(Hoya Capital Real Estate, Co-Produced with Colorado WMF)
Storage REITs stumbled into the pandemic with challenged fundamentals and an outlook for near-zero growth amid oversupply challenges. Catalyzed by the suburban housing boom, self-storage demand is suddenly insatiable. In the Hoya Capital Self-Storage REIT Index, we track the five major self-storage REITs, which account for roughly $100 billion in market value: Public Storage (PSA), Extra Space (EXR), CubeSmart (CUBE), Life Storage (LSI), National Storage (NSA), along with micro-cap Global Self Storage (SELF).
As discussed in our Real Estate Earnings Recap, catalyzed by the suburban housing boom and the desire for more space, self-storage demand has dramatically rebounded over the last eighteen months, powering the most comprehensive "beat and raise" quarter by any REIT sector in recent memory in the second quarter. All five self-storage REITs raised their full-year FFO growth outlook by at least 500 basis points in Q2, led by CubeSmart and National Storage which both posted upward revisions in excess of 1,000 basis points and now expect nearly 20% FFO growth, on average. All five storage REITs also expect double-digit same-store NOI growth this year.
Storage REITs hit 'rock bottom' of a multi-year downtrend early in the pandemic after reporting a sharp slowdown in leasing activity, but green shoots began to emerge around this time last year. Initially dismissed as a short-term blip, these REITs have reported substantially improving trends in each of the subsequent quarters. Following years of heavy discounting and "free rent," pricing power has strengthened considerably over the last year with move-in rental rates surging by roughly 50% year-over-year in the second quarter even as occupancy rates climbed to fresh record highs.
Forward-looking indicators and interim updates suggest that third-quarter results should be similarly strong. The Producer Price Index for self-storage facilities - which has historically exhibited a near-perfect correlation with same-store revenue growth metrics - showed a continued reacceleration through the end of Q3. The most recent August PPI report showed the strongest year-over-year rise in self-storage rents on record with prices rising by 12.0% year-over-year with both July and August rising at annualized rates above 20%. Meanwhile, Google Search traffic for "storage unit" remains roughly 30% above the 2019 baseline on a trailing four-week average.
The 'suburban revival' has been a boon for self-storage REITs, which had entered the pandemic as perennial underperformers with challenged fundamentals. The residential rental markets have taken the reigns from the ownership markets of late as Zillow (Z) reported last week that multifamily and single-family rents are soaring at the fastest pace on record. Realtor.com echoed these trends, also reporting that rents rose to record-highs in August with national rental rates growing by 11.5% from the prior year, the first month of double-digit rent growth on record. Apartment List also released their October Rent Report last week, which showed that rents have risen by a "staggering" 16.4% through the first nine months of 2021.
All six REITs are well-positioned for the "suburban revival" theme with a high percentage of their portfolios in Sunbelt and suburban markets. The three largest REITs - Public Storage, CubeSmart, and Extra Space - operate relatively higher-rent portfolios in more primary markets, while Life Storage, National Storage, and Global Self Storage operate facilities with lower rents in secondary and tertiary markets. Revenue management technology, brand value, and cost of capital have historically given these REITs a competitive advantage over private market competitors and smaller brands.
The pandemic tested - and perhaps confirmed - our belief that the self-storage industry is aptly viewed as an extension of the U.S. housing industry, which has been a consistent leader throughout the pandemic. Despite the rally over the past two years, valuations remain compelling as the sector's strong balance sheets, low cap-ex profile, and above-average external growth potential warrant a premium multiple relative to other REIT sectors. Additionally, the long-term macro outlook remains favorable as the sector should continue to benefit from the compelling trends of strong demographic-driven demand and limited supply across the U.S. housing sector.
Along with their residential REIT peers - apartments and single-family rental REITs - self-storage REITs have ridden the tailwinds of the red-hot housing market to robust share price gains through the first three quarters of 2021. Self-storage REITs are the fifth-best-performing property sector this year with average price gains of 38.9%, nearly doubling up the 21.5% returns from the market-cap-weighted Vanguard Real Estate ETF (VNQ) and nearly triple the gains from the S&P 500 (SPY) which has gained 16.8%.
The strong performance this year follows returns of 12.9% in 2020, which was well above the -8.0% total returns of the Equity REIT Index. A much-needed reversal of fortunes, self-storage REITs entered 2020 having lagged the REIT Index in three of the prior four years, a stretch of underperformance that came after a half-decade of sector-leading growth early in the 2010s. The self-storage sector's record-setting six-year streak of outperformance earlier last decade from 2010-2015 was broken last year by manufactured housing REITs, which delivered a remarkable eighth straight year of outperformance.
Over the last five years, National Storage - which focuses on secondary and tertiary markets - has been the top overall performer in the sector with average annualized returns of 28.3% since 2015, followed by Extra Space with average returns of 21.9%. National Storage has again led the gains this year with gains of over 50% followed closely by Life Storage, Extra Space, and CubeSmart. Public Storage has lagged over the last quarter, consistent with the broader theme of underperformance from large-cap REITs.
Fortunes have changed rapidly for self-storage REIT fundamentals, which were among the softest in the REIT sector heading into the coronavirus crisis. After producing REIT-leading NOI growth above 10% in late 2016, same-store NOI growth underperformed the REIT sector average in 2018 and 2019 but rebounded in 2020 with the third-highest NOI growth among REIT sectors. Storage REITs recorded NOI growth of 20.8% in Q2 according to NAREIT T-Tracker data, by far the strongest growth ever recorded for the sector.
The record-high surge in NOI growth was primarily driven by three factors: a 7.4% average rise in realized rents, a 350 basis point improvement in occupancy rates, and a 730 basis point improvement in NOI margins. With occupancy and NOI margins now at record-highs, Public Storage noted on its earnings call that "the baton has been passed to rate growth, which will be the driver of performance in the second half." Consistent with the nearly 50% surge in move-in rates across the sector, each of the storage REITs provided a confident outlook for realized rent growth for the back half of 2021.
Acquisition and consolidation opportunities should also be plentiful over the next decade for these storage REITs as a result of this supply boom, and we did indeed acquisition activity ramp-up over the past several quarters as these REITs have now acquired more than $6.7B in assets over the past year and $3.2B in Q2 - the largest single-quarter of acquisitions on record. Fueling this record pace was Public Storage's $1.8B acquisition of ezStorage - the largest self-storage company in Maryland, Virginia, and Washington DC - buying a portfolio comprised of 48 properties and 4.2 million net rentable square feet. PSA expects the transaction to be immediately accretive to FFO.
Importantly for their external growth prospects, self-storage REITs operate with some of the most well-capitalized balance sheets across the real estate sector. On average, self-storage REITs operate with debt ratios that are well below the REIT sector average of 34%, 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. CubeSmart, Life Storage, and National Storage all hold investment-grade long-term bond ratings as well. All six self-storage REITs operate with debt ratios below 40%.
There are roughly 50,000 self-storage facilities in the United States, and proximity to one's home (generally 3-5 miles) is typically cited as the most important feature. 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. Nearly half of renters stay longer than two years, and about a quarter rent for at least a decade. The self-storage industry remains a highly fragmented industry, and these six REITs own roughly 20% of the total square footage in the US.
The darlings of the REIT sector in the early 2010s, self-storage REITs had fallen on tougher times in recent years as developers and new operators flocked to the sector and added new supply at a furious rate, weakening fundamentals. Consistent with recent construction spending data from the Census Bureau, self-storage REITs have noted signs of moderating supply growth in recent earnings calls as COVID uncertainty and the lagged effects of the weak pre-pandemic fundamentals appear to be suppressing speculative development, which should help to alleviate the acute oversupply issues in the self-storage sector over the next several years.
The pre-pandemic trends towards smaller homes in dense urban markets have been reversed by the pandemic as households seek additional space and more at-home amenities. Storage demand has exhibited particularly high correlations to moving rates into suburban markets, and recent reports from U-Haul (UHAL) and Zillow confirmed this "urban exodus" out of many higher-tax and less business-friendly urban metros into Sunbelt and suburban markets. Zillow sees a "Great Reshuffling" with sustained levels of higher moving rates into lower-cost Sunbelt and secondary markets driven by the flexibility to work-from-home and propelled by efficiencies in the home moving process gained through real estate technology.
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 Index, which tracks the performance of the US housing industry. Rent collection has remained essentially spotless throughout the pandemic, consistent with our predictions early in the pandemic in which we projected that collection rates should remain resilient because rents are essentially "collateralized" by a renter's stored possessions as unpaid rents result in the repossession and auction of the goods within the storage locker. Storage units are the "Hotel California" of the REIT sector: once you're checked in, "you never leave."
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 these REITs, the ease and efficiency at which operators can enter the market has 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.
Storage REITs were one of the only property sectors that went completely unscathed by the wave of coronavirus-related dividend cuts that sweep across the REIT universe last year. Storage REITs pay an average dividend yield of 2.8% which is exactly in line with the market-cap-weighted REIT sector average. Self-storage REITs pay roughly 70% of their available cash flow also in line with the REIT sector average. Four of the six storage REITs - EXR, NSA, CUBE, and LSI - have increased their dividends this year and each of the four are paying dividends above their pre-pandemic rates.
Diving deeper into the sector, we note that the dividend yield ranges from a high of 4.90% from micro-cap Global Self Storage to a low of 2.66% from Public Storage. Notably, CubeSmart, National Storage, and Extra Space have been among the leaders in dividend growth across the REIT sector over the past five years with double-digit average annual dividend growth rates.
Investors willing to forego some upside potential but capture a relatively steady stream of income have the option of going the "preferred route." Public Storage is the single-heaviest issuer of preferred stock within the REIT sector with a suite of 13 securities including its 4.90% Series E Preferred which PSA announced may be redeemed using the proceeds of the issuance of its new 3.95% Series Q and 4.0% Series P Preferreds. PSA's suite of preferreds pays an average current yield of 4.4%, below the REIT Preferred average of 6.0%. National Storage also has an outstanding preferred issue, a 6.00% Series A that pays a current yield of 5.83% and is callable beginning next October.
Despite the self-storage sector's 40% gains this year - and more than 100% rebound from the lows last March, self-storage valuations are only slightly above the REIT sector average. Self-storage REITs trade with an average forward Price-to-FFO ("Funds from Operations") multiple of roughly 24.8x, only slightly above the REIT average of 23.3x, and well below the sector's peak multiples of around 28x. Self-storage REITs achieved FFO growth of above 9% over the past five years, which is above the REIT sector average of 5%.
Storage REITs stumbled into the pandemic with challenged fundamentals and an outlook for near-zero growth amid oversupply challenges. Catalyzed by the suburban housing boom, self-storage demand is suddenly insatiable. Like a phoenix rising from the ashes, storage REITs have continued their incredible turnaround this year. Storage REITs delivered the most comprehensive "beat and raise" quarter of any REIT sector in recent memory. Every storage REIT now expects double-digit FFO and NOI growth this year.
Forward-looking indicators - including PPI data and search engine trends - along with interim updates from these REITs suggest that third-quarter results should be similarly strong. Despite the rally, valuations remain compelling as the sector's strong balance sheets, low cap-ex profile, and above-average external growth potential warrant a premium multiple relative to other REIT sectors. Additionally, the long-term macro outlook remains favorable as the sector should continue to benefit from the compelling trends of strong demographic-driven demand and limited supply across the U.S. housing sector.
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