I n an industry where size really matters, real estate investment trust Extra Space Storage is bulking up.Extra Space Storage ( EXR ) operates, and mostly owns, 1,147 self-storage properties in 35 states, Puerto Rico and Washington, D.C. It’s the second largest owner-operator of self-storage warehouses in the U.S. and the largest self-storage management company.
(Known historically by the public as warehouses, the upscale Extra Space prefers that they be called stores.)
Thanks to a recent deal, Extra Space is about to gain even more muscle. In June, the company agreed to acquire SmartStop Self Storage, a public, non-traded REIT. Extra Space will pay $1.3 billion for the SmartStop assets that it’s keeping, and will dispose of about $100 million of additional assets before the deal closes.
SmartStop is the seventh-largest owner and operator of self-storage facilities in the U.S., with 169 self-storage properties in 21 states and Toronto, Canada. Its stock performs the best by fundamental and technical metrics among its top publicly traded rivalsSovran Self Storage ( SSS ),Public Storage ( PSA ) andCubeSmart ( CUBE ).
Once the acquisition is completed, Extra Space will own 122 SmartStop stores and will assume the property management of 43 third-party managed stores, all in the U.S.
Extra Space estimates that the buy will add 10 cents to 18 cents in the first 12 months to its funds from operations (FFO), the key earnings metric for REITs, says Jeff Norman, senior director of investor relations. The deal is expected to close Oct. 1.
What’s the rationale behind the deal?
“It helps us have a stronger physical and digital presence in markets where we already operate,” said Norman. “The SmartStop properties overlap quite well with our existing footprint.”
He says that the acquisition would increase Extra Space’s size (square footage, number of storage units and revenue) by about 15% — and, the company said earlier, “provide opportunities for occupancy and rate increases and other income opportunities.”
Acquisitions have become the name of the game for the large players in the self-storage industry.
Extra Space operates in a very fragmented industry, with about 50,000 storage facilities in the U.S. and only five publicly traded companies participating, says Norman, including those mentioned above andNational Storage Affiliates Trust ( NSA ). The public REITs control less than 5,000 properties or about 10% of the total.
“There’s a significant opportunity for consolidation,” said Norman. “All the (publicly traded) REITS have been aggressive in acquiring smaller, mom-and-pop operators with one and two facilities and even regional operators with larger portfolios.”
Extra Space benefits in many ways from building economies of scale, notably in mass marketing, as most people who need a self-storage facility search online.
“The larger operators have a higher level of sophistication and are better able to acquire new customers online,” said Norman. “Unlike an office building or apartment that turns over every several years, self-storage leases are month to month. So we constantly have to replenish tenants. On average, we go out and find 40,000 new customers a month. The larger operators can do that more efficiently and effectively.”
Norman says that as Extra Space acquires mom-and-pop operations, it usually can generate more revenue than the prior owners.
“That’s why larger operators have been acquiring,” he adds. “They can get more out of those properties.”
RBC Capital Markets analyst Wes Golladay said, “the bigger you are, the better” in self-storage, with more “robust systems and better analytics” to handle Internet search engine optimization.
“Once they have economies of scale, they can buy assets and plug them into their systems and increase their performance,” he said. “When you have the ability to buy competitors and plug them into your platform, and all of a sudden you boost the performance, you get even bigger.”
Extra Space is “very acquisitive,” he adds. The SmartStop acquisition was a “big one”; it increased Extra Space’s footprint by 15%.
Year to date, through June 30, Extra Space has acquired 39 facilities for about $346 million total.
More Properties To Buy
“We plan to continue to acquire throughout the year,” said Norman. “The guidance we provided anticipates closing on a total of $1.8 billon in acquisitions by the end of the year.”
The $1.8 billion would include the Smart Stop acquisition and the $326 million in acquisitions that the company has closed year to date, so it’s almost at its goal.
On June 30, the company paid a second-quarter dividend of 59 cents per common share, up from 47 cents quarterly.
Extra Space has been enjoying a long-running winning streak of both quarterly revenue and net operating income (NOI) growth. FFO as adjusted has grown by double digits for 19 consecutive quarters.
And its stock price is trading at record highs, now about 8% extended beyond a 72.56 flat-base buy point.
What’s the draw for investors?
“Their existing properties are doing better than everyone had thought they would, and they’re acquiring more than investors had anticipated,” said Golladay. “They’re surprising on the upside on both of these.”
In the second quarter, FFO as adjusted rose 17.2% vs. a year earlier to 75 cents per share. Same-store revenue increased 9.4% from a year earlier, and same-store NOI climbed by 12.1%.
Analysts polled by Thomson Reuters expect 2015 FFO as adjusted to rise 14.6% to $2.99 a share. They see a 15.3% increase in 2016 and a 9.3% gain in 2017.
Norman says that acquisitions have helped drive growth.
Actively And Accretively
“We have acquired actively, and we have acquired accretively,” he said. “That’s been one big driver of our FFO growth, and we’ve continued to generate more revenue and NOI and FFO out of our existing properties. The organic growth we’ve had at the store level outpaces our competitors by a fair clip. And we’ve also had effective management of our balance sheet.”
The “most significant impact” on the sector’s growth of late has been a lack of new supply coming into it, Norman adds.
“Demand for the product has grown steadily, while the supply has stayed relatively flat,” he said. “That’s allowed pricing power for the storage operators, and as a result the industry as a whole is seeing record high occupancy levels, and it’s also seen price gains.”
Extra Space is a part of IBD’s Finance-Property REIT industry group. Its stock has earned a 97 Composite Rating out of a possible 99. Other highly rated members of the group, Sovran Self Storage rates 95 and Public Storage rates 92.