Extra Space Storage Inc. (NYSE:EXR) Q3 2023 Earnings Call Transcript

Extra Space Storage Inc. (NYSE:EXR) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Good day, and thank you for standing by. Welcome to the Q3 2023 Extra Space Storage and Earnings Conference Call. [Operator Instructions]. Please be advised as being recorded. I would now like to hand the conference over to your speaker today, Jeff Norman. Please go ahead.

Jeffrey Norman: Thank you, Kevin. Welcome to Extra Space Storage’s Third Quarter 2023 Earnings Call. In addition to our press release, we have furnished unaudited supplemental financial information on our website. Please remember that management’s prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the company’s business. These forward-looking statements are qualified by the cautionary statements contained in the company’s latest filings with the SEC, which we encourage our listeners to review.

Forward-looking statements represent management’s estimates as of today, November 8, 2023. The company assumes no obligation to revise or update any forward-looking statements because of changing market conditions or other circumstances after the date of this conference call. I would now like to turn the call over to Joe Margolis, Chief Executive Officer.

Joseph Margolis: Thanks, Jeff, and thank you, everyone, for joining today’s call. We had a busy third quarter. In July, we successfully completed our merger with Life Storage adding over 1,200 stores to our portfolio and over 2,300 new members to team Extra Space. The transition is going very smoothly, and I am proud of the teamwork and innovation our employees are demonstrating through the merger. Our combined portfolio of 3,651 stores provides greater diversification, stability, revenue opportunities, operational efficiencies that I believe will improve our property level and external growth for years to come. From a performance standpoint, the third quarter was generally in line with expectations. Revenue growth moderation for the Extra Space same-store pool flattened meaningfully during the third quarter and our 1.9% same-store revenue increase was modestly ahead of our expectations.

Revenue growth was driven by high average occupancy in the quarter of 94.4%. Existing customer behavior continued to be strong with solid length of stay, muted vacates and continued acceptance of rate increases. Rental volume was also steady year-over-year, albeit at lower new customer rates. Expenses came in higher than our estimates, offsetting the revenue outperformance. This was driven by higher-than-expected property tax increases. The higher-than-projected expenses resulted in a modest miss in our same-store NOI, which was offset by a beat in G&A, resulting in core FFO of $2.02. This was in line with our internal forecast. Short-term dilution from the merger with LSI was consistent with our estimates for the third quarter. We have achieved our target G&A synergy run rate of $23 million and we’ll continue to gain additional synergies as we further integrate the team, platform and portfolio.

We have also started a property level revenue synergies as we move existing LSI customers to rates more consistent with the Extra Space portfolio. The incremental FFO contribution from these improvements is partially offset initially by lower occupancy at the LSI properties due to catch up auctions and lower new customer rates to drive rental demand. However, once we achieve stronger new customer rates and build occupancy, the benefit to FFO will ramp up and we remain confident we will reach our total expected synergy run rate in the first quarter of 2024. We have slowed our acquisition pace given the LSI merger, but we continue to be very active in third-party management, adding 49 new stores gross in the third quarter, not including the LSI managed stores.

Year-to-date, outside of the LSI merger, we have added 151 stores gross to the managed platform with only 17 departures. We have also continued to have steady bridge loan volume despite the difficult interest rate environment. In short, property level performance is in line with expectations. The integration of the Life Storage properties is on track, and we continue to be active in our capital-light external growth channels. As a result, we have tightened our annual core FFO guidance for 2023, maintaining the same midpoint. We will remain focused on maximizing performance at all of our stores and executing our integration plan in the fourth quarter. As we have interacted with our shareholders throughout the quarter, it has been hard to miss the serious concerns people have about wars, the economy, interest rates, consumer health, sector demand and our stock price.

We absolutely share those concerns. That said, I think it is important to step back and not lose sight of where we stand today. Storage has consistently proven to be a remarkably durable asset class and Extra Space Storage has the largest and most diverse portfolio in the industry. Occupancy averaged over 94% in the quarter, and it remains very healthy. New customer rates, while not as strong as last year, remained 12% higher than 2019 pre-pandemic levels and customer health remains strong. New supply continues to moderate and the headwinds to future new development are substantial and increasing. Our external growth drivers continue to fire on all cylinders, and I am confident in our ability to further scale our platform. And finally, I believe we have the strongest team and operating platform in the industry.

It is still a great time to be in storage, and I believe the future of Extra Space remains very bright. I will now turn the call over to Scott.

Scott Stubbs: Thanks, Joe, and hello, everyone. As Joe mentioned, we would characterize the third quarter as in line, meeting our internal FFO projections, the modest miss in property NOI due to higher noncontrollable expenses was offset by beats in interest income and G&A. Achieved rates to new customers were down an average of 11.8% year-over-year in the third quarter, gapping widest in August and tightening modestly in September and further in October to a negative 10.8%. Given the easier September and October comps, we would have liked to have seen that gap narrow more, but we continue to have a headwind from new customer rates. Fortunately, lower year-over-year vacates and strong existing customer health continues to more than offset the headwind and revenue performance as a whole continues to hold up.

Weighing these factors as we forecast revenue for the fourth quarter, new customer rate improvement hasn’t been compelling enough for us to raise the high end of our same-store revenue guidance range, but existing customer performance has been steady enough to remove our most cautious scenarios from our full year revenue guide. As a result, we increased the bottom end of our same-store revenue by 25 basis points to a range of 2.75% to 3.5% for the full year. On the expense front, we felt greater-than-expected pressure from property taxes, primarily in Georgia and Florida. We also had significant increases in property insurance premiums. We updated our annual same-store expense guidance to recognize actual expenses as well as a higher run rate for property taxes resulting in a revised same-store expense range of 4% to 5% for the full year.

This results in a tightening of the same-store NOI range of 25 basis points both [Technical Difficulty] the low end of the range, maintaining a midpoint of 2.75%. Turning to the balance sheet. We drew on our line of credit and an undrawn term loan of $1 billion to pay closing costs and to retire Life Storage’s debt that we did not assume. With the merger, we assume $2.4 billion in Life Storage’s publicly traded bonds at the same coupons and maturities. With the assumption of these bonds mark the debt to market, and we have broken out the noncash interest expense, which has been added back to core FFO. Upon completion of the merger and the assumption of debt, S&P Global upgraded its credit rating on Extra Space to BBB+, which will drive future interest expense savings for the company.

Details to our updated debt stack and revised interest rate spreads on our credit facility are included in our supplemental. Last quarter, we provided freestanding guidance for Extra Space Storage and then provided separate details related to the anticipated dilution associated with the merger. In last night’s earnings release, we updated our 2023 FFO guidance ranges for the combined portfolio. The same-store performance ranges I previously referenced applied to the Extra Space same-store pool as we have not added the Life Storage properties to the pool. Separate disclosures related to the performance of the Life Storage stores are included in our supplemental financials. Our core FFO range, which includes the short-term dilutive impact of the LSI merger as well as an add-back for transaction and transition expenses was tightened to $8.05 to $8.20 per share, maintaining the previous midpoint.

We have also provided updates to key assumptions for the combined company. As Joe mentioned, our performance was in line with our expectations coming into the quarter and the integration of Life Storage remains on track. We continue to believe storage as an asset class is among the most resilient in the REIT space. We believe our operating platform and highly diversified portfolio has become even stronger through the Life Storage merger and it is positioned for outsized future growth. And with that, Kevin, let’s open it up for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Michael Goldsmith with UBS.

Michael Goldsmith: Your updated same-store revenue outlook implies positive fourth quarter same-store revenue growth of 0.8% at the midpoint. And you took the low end of the full year guidance range up slightly. So should we interpret the increase in guidance is confidence that you will hit this range? And what have you seen from street rates in October and expect in November and December to meet this range.

Scott Stubbs: Yes, Michael, your assumptions are correct. It does imply at the midpoint that it’s positive for the entire quarter. And we obviously have October, largely we know what October was. And so we’re confident that we should hit those numbers.

Michael Goldsmith: My next question is about how Life Storage portfolio is responding to the Extra Space strategy in part of the revenue synergies from the deal is based on the ability to roll out the Extra Space, rental growth algorithm. So can you walk through how the Life Storage customer is responding to lower street rates and also how the Life Storage customer is responding to the elevated ECRIs?

Joseph Margolis: Great question. So the short answer is everything is going as planned. We have begun sending out the ECRI notices to the Life Storage customers, and they are accepting them at the same rate or maybe even slightly better rate than Extra Space customers. We have headwinds of catch-up auctions and the slightly elevated vacates from the CRI notices, the occupancy on the LSI portfolio. So we have discounted rates on the web, in particular, to protect that occupancy while we do that. And that’s been very successful, and we’ve actually seen a slight uptick in occupancy in the LSI portfolio. So we’re really happy with how the strategy is playing out, and we continue to monitor it and make sure there’s no bumps in the road.

Operator: Next question comes from Jeffrey Spector with Bank of America.

Jeffrey Spector: Joe, you mentioned that as you’re integrating and now operating the LSI assets you’re using street rate to build up that occupancy. How should we think about that over the coming months? How long will that take place? And given the existing overlap with the EXR portfolio, is that creating some of the drag, let’s say, on street rate in markets?

Joseph Margolis: So I might describe it a little differently. We’re using rate, I think, to protect occupancy more. We don’t really expect to make significant gains in occupancy until we’re done correcting the rates and getting through the auctions. So we gained some occupancy, but it’s certainly not spiking, and we probably don’t expect that until next rental season. With respect to effect on Extra Space stores, that’s very market specific, and I don’t think very significant.

Jeffrey Spector: And then on the existing customer, you mentioned again the strength there. Can you characterize pricing power today versus, let’s say, 6 months ago? And then can you quantify the length of stay versus the vacates?

Joseph Margolis: So I don’t think pricing power to new customers is significantly different than 6 months ago. And I guess I’d say the same thing about pricing power to existing customers, which is very strong. It is also the same, right? We’re not seeing a greater amount of ECRI induced vacates. And I’m sorry, what was the second part of the question?

Jeffrey Spector: If you were able to quantify the vacates versus the length of stay?

Joseph Margolis: I’m not sure I understand the question.

Jeffrey Spector: Where is length of stay today? You had mentioned that the length of stay remains strong and vacates are down.

Joseph Margolis: I should understood what you were saying. So lots of different ways to measure length of stay. Our average in-place customer is about 34.4 months, which is up a month year-over-year. Our existing customers who have been in the store for 12 months is 61%. That’s done a little bit as we continue to normalize from those COVID highs at that metric. We’ve also lost a little bit of our 24-month customers. That’s about 45% now, but still higher than pre-COVID. Is that helpful?

Operator: Our next question comes from [indiscernible] with Truist Securities.

Unidentified Analyst: So in the quarter, you showed an improved pace of same-store revenue and same-store NOI deceleration. Is that because of easier comps? Or do you think rates have somewhat stabilized at current levels? I’m just trying to better understand if this improves deceleration is sustainable? Or if we should expect a steeper deceleration in 2024?

Scott Stubbs: Yes. So comps throughout this year have gotten easier as we’ve moved through. In terms of how it came out versus what we were expecting, it was pretty similar to what we were expecting. As we mentioned earlier, we don’t expect things to go negative in the fourth quarter and that sets us up for what we hope to be a good 2024. I think our occupancy is holding up well and not going negative, I think, is a positive thing.

Unidentified Analyst: Got it. And then shifting gears a little bit. Can you talk about or can you give us your thoughts around your balance sheet and your variable rate debt. Right now, approximately 30% of your debt is variable. Do you have any plans to decrease your exposure there? Or are you planning on keeping the portion of [indiscernible] that where it is?

Scott Stubbs: So our variable rate debt actually ticked up slightly in the quarter as we completed the merger. With the merger, we had to pay off some fixed rate debt. You had private placement bonds on Life Storage that weren’t allowed to be prepaid. To do that, we’ve used a bridge loan, a $1 billion bridge, that’s a 2-year loan, and we will be terming that out over the next 1 to 2 years. So we will be bringing that down. If you look at our variable rate debt net of the variable rate borrowings, it’s about 75%. But again, we’ll be bringing those down, variable receivables.

Operator: Next question comes from Todd Thomas with KeyBanc Capital Markets.

Unidentified Analyst: This is A.J. on for Todd. Real quick, could you just provide an occupancy update for October and what that looks like year-over-year?

Scott Stubbs: For the two portfolios, Extra Space, the same-store ended October at 93.9%. It’s a 1% gap from where we were last year. The Life Storage occupancy is 90.8% compared to last year, and that has actually narrowed the gap slightly. Our occupancy calculation is slightly different than the way Life Storage calculated. We’re going with this calculation going forward as they excluded or made adjustments that we don’t make on an ongoing basis.

Unidentified Analyst: And what is that year-over-year?

Scott Stubbs: It’s narrowing and I actually don’t have last years in front of me right now.

Joseph Margolis: We haven’t adjusted last year’s like storage occupancy to reflect our methodology.

Unidentified Analyst: Good to know. And then my second question. So you provided a little color around the $100 million of synergies. You noted that you have met the $23 million in G&A synergies. We see some gains in tenant insurance. How should we think about the opportunity to meet or exceed the $100 million guidance over the next several months?