Self-Storage REITs stumbled into the coronavirus pandemic with challenged fundamentals and an outlook for near-zero growth amid oversupply challenges, but catalyzed by housing market strength, self-storage demand has suddenly become insatiable. In the Hoya Capital Self-Storage REIT Index, we track the five major self-storage REITs, which account for roughly $120 billion in market value: Public Storage (PSA), Extra Space Storage (EXR), CubeSmart (CUBE), Life Storage (LSI), National Storage (NSA), along with micro-cap Global Self Storage (SELF).
The pre-pandemic trends towards smaller homes and high-density urban markets have been reversed by the pandemic as households seek additional space and more at-home amenities. Storage demand exhibits high correlations with moving rates, and recent reports from U-Haul (UHAL) and Zillow (Z) indicated an ongoing "coastal exodus" out of many higher-tax and less business-friendly urban metros in the Northeast and California. 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 tech-driven efficiencies in the home moving process.
As discussed in our Real Estate Earnings Recap, with these tailwinds at their backs, self-storage REITs continue to ride one of the most impressive turnarounds in recent memory and posted yet another comprehensive "beat and raise" quarter in Q3 and all signs point to similarly strong results in Q4. All five self-storage REITs raised their full-year FFO growth outlook by at least 450 basis points in Q3 following even larger guidance boosts in Q3. Storage REITs now expect FFO/share growth of nearly 25% this year driven by record-high occupancy gains, double-digit annual rent growth, and accretive external growth through acquisitions and development.
Forward-looking indicators and interim updates suggest that the momentum has continued into early 2022, although not quite at the breakneck pace during the early summer. The Producer Price Index for self-storage facilities - which has historically exhibited a near-perfect correlation with same-store revenue growth metrics - showed continued strength deep into Q4. The most recent PPI report showed the strongest year-over-year rise in self-storage rents on record in October with prices rising by 13.8% year-over-year before moderating slightly to 13.0% in November. Google Search traffic for "storage unit" has also shown some moderation in late 2021, but search traffic remains roughly 10% above the 2019 baseline on a trailing four-week average.
Storage REITs hit 'rock bottom' of a multi-year downtrend early in the pandemic and were left-for-dead by many analysts and investors after reporting a sharp slowdown in leasing activity, but green shoots began to emerge by late 2020. 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 eighteen months with move-in rental rates surging by roughly 30% year-over-year in the third quarter even as occupancy rates climbed to fresh record highs.
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. Residential REITs have historically been one of the most effective inflation hedges across all asset classes, and self-storage REITs are no exception. With average lease terms of roughly 6-12 months, storage 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 have been called the "Hotel California" of the real estate sector: once you're checked in, "you never leave."
The 'suburban revival' has been a boon for these REITs as self-storage rent has historically exhibited a high degree of correlation with rent growth and home values. The residential rental markets have taken the reigns from the ownership markets of late as Zillow 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 November with national rental rates growing by 19.7% from the prior year. Apartment List also released their January 2022 Rent Report last week, which showed that rents have risen by a "staggering" 17.8% in 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 and expense management technology, brand value, and cost of capital have historically given these REITs a competitive advantage over private market competitors and smaller brands.
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 over the past two years. Self-storage REITs were the second-best-performing property sector of 2021 with total returns of 78%, significantly outpacing the returns from the 41% returns from the market-cap-weighted Vanguard Real Estate ETF (VNQ) and the 28% total returns from the S&P 500 ETF (SPY).
The strong performance in 2021 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 ninth-straight year of outperformance in 2021.
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. Storage REITs recorded NOI growth of 23.4% in Q3 according to NAREIT T-Tracker data, by far the strongest growth ever recorded for the sector. The record-high surge in same-store NOI growth was driven by three factors: a 12.7% average rise in realized rents, a 170 basis point improvement in occupancy rates, and a 650 basis point improvement in NOI margins. With occupancy and NOI margins now at record-highs, we expect rent growth to be the primary driver of same-store performance in 2022.
On their earnings calls, all five major storage REITs discussed their expectation for moderating supply growth in 2022 and into 2023 as the lagged effects of the weak pre-pandemic fundamentals along with elongated construction timelines continue to suppress speculative development, which should help to alleviate the oversupply issues that weighed on fundamentals in the late 2010s. Consistent with this commentary in earnings calls, construction spending data from the Census Bureau has indicated that the peak in development appears to have occurred in 2017 and will likely end 2021 with declines of more than 20% after declining by 10% in 2020.
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 30%, 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 Extra Space all hold investment-grade long-term bond ratings as well. All six self-storage REITs operate with debt ratios below 40%.
Acquisition and consolidation opportunities should remain plentiful over the next decade for these storage REITs following the late-2010s supply boom, and we did indeed acquisition activity ramp-up over the past several quarters as these REITs have now acquired more than $7.5B in assets over the past year and $1.6B in Q3. Fueling this record pace was Public Storage's $1.8B acquisition of ezStorage and CubeSmart's $1.69B acquisition of Storage West - an owner and operator of 59 self-storage assets in Southern California (22), Phoenix (17), Las Vegas (13), and Houston (7).
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 in 2020 and were among the leaders in dividend growth in 2021 as well. Storage REITs pay an average dividend yield of 2.5% which is slightly below the market-cap-weighted REIT sector average of 2.7%. Self-storage REITs pay roughly 65% of their available cash flow, leaving plenty of cash flow to fuel accretive growth through acquisitions and development.
Diving deeper into the sector, we note that the dividend yield ranges from a high of 4.52% from micro-cap Global Self Storage to a low of 2.25% 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 7-11% average annual dividend growth rates.
Self-Storage REITs stumbled into the pandemic with challenged fundamentals and an outlook for near-zero growth amid oversupply challenges, but catalyzed by the ongoing housing boom, self-storage demand remains insatiable. Like a phoenix rising from the ashes, storage REITs have delivered an incredible turnaround over the last eighteen months and forward-looking indicators and industry commentary suggest that while the 20-30% growth rates surely won't be sustained, the positive momentum should continue into 2022. While no longer trading at the compelling valuations that we discussed before the 80% total returns in full-year 2021, we see value in targeted opportunities within the storage REIT sector.
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