsmjsm]

Thank you so much for your response. Can there be an interview meeting opportunity with you or anyone who conducted the covid sensitivity analysis by any chance?
(monetary fee will be provided if necessary)

[Macomber T]

Bought some of your advice today LADR- I think was it, thank you again, I just know you make me money. Your awesome

[TagHoyer]

@convoluted
@EdT.cpa_Retired
Last week, I did receive a letter from the self storage that they are increasing my rent...so I guess at least, they are doing ok.
I store both business and personal items in the same unit.

[Hoya Capital]

Thanks @TagHoyer.

[Suraj Bang]

Thanks for a great article, very well covered...
I have a question.. Over 70% tenants are residential and historically, we have seen the cor-relation between residential and self-storage.. As we can see a residential shift from urban to the sub-urban areas, do you think a geographic diversification with higher weightage towards Sunbelt rather than the coastal areas will be more beneficial going forward for self-storage players?

[mikejack]

About one year ago Extra Space Storage (EXR) bought out all of the locally (?) owned Guardian Storage facilities in the area. My daughter had a 10x10 indoor unit that was rented for $90/mo in 2016 and the rent increased in steps to $120/mo in 2019.
She just received a notice from EXR that the rent will be $143/mo starting in August - that's a 19% increase!
Fortunately, she just moved into a larger apartment and cleared out her storage unit a few weeks ago.
I purchased EXR when they took over the Guardian Storage and plan to hold on.
19% increase, that's crazy!

[spanish moss]

Do you, @bradthomas or @Hoya have any thoughts about JCAP... and do you consider it an eREIT or an mREIT. Well done article... thank you!

[Hoya Capital]

JCAP is an mREIT. We were going to write a section on JCAP in this report, but with other newsflow - and the addition of preferred coverage in this report, it will be in the next self-storage report.

We cover mREITs more extensively on iREIT on Alpha with @Brad Thomas. Link to Free 2-Week Trial: seekingalpha.com/...

[Greg_Maryland]

JCAP has recently changed from a developer to an owner (and 3rd party) operator. Happened when they cut the dividend.

[firsTraveler]

Storage should be very busy when the "stay past lease ends" orders run out (assuming they do).

[user1416]

LSI just completed a new facility near me (northern Calif). They bought an old auto dismantling yard that had little value, put a wall around the perimeter and built a nice facility. Right next to a new residential development under construction by Lennar and Meritage.

I think LSI has more runway in Calif and will continue to follow housing.

I do worry about storage revs though. They may be collecting 95% of rents, but all of them also seem to be discounting and running specials. It's going to show up sooner or later, long EXR and LSI.

[TagHoyer]

@user1416
That is correct....how long will this will crazy craze of building and leasing self storage units go on until the excess profits are arbitraged away by building more of them. When the occupancy goes up, then the self storage units send you a letter raising your rent...when the occupancy goes down, then rents go down for newcomers, so established tenants/renters still pay the higher rent or move their belongings to a new unit, even in the same building to obtain the new rate. I have heard of people successfully complaining and having their rent reduced to the new rate without having to move their belongings.

I am thinking about other growth stories that ended and there really isn't one that is similar to self-storage. Maybe something will come out of the blue in which self storage units can no longer use the renters' contents as collateral, and they have to go through eviction process like other landlords which would really undermine the business model. Or zoning problems will come up as municipalities will figure out self storage provide very little employment for the amount of land they use up.

As years go by, and people store more and more paper in the cloud, that might reduce demand, however surprisingly that has not had an impact yet as best I can tell.

I am a renter for a storage unit, and love the convenience of not having clutter in my residence, and belongings in a climate controlled nice place, however I consider it a luxury that I am grateful I can afford. However, it is a 'luxury' and I do wonder from an investment standpoint, how long purchasing stocks in this segment will be so profitable.

I do like investments that are NOT labor intensive, such as self-storage, streaming companies, IT companies (Twitter/Facebook), come to mind as labor exposes a company to health insurance liabilities, lawsuits from employees, etc. However, market efficiencies may make stock prices in these areas already reflecting these realities. Maybe there should be a mutual fund that concentrates on low number of employees per earnings per share.

[William Darusmont]

Brad, well done analysis. I am long PSA and having just downsized, a renter. FYI I just got my bill with 3% increase which should tell us something. Life Storage should get an award for honest advertizing. Also for their stock symbol initials of Lear Siegler!

[EliasMouawad]

@William Darusmont What is the probability that PSA engages in an acquisition in 2020 ?

[William Darusmont]

Dunno...good question.

[Arimnestos]

EXR is the best operator, but I'm not real excited about their balance sheet. PSA has junky assets and is not a great operator, but their balance sheet is border line bullet proof. I took a position in PSA at about 180 and would add below 170.

[EdT.cpa_Retired]

PSA-J?

[Hoya Capital]

Thanks, @EdT.cpa_Retired yes that was just added to the Preferred Tracker. We missed a few of the newest issues in the initial aggregation.

[Greg_Maryland]

Nice note. Long JCAP-B.

[Hoya Capital]

Thanks, @Greg_Maryland!

[thebrucemac]

I'm looking for SWANs. In this sector I purchased PSA for a retirement portfolio.

[Hoya Capital]

The PSA Preferreds may be interesting to look at as well.

We track all 175 REIT Preferred and Baby Bond issues for iREIT on Alpha subscribers with @Brad Thomas.

Link to 2-Week Free Trial Here: seekingalpha.com/...

[TagHoyer]

I just received a letter from my self storage facility of notice of a rent increase for my unit. I would like to invest in this segment, however I am always nervous about putting new money to work in a sector that has done so well for so many years. Buying high, and selling higher (momentum investing) works for some.

[Hoya Capital]

Interesting, thanks for sharing @TagHoyer.

[malaparte]

And what happens in the next 10-15 yrs as the Baby Boom generation, the largest users of storage die out. Seems the generations that are following either don't appreciate their parents belongings, don't want much as they've already possess a lot of stuff or are too broke to spend on storage

[TagHoyer]

@malaparte
It is interesting to think about what will happen to all the storage units...will they be converted to office space....someone will come up with this new idea of NOT WORKING FROM HOME, and to have a place where people can collaborate in person as being more effective....a whole generation from now...there will be television segments about the advantages of working in an office with other people.....just like today the television segments are on the opposite.
At some point it does seem like this crazy craze of self storage units opening on every street corner...actually intermittently lining entire boulevards has to end. Maybe self storage is a bubble bubble. Perhaps if the Empire State Building becomes a mega-self storage place, then we will know we are at a top of the self storage bull market.

[Hoya Capital]

It's important to seperate-out the age-effects vs. the generational effects.

We haven't seen any compelling evidence that younger cohorts are less likely to become self-storage renters as they age into the demographic profile that utilizies self-storage with higher frequency.

That said, in the past, we've discussed how there seems to be a lack of good, reliable customer profile data - at least any that is publicly available. We've been critical of PSA and others for not knowing basic demographic information about their customer base in responses to questions on earnings calls.

[Iggy_de_la_Varga]

I thought I read somewhere that young to middle-age woman are the largest self storage rental demographic? Never having rented a self storage locker I do not know if sex age marital status etc information is part of the application but it would be easy to collect such data, that seems like a major shortcoming if ss managements do not know that date just from the point of view of marketing

although maybe income, housing options, and population density are more important?