Extra Space Storage Inc. (NYSE:EXR) Q4 2023 Earnings Call Transcript

Extra Space Storage Inc. (NYSE:EXR) Q4 2023 Earnings Call Transcript February 28, 2024

Extra Space Storage Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and thank you for standing by. Welcome to the Extra Space Storage Fourth Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Jeff Norman, Senior Vice President, Capital Markets. Please go ahead.

Jeffrey Norman: Thank you, Liz. Welcome to Extra Space Storage’s fourth 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, February 28, 2024. 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’d now like to turn the call over to Joe Margolis, Chief Executive Officer.

Joe Margolis: Thanks, Jeff, and thank you, everyone, for joining today’s call. We had a solid fourth quarter where we focused on optimizing the performance of the recently added Life Storage assets while maximizing the performance of the legacy Extra Space locations. We were also very productive on the external growth front adding another 74 third-party managed stores, 8 stores through acquisition and $129 million in bridge loans. Operationally, the Extra Space same-store pool maintained high occupancy and solid in-place rents, driving same-store revenue growth of 0.8% for the quarter. Core FFO in the quarter was $2.02 a share and full year core FFO was $8.10 per share. On our last call, we outlined that in order to reach the high end of our guidance range we would need achieved rates to new customers to improve on a year-over-year basis.

While demand was steady and allowed us to maintain strong occupancy, it was not strong enough to eliminate negative new customer rates, which remained at approximately negative 10% during the quarter. As a result, we faced the headwind of higher negative churn, and our full year performance was near the midpoints of our same-store and FFO ranges. Turning to Life Storage. One of the factors in our merger decision was our belief that we could enhance Life Storage property performance through our more sophisticated platform. Seven months removed from closing, we are happy to report that our assumptions have proved true. Customer acceptance of rent increases has been in line with our expectations, and we are seeing the net rent per square foot for legacy Life Storage customers move closer to that of nearby Extra Space locations.

Occupancy is also responding positively and we saw the occupancy gap between the LSI and Extra Space Storage same-store pools tightened through the quarter, improving from a gap of 350 basis points at the beginning of the fourth quarter to a gap of 250 basis points at year-end. Today, that gap has tightened further and is approximately 200 basis points. The occupancy improvement together with the benefit of existing customer rent increases resulted in Legacy LSI same-store revenue growth of 1.8%, an acceleration of 80 basis points over the third quarter growth rate. However, similar to the Extra Space properties, we continue to see new customer price sensitivity at the Life Storage locations, resulting in lower-than-anticipated new customer rates.

So while we are achieving the anticipated incremental outperformance we expected for the Life Storage assets, reaching full property level synergies is taking longer than anticipated due to current market conditions, which we know will eventually normalize. The current level of demand also influences our outlook for 2024. We are encouraged by our rental velocity, occupancy levels, existing customer health, length of stay and the potential benefits of moderating new supply. However, these factors have not yet led to material improvement in new customer rates. We are confident we can hold strong occupancy and generally maintain current revenue levels, but we believe it will be difficult to drive a reacceleration in revenue growth until we regain pricing power with new customers.

We are seeing some positive signs that we are getting closer. And given our strong occupancy levels, when pricing power returns, we are very well positioned to push rates quickly. We just have not seen enough progress to date to feel confident this inflection will be in time for the 2024 leasing season or to include this scenario in our guidance. So, while the industry as a whole will likely face headwinds from lower new customer rates in the near term, the long-term outlook for our sector and for Extra Space specifically remain bright. 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. New supply continues to moderate and the headwinds to future new development are substantial and increasing.

We have very strong third-party management and bridge loan pipelines and a robust joint venture program and I am confident in our ability to further scale our capital-light growth activities. We expect to outsize relative growth from our LSI assets in 2024 and with additional synergies to be unlocked as the rental environment improves. And as I mentioned, our occupancy today is over 93% at what is normally our low point for the year. Once demand improves, we are very well positioned to capture it. I will now turn the time over to Scott.

Scott Stubbs: Thanks, Joe. And hello, everyone. Our results were generally in line with our expectations with a few exceptions. As Joe already covered, lower new customer rates caused revenue growth to come in modestly below our internal estimate. The revenue mix was partially offset by lower-than-expected property taxes. We also had a beat from G&A savings, partially offset by lower than modeled tenant insurance. All of our other income and expense line items were generally in line with our forecast. As of January 1, we have completed the migration of the Life Storage customers to our tenant insurance program, and we believe we will achieve $16 million in synergies from tenant insurance, exceeding our original estimate by $4 million in 2024.

Our G&A run rate from Q4 and is lower than our expected 2024 full year run rate as we continued hiring during the fourth quarter, and we have some G&A seasonality. We now expect to realize 2024 G&A synergies of $39 million, an increase of $16 million over our original forecast of $23 million. Turning to the balance sheet, we completed a $600 million bond offering in the fourth quarter and another $600 million bond offering in the first quarter of 2024. We have used the proceeds from these offerings to pay off the $1 billion variable rate bridge loan we obtained in conjunction with the closing of Life Storage. Our only remaining 2024 loan maturities can be extended at our option, and we have plenty of dry powder if opportunities arise in the market.

In last night’s earnings release, we provided our 2024 outlook for both the Extra Space and legacy Life Storage same-store pools. We have provided wider same-store revenue and NOI ranges to capture the different scenarios we believe are possible given the unusual 2023 comparables and uncertainty around new customer pricing. With interest rates potentially remaining higher for longer, our guidance does not assume a material improvement in the housing market during the summer leasing season. For the EXR same-store pool, our same-store revenue guidance is negative 2% to positive 0.5%. Our expense growth range is 4% to 5.5% driven by marketing, insurance and property taxes resulting in an NOI range of negative 4.25% to negative 0.5%. For the legacy LSI same-store pool, we expect stronger property-level growth with same-store revenue ranging from 2% to 4.5%.

We expect outsized expense growth at the LSI stores in 2024, especially in the first half of the year. This will be driven by higher payroll as we have brought the LSI stores back to full staffing levels. We expect additional expense pressure on repairs and maintenance, property taxes and property insurance, resulting in a range of 6.25% to 7.75% yielding a life storage same-store NOI range of negative 0.25% to positive 4%. Our core FFO range for 2024 is $7.85 and to $8.15 per share and assumes the full year impact of the shares and debt added through the Life Storage merger. And with that, Liz, let’s open it up for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from the line of Jeff Spector with Bank of America.

Lizzy Doykan: Hi, this is Lizzy on for Jeff. Just I guess going back to Joe’s opening comments on not really having the confidence right now to include a scenario on pushing new rates more quickly and not assuming a rebound in housing. So I guess, if you could provide color on what your assumptions are for new move-in rates and how that should trend that’s leading to the lower end versus the higher end of the same-store rev guide, that would be helpful.

Joe Margolis: So our guidance is really revenue based and new move-in rates to customers are one component we’re a little agnostic between occupancy and new move-in rate and ECRI program and promotions and all the various components that go into the revenue assumptions that produce our guidance. As I said and you indicated, we don’t see enough now to guide to a strong rebound in the housing market in time for the leasing season. We still see price sensitivity from new customers, although rental demand is good, and we’ve had a really good start to this year. We don’t think interest rates are going to go down in time to have a material impact on the leasing season. So while we don’t have a crystal ball, we thought a reasonably prudent guidance would be not to assume that rebound.

Scott Stubbs: Yes, Lizzy, maybe to add a little bit more color to Joe’s comments, our guidance, the base case assumes that we do have sequential rate growth on a month over month basis from now into our leasing season, but just not enough to necessarily close that negative gap that we’re experiencing today.

Lizzy Doykan: Okay. That’s helpful. And as my follow-up question, we just noticed that the assumption on the SOFR curve driving interest expense within guidance. It seems a bit aggressive just based on where SOFR sits today. So could you just walk through kind of your outlook on rates and what’s embedded in guidance in terms of debt and refi activity? Thanks.

Scott Stubbs: Yes. So as we were preparing our guidance and preparing our annual budget, the SOFR curve was moving around pretty quite a bit. We saw moving almost every day. So we picked a point in time that had an average of 4.75. That was approved probably 1.5 weeks ago is when we finalized and we figure it will move throughout the year, but that’s the assumption we made in our guidance.

Lizzy Doykan: Thank you.

Scott Stubbs: Thanks, Lizzy.

Operator: Our next question will come from the line of Michael Goldsmith with UBS.

Michael Goldsmith: Good afternoon. Thanks a lot for taking my questions. My first question is just on the kind of the strategy of increasing occupancy and cutting street rate and then using ECRI as a lever to drive rent growth. Has that held up, has that strategy been effective through the quarter? And then along with that, can you talk a bit about just the customers’ reception to ECRIs? Has that changed at all?

Joe Margolis: Sure, Michael. So our strategies are designed to maximize long-term revenue, not to maximize incoming rate or any other metric. And all the testing we do – that we constantly do shows that to lean into occupancy a little more, lean into acquiring web customers at lower rates because they tend to be the longer-term customers and rely on ECRI produces the best long-term revenue growth. Customers’ acceptance of ECRI has not changed at all. We monitor that every month as we send out ECRI notices, and we have not seen any increase in customers vacating the stores because of ECRI. So we believe this strategy is both valid and working.

Michael Goldsmith: Thank you for that. My follow-up is just on the – is on the Life Storage portfolio. Can you kind of – it sounds like the stuff that you can control within the integration and the environment has been working well. It’s kind of some of the stuff that is plaguing the industry, which is kind of the slower demand and also just the pressure on rates is kind of weighing on the ability to generate synergies, is that right? And then does that kind of change the path to generate the synergies that you expected, whereas like it will not necessarily be generating them all in 2024, but it may require kind of a multi-year process to reach that kind of synergy number that you had initially thought of. Thanks.

Joe Margolis: Yes, it’s a great question. And I think it’s accurate assessment of what’s going on. The things we control, like G&A and tenant insurance, we’re not only working, but working better, as Scott pointed out in his comments, than underwritten. And we’re not done there. We’re going to continue to look for further savings in those areas. We’re outbidding contracts to get savings from the greater scale that we have now. We’re going to continue to work real hard to improve on those numbers. What’s also working is that the Life Storage properties do perform better and are trending better on our systems. But the headwind that we face that we don’t control is the market conditions, and that is slowing down the achievement of the full underwritten property synergies.

So two things are going to happen. The mix of what contributes to the targeted synergies is going to change, and there’s going to be less near-term contribution from the properties and more near-term contribution from the other aspects. And depending on where you are in our guidance, it potentially could not occur until after this year. At the high end of our guidance, we’ll get real close, and at the lower end of our guidance, we’ll fall somewhat short.

Operator: Our next question will come from the line of Todd Thomas with KeyBanc Capital Markets.

Todd Thomas: Hi, thanks. First, I just wanted to see if you can talk a little bit more about the differences that you’re forecasting for same-store revenue growth between the EXR and LSI portfolios. If you can expand a little bit on the primary drivers behind those differences and discuss trends that you’re seeing in occupancy and any differences in move-in rates for those two portfolios.

Scott Stubbs: Yes. Hey Todd, it’s Scott. So a couple of things, one is the occupancy delta. So mid-summer last year you were 400 basis points difference between the two pools. When we ended the year, we are 250 basis points different. Today, we’re about 200 basis points different. Through February, we’ve continued to increase occupancy at the Life Storage properties at a time when we were clearing up some auctions, so during the fourth quarter, we had quite a few auctions there, and so you had more churn than is normally happening. On the positive side, at those stores, we have seen customers accept the ECRIs and they have actually moved out at a slightly lower rate than the Extra Space customers receiving ECRIs. So that’s the good news.

The thing that has been a bit of a headwind has been the current market conditions. And so we do expect the occupancy gap to close here in this rental season, and we expect to start closing the rate gap also. Today, their stores are priced as much as 10% lower than the Extra Space stores. And as that occupancy gap closes, we would expect to close that gap also.

Todd Thomas: Okay. And then it sounded like, I think, Joe, you said that you’re encouraged by the rental activity and what you’re seeing so far early in the year? Are you able to provide an update on January and February occupancy and move-in rate trends?

Joe Margolis: Yes. The occupancy as of today is 93.1 on the Extra Space same-store pool. And so good news, occupancy delta at the end of the year was a negative delta of 110 basis points. Today, it’s a positive 40 basis point delta, so strong rentals in the month of January. Now, the – maybe the downside of that is it has come a bit at the expensive rate, our new customer rate, we’ve still found some pushback on rate. Rates in the fourth quarter were down 10%, as mentioned in the prepared remarks, during January, February, they’re down about 17%. But to add some context to that, we pushed rates really hard last year. And so we have actually increased rates again this year, December through the end of February, but just not as much as we pushed them last year. So good news is the occupancy is moving in the right direction or at a time of year when you’re usually losing occupancy, but it is coming at the expense of new customer rate.

Todd Thomas: Okay. And that’s for the EXR legacy same-store that you’re referring to?

Joe Margolis: I’m referring to actually the new same-store pool, which is slightly different, but the old same-store pool occupancy moved almost the exact same. And that’s the Extra Space same-store pool. The life storage legacy pool, the occupancy delta, as I mentioned, as of today, is about 200 basis points, as opposed to at the end of December, it was 250 basis points.

Todd Thomas: Okay, that’s helpful. Okay. Does the change in the same-store pool for either EXR LSI have any expected meaningful impact?

Joe Margolis: So there’s not going to be any change in the LSI pool. We’re keeping it the exact same. The Extra Space pool, the benefit in revenues this year is going to be about 40 to 50 basis points, similar to what we’ve seen in the past. And the occupancy delta, as of today, about 30 basis points of that delta is being generated by the change in pool. So it’s moved between December and today about 140, 150 basis points and 30 basis points of that is due to the change in pool.

Todd Thomas: Okay, great. Thank you.

Joe Margolis: Thanks, Todd.

Operator: Our next question will come from the line of Samir Khanal with Evercore ISI.

Samir Khanal: Hi. Good morning, everyone. I guess, Scott, can I ask you to comment on expenses? The midpoint is 4.75%, but help us through, think through the various line items.

Scott Stubbs: Yes. So the Extra Space pool, the midpoint 4.75% includes an increase of payroll that is inflationary to slightly plus, but call it, 3%. Biggest line item in terms of dollar increase is marketing, which includes its upper teens in terms of increase year-over-year. And we’re expecting to continue to have to spend on the marketing we saw that increase as we moved through 2023. Property taxes are between 2% and 3% and then tenant insurance is the biggest line item with closer to 20%, I’m sorry, property and casualty insurance is closer to 20%.

Samir Khanal: Okay, got it. And just switching gears here, maybe on revenue growth, maybe comment on kind of what you’re seeing, maybe in the New York region. I looked at your sort of top three markets, LA and Atlanta, holding up versus maybe New York, down about 150 bps sequentially. So maybe give a bit more color on kind of the New York-New Jersey market. Thanks.

Joe Margolis: Sure. So the New York-New Jersey, MSA market is, I think it’s being driven down or negatively impacted by Northern New Jersey. So if you look at the borough, the borough continues to outperform our portfolio as it has for the last three or four quarters. New York was laggard for a while, and now New York markets rotate, and now New York is performing very well. But Northern New Jersey in particular is dragging down the overall MSA performance.

Samir Khanal: Okay, thank you.

Joe Margolis: Thanks, Samir.

Operator: Our next question will come from the line of Nick Yulico with Scotiabank.

Nick Yulico: Thanks. Hi, everyone. In terms of the move-in, move-out rates, that’s very helpful in the disclosure. Can you just give us a feel for how you’re thinking about that sequential benefit, which you did cite, some sequential benefit expected in the move-in rates this year? Is it going to be a similar shape to last year, how it played out in terms of looking at, say, mid-year move in rates versus the ending fourth quarter rates in 2022?

Scott Stubbs: We would expect it to be somewhat of a bell curve with less negative churn in the summer months than today. This is kind of the depths of that negative churn, end of the year till end of February. And that’s that negative 35% that you saw in our subs. But we would expect it to go more similar. And we hope to get rate power. We hope to flatten that out somewhat.

Nick Yulico: Okay, great. Thanks, Scott. Just one other question on the $0.20 dilution from acquisitions and such, is that relating to something more than the $250 million of acquisitions in the guidance, is there some impact from last year? Just seems a lot for like a about a $44 million overall number. So I just wanted to make sure I understood what that related to.

Scott Stubbs: This is the – sorry, sorry, Joe. This is the impact of last year’s lease up assets, including certificate of occupancy and this year. So it’s things that aren’t in the same-store pool, basically.

Nick Yulico: Okay, perfect. Appreciate it. Thanks.

Scott Stubbs: Thanks, Nick.

Operator: Our next question will come from the line of Spenser Allaway with Green Street.

Spenser Allaway: Hi, can you guys hear me?

Joe Margolis: Yes, we can, Spenser.

Spenser Allaway: I’m sorry. Yeah, my audio cut out. Thank you. Maybe we could just circle back to expense management, again, just given the environment and there being minimal new customer demand. How important do you view marketing aggressively right now when customers are presumably making storage decisions based on proximity and price?

Joe Margolis: So I just want to clarify. There’s not minimal new customer demand. We’re still renting an awful lot of units every month. It’s just that the price sensitivity of those customers is such that we’re not successful in pushing prices. Marketing spend – I’m sorry?

Spenser Allaway: No, no, I was going to say that’s a fair point. So thank you for the clarification.

Joe Margolis: Sure. So marketing spend, which is only about 2% of revenue, we really look at as an investment. We’re happy to spend or willing to spend the marketing dollars as long as we can get an ROI in those dollars. And we have a metric that we use to make sure we’re getting a good return on every marketing dollar we spend.

Spenser Allaway: Okay. Thank you. And then can you comment on how the cost of marketing in terms of Google clicks and ad space today compares with historical norms? Just trying to understand how that fares relative to historic norms. And trying to understand if some of the increase in marketing is just due to higher absolute cost of advertising versus maybe the amount you’re advertising versus last year.

Joe Margolis: It is slightly higher. That’s certainly a factor. We also are using Sparefoot more than we have in the past. It was a lesson we learned from the LSI merger and that has a slightly higher cost.

Spenser Allaway: Okay. Thanks. And then maybe just one last one, if I can. Just looking at your marketing performance, can you just – market performance, excuse me, can you just comment on what was driving the expense cut in your Chicago market?

Scott Stubbs: It’s property tax appeals, so it’s successful appeals. And so you had negative expense effectively in some of those stores.

Spenser Allaway: Okay. Great. Thank you.

Scott Stubbs: Thanks, Spenser.

Joe Margolis: Thanks, Spenser.

Operator: Our next question will come from the line of Eric Wolfe with Citi.

Eric Wolfe: Hey, thanks. You mentioned that LSI rates were getting a bit closer to legacy EXR in the same submarkets, but still 10% below. Just curious, if you achieve your guidance for this year, it sounds like maybe you’d still have another call at 8% or 9% on rate to get to a similar level. Is that the right way to think about it?

Scott Stubbs: So depending on where you are in the range of that, rates do go up and we do assume that they’ll move in the right direction. And we are seeing that as you move throughout the year, the fourth quarter compared to the third quarter is a normal time when you do see rent per square foot tick down, that’s not odd. You saw that in the portfolio. It was also impacted a bit by some of the churn from auctions. But as we move into January, February, we are seeing that rent gap continue to close and move in the right direction.