Life Storage's (LSI) CEO Joe Saffire on Q2 2021 Results - Earnings Call Transcript

Life Storage, Inc. (LSI) Q2 2021 Earnings Conference Call August 4, 2021 9:00 AM ET

Company Participants

David Dodman – Senior Vice President-Investor Relations and Strategic Planning

Joe Saffire – Chief Executive Officer

Andy Gregoire – Chief Financial Officer

Conference Call Participants

Juan Sanabria – BMO Capital

Jeff Spector – Bank of America

Smedes Rose – Citi

Samir Khanal – Evercore

Ki Bin Kim – Truist

Todd Thomas – KeyBanc Capital Markets

Operator

Good morning, ladies and gentlemen, and welcome to the Life Storage Second Quarter Earnings Release. [Operator Instructions] It is now my pleasure to turn the floor over to your host, David Dodman, Senior Vice President, Investor Relations and Strategic Planning. Sir, the floor is yours.

David Dodman

Good morning, and welcome to our second quarter 2021 earnings conference call. Leading today’s discussion will be Joe Saffire, Chief Executive Officer of Life Storage; and Andy Gregoire, Chief Financial Officer. As a reminder, the following discussion and answers to your questions contain forward-looking statements. Our actual results may differ from those projected due to risks and uncertainties with the company’s business. Additional information regarding these factors can be found in the company’s SEC filings. A copy of our press release and quarterly supplement may be found on the Investor Relations page at lifestorage.com.

Also as a reminder, during today’s question-and-answer session, we ask that you please limit yourself to two questions to allow time for everyone who wishes to participate. Please requeue with any follow-up questions thereafter.

At this time, I’ll turn the call over to Joe.

Joe Saffire

Good morning, and thank you for joining today’s call. I’m very pleased to report another outstanding quarter. Demand continues to be strong across our footprint, driving significant margin expansion as we maintain record occupancy, strong pricing power and disciplined cost control. With this strong demand, we achieved average quarterly occupancy that was 420 basis points higher than last year. We grew occupancy 170 basis points during the second quarter. This has allowed us to be more aggressive with rates, which has helped to drive an increase in net effective rates by more than 50% through the end of June.

Our footprint continues to expand through both acquisitions and third-party management as we leverage our deep relationships. The vast majority of our acquisitions were off market, including 13 stores from our third-party management portfolio through the first half of 2021. We closed on a record $534 million of wholly owned acquisitions through the first half of this year, already matching our total acquisition volume of last year. These acquisitions are expected to generate a blended year one cap rate of 4.5% and represent a nice mix of markets and maturity with almost one-third in lease-up and roughly 70% in the Sunbelt region.

In addition to $22 million of closed acquisition, subsequent to the quarter end as well as an additional $80 million currently under contract, we have a strong late-stage pipeline of attractive opportunities that our team continues to work on. Our third-party management portfolio totalled 340 stores at quarter end, and we added 19 more stores in July as owners and developers are attracted to our operating performance and innovative technology platforms. Our team has evaluated a record number of management opportunities this year, and the pipeline continues to grow.

We also continue to show strong progress in warehouse anywhere, including rental income associated with these business customers, Warehouse Anywhere’s year-to-date revenue is up almost 30% to a $14 million run rate, including $9 million of annualized fee income. Our tech-enabled enterprise and Lightspeed products have growing pipelines of companies in search of inventory management and last mile logistics support. Many of these businesses would unlikely be using self-storage if it were not for the solutions provided by Warehouse Anywhere.

With the strong demand and performance, we exceeded our expectations substantially for the quarter and are, therefore, once again increasing our guidance for the remainder of the year. We have increased the midpoint of our estimated adjusted funds from operations per share, 8.5% to $4.74 this year, which would be 19.4% growth over 2020.

And with that, I will hand it over to Andy to provide further details on the quarter and revisions to our guidance.

Andy Gregoire

Thanks, Joe. Last night we reported adjusted quarterly funds from operations of $1.20 per share for the second quarter, an increase of 27.7% over the same period last year. Second quarter same-store revenue accelerated significantly to 14.7% year-over-year, more than double the 7.3% growth produced in the first quarter. Revenue performance was driven by a 420 basis point increase in same-store average quarterly occupancy. That occupancy contributed to very positive rent roll-up and substantially lower discounting on the new rentals.

In the quarter, our same-store move-ins were paying almost 16% more than our move-outs. This pricing power along with our ability to push rates on existing customers contributed to an 8.3% year-over-year growth of same-store in place rates for the second quarter, up from just 1.3% growth in the first quarter of this year. Discounts as the percentage of same-store rental revenue declined 60% year-over-year to 1.4% in the quarter. Same-store operating expenses grew only 3.9% year-over-year for the quarter.

The largest negative variance during the quarter occurred in repairs and maintenance and real estate taxes. The increases were partially offset by an 11% decrease in internet marketing expenses. The net effect of the same-store revenue and expense performance was a 320 basis point expansion in our net operating income margin resulting in 20.2% year-over-year growth in same-store NOI for the second quarter. Our balance sheet remains strong. We supported our acquisition activity and liquidity position by issuing approximately $148 million of common stock via our ATM program in the second quarter.

Our net debt to recurring EBITDA ratio decreased to 5x and our debt service coverage increased to a healthy 5.3x at June 30. At quarter end, we had $360 million available on our line of credit and we have no significant debt maturities until April of 2024, when $175 million becomes due. Our average debt maturity is 6.2 years. We have substantial liquidity available to continue growing our asset base with investment opportunities that provide our shareholders with attractive risk adjusted returns.

Regarding 2021 guidance, we’ve substantially increased our same-store forecast driven primarily by higher expected revenues and unchanged expense expectations. Specifically, we expect same-store revenue to grow between 10.5% and 11.5%. Excluding property taxes, we continue to expect other expenses to increase between 2.25% and 3.25%, while property taxes are expected to increase 6.75% to 7.75%. The cumulative effect of these assumptions should result in 13.5% to 14.5% growth in same-store NOI. We have also increased our anticipated acquisitions by $325 million to between $800 million and $1 billion. Based on these assumption changes, we anticipated adjusted FFO per share for 2021 year to be between $4.69 and $4.79.

And with that operator, we will now open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question today is coming from Juan Sanabria at BMO Capital. Your line is live. You may proceed.

Juan Sanabria

Hi. Good morning. I was just hoping you could speak to, firstly, the trends you’re seeing in July for rate growth and occupancy, if you could just give us some spot numbers, I guess, we’re in August now. And what you’re assuming for occupancy do you sell, if any, in the back half of the year? If you could just give us a range of what your expectations are?

Andy Gregoire

Sure. Good morning, Juan. Yes, July saw a slight uptick in occupancy. So our move-ins on a preliminary basis were higher than our move-outs. So we saw a slight uptick in occupancy in July. Rates are still very strong at over 50% increase year-over-year. So no real changes there from the trends we saw in the late second quarter. Regarding what is in guidance – what’s embedded in guidance for the second half of the year, now we’re looking at about 250 basis points decline in occupancy. So we looked at, historically, what occupancy may do the second half went towards the higher end of what that decline could be, and that’s what’s embedded in occupancy. So we end the year slightly above where we ended last year on the same store, which is a little changed from where we were 3 months ago.

Juan Sanabria

Great. And then just on supply. I was just hoping you could give kind of your latest thoughts on what you’re seeing and expectations for 2022. And if you think that you will see a greater amount of new supply kind of migrate to some of the secondary markets given some of the migration trends we’ve seen as a result of COVID?

Joe Saffire

Hi, Juan. Nothing really new from what we said last time. Obviously, we do our best to monitor supply in all of the markets that we are based in. 2021, we believe, this year, we should have about 145, 150 new deliveries, that compares to about 50 last year and 170 in 2019. So still having 2019 the peak. Looking out to 2022, we see a similar amount of deliveries as 2021. Clearly, there’s a lot of developers out there, and I think everyone is taking note of what’s going on in our sector. But at this point, with construction costs, the difficulty of getting entitlements, et cetera, we think 2022 will be similar to 2021. We aren’t necessarily seeing a significant rise in some of the secondary markets, but I would expect that to happen as this occupancy sticks, and it’s not just in some of the larger markets, it’s pretty much everywhere. But right now, we feel pretty good about the new supply coming on this year and next year.

Juan Sanabria

Thank you.

Operator

Thank you. Our next question today is coming from Jeff Spector at Bank of America. Your line is live. You may proceed.

Jeff Spector

Good morning. My first question is a follow-up on your comment, second half guidance, estimating an occupancy drop of, I think you said 250 basis points. Did you say that’s in line with historical for this time of the year? And are you – do you view that as conservative? Are there any signposts that – right now that indicate we could see such a drop?

Andy Gregoire

Yes, Jeff, there’s no signs. We haven’t seen any signs. We didn’t see them in July either. We haven’t seen the move-outs, which has just been incredible that the customer demand and the need for storage remains. So we haven’t seen the move-outs. That 250 that I mentioned that’s embedded in guidance is the highest we’ve ever saw from this point to the end of the year. So we believe it’s conservative. It’s only happened one year.

Jeff Spector

Okay. Great. And then just to confirm because I’ve been getting more questions on just in the last few weeks, have you seen in any of your markets where, let’s say, the delta variant is rising. Any changes in consumer behavior? Or it sounds like based on your previous answer, leading into, let’s say, this week, last week that things remain strong.

Joe Saffire

Yes, Jeff, we are not – the demand still is strong. We still have customers who are looking for spaces that we can’t serve because we’re full – we do our best to move them to other locations. But yes, demand remains strong. I mean August will be a telling month. Typically, August is a net move-out month. So we should know more towards the back half of this month. And – but clearly, the industry is doing very well and demand continues.

Jeff Spector

Thanks. And then my last question just because we get the question so much is just why customers are staying longer? And of course, this is not something new, this has been increasing for the last 10 years. I don’t know if you do any surveys or – what is your response to that question?

Joe Saffire

Well, I think, Jeff, I think this – you’re right, over time, customers have stayed longer. Consumer is feeling very good about their savings. They’re not thinking about their storage. Economy is very strong. But COVID has brought on some new reasons to use storage. For example, those who are not sure where they’re going to be working, are they’re moving into the office? Are they going to be hybrid? And those decisions won’t be answered anytime soon. And I think that’s part of the reason why items are still in storage. And there’s many other examples of that. Clearly, there was a backlog in construction and home renovations and things are taking longer to get completed. So I think that’s another reason why items are in storage longer. You have a lot more businesses using storage. Obviously, we focus on businesses and it’s so important for companies to get product close to the end user. So I think there’s a number of elements as to why the customers are staying on and not moving out.

Jeff Spector

Thank you.

Operator

Thank you. Our next question today is coming from Smedes Rose at Citi. Your line is live. You may proceed.

Smedes Rose

Hi. Thanks. I wanted to ask you a little bit about your raised acquisition outlook and kind of what – it seems like there’s more properties available for sale. And I guess I’m trying to square your ability to find deals that you like with the sort of theme that more money is coming in and cap rates are sort of concurrently continuing to compress. Just sort of maybe your thoughts around that and your ability to continue to find deals that you like and raised your outlook pretty significantly.

Joe Saffire

Yes. Smedes, thanks. It’s kind of a perfect storm. For many years, the biggest issue in this industry was finding sellers. And we all know that there’s a consolidation opportunity. It’s a very fragmented industry. There’s a lot of mom and pops. And really, this is a perfect storm for us to find deals. I mean we’re really excited about it. I think July was our busiest month ever in reviewing deals. I mean it’s never been busier. So there are great opportunities out there. We love the fact that we’ve got these deep relationships that go decades, in some cases, and our team does a great job of trying to secure deals off market. And yes, there are more sellers, whether it’s the capital gains uncertainty, whether it’s the cap rates they’re seeing, whether it’s a change in gyrations and you’re seeing all of those things. So it’s a perfect storm. And when you add in our – probably our best cost of capital we’ve had in forever, we are really excited about the opportunities. More excited that we actually can find these off market and we can get some deals done. And we expect the second half of the year to be very strong.

Smedes Rose

Okay. And then I just wanted to ask you, I know it’s a relatively small piece, but in the past you’ve talked about the Toronto market and investing there. Could you just provide an update on what you’re doing there? I didn’t see anything in your release, but I might have missed it.

Joe Saffire

Yes. No, it’s a great question, Smedes. Listen, we think the GTA in Canada is a great opportunity for us. The problem we had is the border has been closed. We’ve been so busy in the U.S. We really haven’t focused on acquisitions or getting our brand up there. We were managing – we did end that relationship with our partner up there. They’re a great partner in the U.S. But after two years, we decided if they’re not going to change the brand. They were going in places that we weren’t really comfortable managing they are now self-managing. The good news is we know how to operate up there. And I would expect that we would find some opportunities over the next year to get Life Storage brand in Canada. It’s a great market. It’s a growing market. Toronto, in particular, is one of the fastest-growing cities in North America. We know how to operate up there. And as soon as the border reopens, we’ll be sending some teams up there to find some deals.

Smedes Rose

Okay. Thank you.

Operator

[Operator Instructions] Our next question today is coming from Samir Khanal at Evercore. Your line is live. You may proceed.

Samir Khanal

Good morning, everyone. Hi, Joe, it’s been well documented that it’s difficult to hire employees or staff right now. I guess, what impact have you seen maybe at the store level, whether it’s pay or a number of hours, et cetera?

Joe Saffire

Yes, it’s challenging across our industry and across many industries. Fortunately, for our industry, it only takes one or less or even two people to run our stores. The biggest issue we’ve had in our industry is that part-time associate who tend to look for full-time work and more pay, and that’s a high turnover position, and it’s a little higher this year. And things like technology, things like rent now, other things that we’re doing to reduce the number of FTE hours at a store has helped mitigate some of that turnover. And I would expect for us to continue to find ways to reduce the sort of dependence on a part-time worker or double coverage, that sort of thing. So it’s been very manageable.

Our operations team does a great job of having people move around, and we’re very comfortable in having some managers manage more than one property. And so – and we’re experimenting with reduced hours in certain locations. It’s not such a terrible thing at this time when you’re pretty full, and there’s not a lot of move-in activity. But it’s always been a difficult task to find good people who want just that part-time work. But otherwise, we feel okay though. I mean operations are doing a great job look at the number of stores we’ve been able to onboard in a timely fashion. The 17 store JV acquisition that we did, we had to hire for each one of those stores, and our human resources team did a fantastic job of finding really good people to work those stores as soon as the brand change. So we’re able to find very good people. We’ve got a great team, a lot of experience in recruiting and hiring.

Samir Khanal

Thanks for that. And I guess my second question is around a little bit more broad-based here. But I know in the past, we’ve talked about sort of how – since you’ve come on board, you’ve done a good job in improving the margins of the company cutting costs. I guess how much more is there to do on that side, as we kind of think about next year and whether it’s on the utility side. Maybe you can elaborate a little bit more than that.

Joe Saffire

Sure. Obviously, we are focused on our margins. Cost control has been a very important part of our strategy. Obviously, we came out early on and talked about how technology can reduce the amount of payroll, you’re seeing some of our peers do the same now that they’ve launched the online platform. And we still believe there’s more opportunities there as the utilization of rent now increases over time. We’re also looking at other technologies, as I just mentioned, to reduce some of the hours in the stores. We do a lot of A/B testing and so forth. So clearly, payroll is something we keep an eye on. And then obviously, things like utilities, we’re doing a lot more solar these days into 2022.

I still think there’s opportunities, Samir, but what we’re doing strategically for the company as a whole, you see us through our acquisition volume, we’ve been very aggressive buyers over the last few years, and they tend to be bigger stores with better rates, in really strong markets, newer stores with climate control. And over time, that will continue to improve our margins as well as we generate more revenue per store. So all of the strategies that we have in place are really focused on how do we improve the profitability of this company. So it’s not just one thing, but you’ll continue to see us focus on it. And I think you should also look at what we’re doing on the technology side and how do we generate more efficiencies in the company?

And then also even if you look at technology on warehouse anywhere, it’s not adding anything to our margins today, but I’m very excited about it, which is helping us generate a lot more fee income, and that as well will help our margin growth as well our third-party management business, you’ve seen that grow nicely and that’s a great way to improve our margins. So there’s a lot of things that we’re focused on, Samir. So for sure, I think there’s more opportunities for us to improve margins.

Samir Khanal

Thank you, Joe.

Operator

Thank you. Our next question today is coming from Ki Bin Kim at Truist. Your line is live. You may proceed.

Ki Bin Kim

Thanks a lot and good morning. Just wanted to go back to the acquisition topic. Can you just talk a little bit more in depth about the type of assets you’re targeting, quality, the yields? And ultimately, how do you balance more activity in the markets and more assets for sale versus higher prices? And I guess I’m asking how do you balance, I mean less deals versus like – because things are more expensive.

Joe Saffire

Sure, Ki Bin. Every deal is so different, and every deal can present different opportunities. When you find deals off-market, it’s fantastic. We’ve had a couple of opportunities, portfolios, family run, and those are great because we know that we’re going to add value when it’s on our platform. And obviously, we’re excited when we find those deals. We have a mix. We want to have accretion in year one. We had the same strategy last year. But I’ll be honest, the cap rates have compressed, but the cost of capital has improved, I believe, even greater. So really, the opportunity is still there for us to find good deals. Year one cap rate of a blended lease up and stabilized deals at a 4.5% cap is accretive. And we’re still underwriting these to north of a 5% cap, 5.5% cap. In some cases, 6% cap upon stabilization. So as long as that opportunity is there, where we could find deals and our cost of capital makes it possible for us to pencil them out to be accretive for the company, we’ll still acquire. So…

Ki Bin Kim

Got it. Okay, that’s all for me. Thank you.

Operator

Thank you. Our next question today is coming from Todd Thomas at KeyBanc Capital Markets. Your line is live. You may proceed.

Todd Thomas

Good morning. First question, I think you said occupancy increased further in July. Can you quantify that? I apologize if I missed it, but I’m curious where occupancy ended July and what the year-over-year spread is? And then the 250 basis point occupancy decrease that’s embedded in the guidance, is that off of the June 30 occupancy on a seasonally adjusted basis, what’s, I guess, the starting point that you’re referencing? If you could provide that detail, that would be helpful as well.

Andy Gregoire

Sure, Todd. I was referring to the June 30 occupancy. The July occupancy bump was less than 10 basis points. So it wasn’t even – didn’t round to change. So it’s still at 95% [ph].

Todd Thomas

Okay. Got it. And then, Joe, in terms of the demand – customer demand, which has been pretty strong, we’ve heard, obviously, a lot of things about work from home and sort of pandemic-related demand. But I’m curious, I’m looking at the 2021 deliveries in your lease-up schedule. And those assets are just a few months, they’re 70% to 90% physical occupancy. I think that the Dallas delivery in June is over 90% physical occupancy already. And I’m just wondering, as you’re looking at those assets, if you have any better sense and those assets in the fill upstage, where are the customers’ demand is coming from? You’re seeing them move in at a pretty fast pace. And then also, how long do you think development lease-up can remain accelerated at this pace?

Joe Saffire

Those are great questions, Todd. Obviously, demand is strong. And when you have full occupancy pretty much across the board, the lease-up stores, even if they’re a little bit farther away from the consumer, they’re going to get filled up quicker. So the real question is how long is this demand going to remain? And that feeds into a lot of the questions about guidance, about end of year occupancy. So I think the challenge for a lot of developers is when does it slow down? When does the pandemic demand slow down? And because the cost of construction is so much higher today and slower, if they get these things, the shovel in the ground today and they can’t open until the end of next year, what’s it going to be like where rate is going to be. So I think that helps curtail some of the new supply. Your normal deliveries are going to continue to come on board and they’ll fill up. But I don’t really have an answer for you as to how long this will remain. It’s such an unusual period of time for the industry. Wish I knew, but I don’t.

Todd Thomas

How much of the demand, the move-in activity at these newer lease-up facilities is outside of, I guess, the traditional drive time or distance that you normally would see? I guess how much of that move in demand is the call center, the platform sort of steering customers away from full facilities to those facilities. Do you have a sense of that?

Joe Saffire

I really don’t. It’s anecdotal at this point, but we have changed the procedures. Our operations team has done a great job of allowing store teams at the store to be able to find inventory in their region, so that they can put a customer into another store. Those are things that they never had to do before because they never work full. We’ve done a lot of work in expansions and trying to get some damaged spaces open quickly. The call center does a great job of working with customers. We have waitlists. We try to understand customers’ time frames. And so it’s an issue right now because the stores are so full, that – it’s probably more common to be putting customers in a second or third choice store versus the one that’s closer to their home. But I don’t have exact statistics on that hand.

Todd Thomas

All right. Thank you.

Operator

Thank you. We have no further questions in the queue at this time. Mr. Saffire, do you have any closing comments you’d like to finish with?

Joe Saffire

Well, I just want to thank everyone for dialing in today for all the questions. We hope everyone has a safe and enjoyable remainder of the summer, and we look forward to seeing you in person in the fall. Thank you.

Operator

Thank you, ladies and gentlemen. This does conclude today’s event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.