Public Storage (NYSE:PSA) Q4 2023 Earnings Call Transcript

Public Storage (NYSE:PSA) Q4 2023 Earnings Call Transcript February 21, 2024

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

Operator: Greetings, and welcome to the Public Storage Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Ryan Burke, Vice President of Investor Relations and Strategic Partnership, for Public Storage. Thank you. Mr. Burke, you may begin.

Ryan Burke: Thanks, Rob. Hi, everyone. Thank you for joining us for our fourth quarter 2023 earnings call. I’m here with Joe Russell and Tom Boyle. Before we begin, we want to remind you that certain matters discussed during this call may constitute forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to certain economic risks and uncertainties. All forward-looking statements speak only as of today, February 21, 2024, and we assume no obligation to update, revise or supplement statements that become untrue because of subsequent events. A reconciliation to GAAP of the non-GAAP financial measures we provide on this call is included in our earnings release. You can find our press release, supplement report, SEC reports and an audio replay of this conference call on our website, publicstorage.com.

We do ask that you initially limit yourself to two questions. Of course, if you have more, please feel free to jump back in queue. With that, I’ll turn it over to Joe.

Joe Russell: Thank you, Ryan, and thank you for joining us today. Tom and I will walk you through our fourth quarter and full year 2023 performance, industry views and 2024 outlook. Then we’ll open it up for Q&A. 2023 was a year of significant achievement for public storage amidst a competitive industry environment. The team elevated our customer experience and financial profile through digital and operating model transformation. Enhanced existing properties with over 500 solar installations and the Property of Tomorrow program. Advanced complementary business lines, including tenant reinsurance and third-party management and grew the portfolio through acquisitions, development and redevelopment. We did so while maintaining one of the real estate industry’s best balance sheets, which is poised to fund growth moving forward in conjunction with significant retained cash flow.

Just a few of our collective accomplishments include: exceeding 3,000 owned properties and serving nearly 2 million in-place customers. Achieving an approximately 80% stabilized direct NOI margin through revenue generation and expense efficiency that only Public Storage is capable of. Acquiring and quickly integrating the $2.2 billion Simply Self Storage portfolio with approximately 90,000 customers across nearly 130 properties. This was the largest private acquisition in company history. Increasing the size of our high-growth non-same-store pool to 705 properties and 63 million square feet now comprising nearly 30% of our overall portfolio. Generating record revenues, net operating income and core funds from operations. Accelerating growth in third-party property management, adding 132 properties and reaching 324 properties in total.

And receiving several accolades tied to sustainability including NAREIT’s Leader in the Light Award, a second consecutive great Place to Work award and achieving top scoring benchmarks among U.S. self-storage REITs. The strength of our team, platform and brand was evident with move-in volumes up an impressive 9% in 2023, despite a backdrop of weaker customer demand during the year. The new customer environment remains challenging, but we have seen a degree of improvement in move-in rent trends recently. And our in-place customer base continues to perform well with average length of stay that are longer than the historic norm. We expect demand from new customers to stabilize during 2024 and the behavior of existing customers including our recent move-ins to remain strong due to clear macro conditions, including the potential for a soft landing, the potential for easing interest rates, resilient consumers, leveling home sales and strong home renter behavior.

We also anticipate fewer completions of new self-storage facilities nationally reducing the competitive impact of new supply in our local markets. All in, the industry is in better position entering 2024 than it was entering 2023. The full Public Storage team is focused on exercising our competitive advantages, which include advancing our digital and operating model transformation, expanding complementary businesses and creating partnerships across the broader industry, growing the portfolio through acquisitions, development, redevelopment and third-party management, and funding innovation and growth today and into the future with the industry’s best balance sheet. All of this adds to the growth of our business over the near, medium and long term.

And it comes at a time with the potential for further stabilization in the move-in environment, existing customers exhibiting strong behavior and an outlook for new competitive supply that is clearly in our favor. With good trends in customer demand, less pressure from new supply and our numerous competitive advantages, we are well positioned for 2024 and beyond. Now, I’ll turn the call over to Tom.

Tom Boyle: Thanks, Joe. On to financial performance, we finished the year reporting core FFO of $4.20 for the quarter and $16.89 for the year, ahead of the upper end of our guidance range representing 1% growth over the fourth quarter of ’22, and 8.3% growth for 2023 overall, excluding the impact of PSB. Looking at the same-store portfolio, revenue increased 80 basis points compared to the fourth quarter of ’22, at the higher end of our expectation. That was driven by better move-in volume and move-in rate performance. On expenses, same-store cost of operations were up 5.1% for the fourth quarter, largely driven by increases in marketing spend to support that move-in activity. In total, net operating income for the same-store pool of stabilized properties declined 50 basis points in the quarter.

Meanwhile, the non-same-store NOI grew 31% and 25% for the fourth quarter and ’23, respectively, demonstrating the continued strength of our lease-up and non-stabilized assets. Now turning to the outlook for ’24. We introduced 2024 core FFO guidance with a $16.90 midpoint on par with 2023. As Joe mentioned, we entered the year more encouraged than we were last year at this time. We’ve seen the industry work through the declines in new customer demand from the peaks of 2021. We’re anticipating that new customer demand stabilizes in 2024 as the macroeconomic picture becomes clearer. That paired with a consistently strong consumer and lower new competitive new supply. If we look at the same-store outlook for ’24 specifically, the midpoint calls for revenue on par with ’23.

Similar to last year, move-in rates continue to be the biggest variable in the forecast heading through 2024 as well. We’re anticipating at the midpoint case that move-in rents lap easier comps through the year, and crossed zero on a year-over-year basis towards the end of the summer. And occupancy results down 80 basis points, which is roughly on top of 2019 occupancies as we sit here today. Our expectations are for 2.75% same-store expense growth driven primarily by property tax and marketing expense. That leads to same-store NOI growth at the midpoint of a decline of 90 basis points. Our non-same-store acquisition and development properties are poised to be a strong contributor again in 2024, growing from $370 million of NOI contribution in ’23 to $505 million at the midpoint and will grow from there in future years.

In addition, embedded in the outlook is incremental acquisition and development activity, $500 million of acquisitions, and we plan to deliver a record $450 million of development in ’24. Finally, our capital and liquidity position remains solid. Our leverage of 3.9x net debt and preferred to EBITDA combined with nearly $400 million of cash on hand at quarter end puts us in a very strong position heading into 2024. With that, I’ll turn it back to you, Rob.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Steve Sakwa with Evercore ISI. Please proceed with your question.

Steve Sakwa: I was wondering, Tom, if you could talk a little bit about the ECRIs that are maybe embedded in the high and low end of growth and how those may be compared to the ECRIs that you achieved in ’23.

Tom Boyle: Sure. Happy to add that color, Steve. I think as you know, I’d like to speak about existing customer rent increases as a combination of customer price sensitivity as well as the cost to replace that customer if they vacate upon receiving a rental rate increase. And as we look at in 2024, there’s a couple of things at play here. One is, as we enter the year, right, demand is a little weaker, we’ll give you a January, February update here shortly, where move-in rents are down year-over-year as we start the year, similar to how we finished in 2023, that’s going to lead to higher replacement costs through the first part of this year. That’s going to be a little bit of a drag to ECRI performance. The flip side is, Joe spoke to the strength in move-in volumes that we experienced through ’23.

Those new customers are going to be eligible for rental rate increases, which will lead to more contribution from the volume of increases that are sent this year. Such that at the midpoint case, we’re looking at contribution overall, pretty consistent with 2023 with those two pieces offsetting each other. In the high-end case and low-end case, a little bit better price sensitivity in the high end and a little bit worse than the low end.

Steve Sakwa: Great. And then on the expense growth, can you maybe just talk about what’s embedded for marketing and sort of how you’re thinking about that? I guess, we were a little surprised that expense growth overall was coming in kind of at $275 at the midpoint. But just what do you have baked in for marketing just given the still somewhat challenging demand environment.

Tom Boyle: Yes. So as I noted in my prepared remarks that the key drivers of expense growth are property taxes and marketing. So I will note, property tax is our largest expense line item. We do anticipate to be up 4% plus or minus, which is a contributor. And then on marketing expense, taking a step back, we increased marketing spend through the year in 2023 and saw very good returns associated with that. The fourth quarter, our marketing expense as a percentage of revenue was 2.5%. And as you’ve heard from me in the past, being in that 1% to 3%, 1% back in 2021 when demand was really, really strong and back towards 3% when you go to a more typical operating environment, pre-pandemic, is a comfortable place for us to be. And so the first part of 2024, we’re going to be lapping comps that will lead to year-over-year growth levels that are higher, similar to what we experienced in the fourth quarter and then we’ll evaluate as we go from there.

But we’re comfortable in the ZIP Code and continue to see a very strong return on that advertising dollar.

Operator: Our next question is from Michael Goldsmith with UBS. Please proceed with your question.

Michael Goldsmith: You finished the year with 80 basis points of same-store revenue growth in your guidance for the upcoming year ranges from down 1% to up 1%. So presumably same-store revenue growth is going to dip before it kind of rebounds and that goes in line with the — I think, some of what you’ve been saying with the — with your expectations of street rates. So — how much of — in the midpoint of your guidance, how much of a dip are you expecting? And when are you expecting trends to kind of inflect better through the year?

Tom Boyle: Good question, Michael. So there’s a couple of components to this question that I’ll respond to. The first is, as we look at our operating metrics, our operating metrics are starting to improve, right? We talked about occupancy closing the gap as we move through last year, and we finished the year with occupancy down 70 basis points compared to down 240 basis points when we started ’23. If you look at move-in rent trends, move-in rents on a year-over-year basis decelerated through the year. In the fourth quarter, they were down 18%. Throughout the quarter, but as we noted in our January update, they improved to down 11% in December. Looking at January and February, they’re down in that same 10%, 11% sort of ZIP code.

So, that improvement has been lasting. And as you heard through our outlook, we anticipate that to continue to close as we move through this year. I highlight that because operating metrics tend to lead financial metrics, meaning that as we’re talking about some of these operating metrics improve, it will take several quarters to see that in financial metrics. And so, if you think about the shape of the curve and the description of the midpoint case that I gave earlier, it would imply that to your point, we’re going to see some deceleration through the first couple of quarters of this year. But then the second derivative, the rate of change of growth is going to flip positive in that midpoint case in the second half and you’re going to see some reacceleration in the financial metrics, again, lagging those operating metrics in the second half.

The second component of the question that I just highlighted is, we’re already seeing that in certain markets. And so if you look at the Mid-Atlantic, for instance or Seattle, markets that maybe didn’t have the high highs in 2021, but have been solid performers. We’re actually seeing those accelerate as we sit here today in the first quarter and would expect those high, high markets, the Floridas, the Atlantas, for instance, to take a little bit longer to find that turn given how high their high was. But we’re already seeing some of that turnaround in some of our operating metrics today.

Michael Goldsmith: And my second question, it’s a multi-parter, but it shouldn’t be too intimidating. You comment in the that softer that — you say, you expect industry-wide demand from new customers. To stabilize this year due to improving macroeconomic conditions. So one, are you seeing that today? Two, can you kind of provide an update on where the move in rent were in January and to the extent that you’re able to provide insight into February? And then three, the — you’ve talked about moving rents crossing the zero. How positive, if that momentum has continued — how positive could move in rents be as we kind of exit the year?

Joe Russell: Okay. Apologies accepted, but you took some liberty there, Michael, but we’ll address your question. All right. So let me start with consumer strength and what we continue to see in the portfolio that’s been trending to a clear advantage, even with the performance we saw quarter-by-quarter in 2023. The consumer activity, first of all, in existing customers, as I’ve mentioned, has been quite strong, and we’re really not seeing any on the margin evidence that that’s likely to change even going into what we’ve seen through almost two months of this year. Balance sheets are quite healthy. Payment patterns are still better than they were pre-pandemic. We’re not seeing any undue or new stress evolving into customer activity.

The acceptance of our ongoing revenue management tied to existing customer rate increases. We have a very active engagement process with existing customers that guides us to the tolerance and the level of activity that we’re pushing through on ECRIs, that too has not hit different levels of either areas that we’ve become more concerned about. In fact, it’s validating many of the things that we’ve already talked about relative to the performance of existing customers and our confidence that that’s likely to stay with us, even coupled with what Tom just mentioned, indicating in certain markets, where you’ve actually seeing the — some good percolation taking place. That ties clearly to the kind of activity from a new customer demand activity.

We’re having to work harder as we did all through 2023 with a variety of tools that we have. They’re quite good. In fact, they continue to get much better. We are very confident market to market with our scale and the knowledge we have market to market. We have the right tools. We have the right brand. We have the right technologies to continue to pull customers to our platform, and we’re going to continue to leverage those going into the next several months. With the anticipation, as Tom mentioned, that by summer or late summer, we’re going to start seeing the residual effects to the positive from all those efforts. And then Tom, you can tackle if you choose to, Michael’s additional questions.

Tom Boyle: So Michael, I’ll just maybe take a step back and talk a little bit about how we thought about the macro environment in our guidance. So last year, on this call, we spent a good bit of time talking about the macro environment. And we did couch the guidance range last year in macro terms and that we viewed it as appropriate given the landscape at the time. At the time, 65% of Bloomberg economists were expecting a recession during the calendar year, for instance, and we thought it would make sense to provide the investment community our assumptions of what that could potentially look like within our guidance range. Clearly, as we move through ’23 that recession outcome became less probable. And as such, our financial performance proved out to be towards the higher end of those expectations as we move through the year.

This year, we are not capturing the range in terms of macro. And as you think about the midpoint of the range, we’re not assuming that the macro environment needs to improve at the midpoint range, but more around the lines of what Joe was speaking to and what we’re seeing today. So I hope that’s helpful in terms of how we thought about the range. And then I will hit on one of your comments just again because you asked about what move-in rents were doing in January and February. I’ll just reiterate that for the group. Move-in rents were down 10%, 11%. So pretty consistent with December performance, which is, what you’d anticipate, right, because we’re at kind of the trough of rental rates in the winter season here, and we’ll be looking to March, April and May to see some acceleration in moving rents.

Operator: Our next question is from Juan Sanabria with BMO Capital Markets. Please proceed with your question.

Juan Sanabria: Maybe just piggybacking off of part of Michael’s question. I guess what is assumed within the range of when street rates break that year-over-year breakeven point? And if you have any color around changes in — or difference in occupancy assumptions at the high or low end of the range?

Tom Boyle: Sure, Juan. I’ll give you some context around both the high and the low. And specifically, you’re speaking to same-store revenues. So that’s where I’ll focus my attention. So as I noted, at the midpoint case, that assumes that we cross that zero on a year-over-year basis for moving rents at the end of the summer and occupancy being down about 80 basis points. Pretty similar to where we finished the year in ’23. And I would note that, that’s — as we sit here today, year-to-date, we’re down 70, 80 basis points in occupancy, so consistent with where we sit today. In terms of the high end and the low end, the low end assumes that it takes a little bit longer for operating metrics to stabilize here. And as such, the assumption on when we cross zero on year-over-year move-in rents is at the end of the year.

And in that case, we’re assuming, right, it takes a little longer to stabilize. The move-in environment is going to be a little bit tougher, Occupancy is down about 120 basis points year-over-year. At the high end, we’re assuming a more vibrant spring leasing season, one, which we see a little bit of a rebound in the housing market, something we spent a good bit of time talking about through the fall of last year. There are some indications that we could experience that this year. The high end of the range assumes that. And as such, that zero crossing point is at the beginning of the summer in that spring leasing season and occupancy, as you’d expect, results in better performance down about 20% — or 20 basis points — sorry, 20 basis points throughout the year with an acceleration in the summer and a higher peak seasonally.

Juan Sanabria: And then for my follow-up, you’re assuming acquisitions in the guidance. So just curious, if you could speak to the investment environment, any color on where you’re seeing stabilized cap rates and just the quality and the quantum of opportunities out in the marketplace?

Joe Russell: Yes, sure, Juan. I’ll take that. I would say, at this point, we’re continuing to see the same environment that we saw through most of 2023. So a lot of owners are reluctant to put properties into the market. Knowing that they’re going to potentially not achieve the cap rate or the valuation that they expected based on prior year inflated valuations, et cetera, when interest rates were at a much different price point. So the reluctance continues. The amount of activity going into the first part of this year, which is typically very light, is just that. We are getting a number of inbound discussions that are tied to properties that are quote-unquote not on the market to either test the water or judge whether or not we are ready to transact at a valuation that either meets or would be acceptable for that particular seller.

We do not have anything as noted in our release, currently under contract. The team is busy. We’re engaged in a number of different conversations with a variety of different size opportunities, whether single assets or larger portfolios. But as we saw in 2023, the beginning of 2024 is likely to be very similar. And we’ll see going into the next few months, if there’s either some pent-up demand or additional realization that cap rates have adjusted, and we’ll just see if, in fact, there’s going to be more trading. Clearly, one thing that could moderate that to some degree in push activity to a higher level is some activity by the Fed reducing interest rates, potentially with some impact on cap rate adjustments, et cetera. But frankly, there’s just not a lot of trading going on right now to give you any really clear sense of how directly cap rates have changed at the moment.

But the gap continues, meaning the level of seller expectations to what we feel are prudent ways for us to allocate capital. Many of the conversations just start with that, and we’ll see how that plays out here in the near term.

Operator: Our next question is from Jeff Spector with Bank of America. Please proceed with your question.

Jeff Spector: Great. Just trying to think about all the comments, upper end, the lower end assumptions, skepticism, we continue to hear. Just some of the concerns, I mean, I guess to be clear, are you saying from the data you’re seeing year-to-date that you finally feel there is more or greater visibility on how to forecast this year versus, let’s say, last year?

Tom Boyle: Yes, Jeff, I think as we sit here today, we do have more visibility, we think, heading into this year. I mean, I just spoke earlier around how we couched the ranges last year in the macroeconomic environment. Our view is the macroeconomic environment is clearer this year. We’re not couching the ranges that way. And as we sit here today, right, is very different than last year. Last year, we knew that demand was weaker, and we were going to see revenue growth decelerate through the year in a pretty meaningful way. This year, that pace of deceleration has really slowed. And as I highlighted earlier, there’s actually some markets in our portfolio that are reaccelerating already in the first quarter, which we view as leading as we move through the year.

And so from a range of variability less than last year, that’s not to diminish the fact that we’re still in an uncertain environment. We’re still talking about moving rents being down 10%, 11% to start the year. That’s not like a typical pre-pandemic year, where we’d be debating our move-in rent is going to be up 3% or are they going to be up 5% in a very tight band. That’s not the environment we’ve been operating through in the last several years. And as such, we think we’ve couched the ranges appropriately to encapsulate that variability. But we do feel more confident in the range of outcomes this year than we did last year.

Joe Russell: And like many times, Jeff, it’s never one single issue, but Tom just went through a number of the things that have given us more clarity and perspective going into this year that we think are, a, additive one by one. Another factor that’s continuing to trend very favorably to the entire industry that we’re seeing, particularly in nearly every market we operate in our reduced levels of deliveries. The development business has continued to be very, very difficult. Funding for new construction is either at a very high cost or from an availability standpoint, very limited. The time to get through entitlements even for our own processes are continuing to be very difficult. So this too creates another additive element that we have even more perspective on now that we’ve been through a multiyear deceleration of new development deliveries, putting us in a very different position even year-by-year that we’ve had more confidence to say this is a different environment, very different than where we were even a year ago.

So with that, we think that we’ve got the right perspective, continue to read the variety of tea leaves out there, but we are very confident that we’ve got the right tools to guide us and put the kind of perspective that we’ve got into our outlook for 2024.

Jeff Spector: Great. And then my follow-up is, can you discuss trends you’re seeing in January and February, including move-in, move-outs, and maybe which markets are doing better or worse? Let’s say, year-to-date?

Tom Boyle: Sure, Jeff. I mean I think I’ve already covered the move-in rate component and as well as the occupancy side. So maybe I’ll just focus on the market part of the question, which is not too dissimilar to fourth quarter performance. We continue to see strength in Southern California, for instance as our strongest area of growth. And as we spoke about through ’23, the markets that had the highest highs in ’21 and ’22 are giving back some of that appropriately so. And so the weaker markets on a growth rate basis to start the year are some of those southeastern markets, Florida, Atlanta, et cetera.

Operator: Our next question comes from Keegan Carl with Wolfe Research. Please proceed with your question.

Keegan Carl: Maybe first, just where is your development line — your development pipelines start for the year? And where are you expecting to end based on your anticipated deliveries in ’24?

Tom Boyle: Yes, Keegan, maybe I’ll just talk a little bit about the development environment and then some of the sequencing of our deliveries. So, as we’ve sat here today, we’ve been trying to grow our development business from where we were delivering more like $100 million to $200 million in deliveries in ’21 and ’22. Last year, we delivered $360 million, as I noted in my remarks, we’re looking to deliver $450 million in this year. So an acceleration when the industry overall is seeing delivery slowdown. So we’re taking some share there in growing that business. We’re doing so because we think it’s the highest risk-adjusted return on capital. And you can see the returns that we’ve achieved on our development vintages in the sub.

And we have an in-house team that’s dedicated to this program, development, construction, design that are all out working on growing that pipeline. This will be a record year. The team is out of figuring out how we’re going to backfill that development pipeline from here in a challenging development environment. But as we sit here today, that’s a business we want to grow. And we’ll be looking to backfill that pipeline and have deliveries next year, hopefully around the same levels that we have this year and go from there.

Joe Russell: And yes, just from a timing standpoint, Keegan, a little lighter in Q1 but then pretty balanced deliveries in the subsequent three quarters a little bit differently than what we saw in 2023, where we had a lot of deliveries hit more towards the second half of the year. So, we’ve got a good combination of both ground up new development, and we’re a little over-weighted on expansion and redevelopment opportunities, particularly tied to unusually large projects that we’ll complete in 2024. So — as Tom mentioned, the team is working hard not only to continue to grow the overall pipeline, but to continue to put these generation five Class A properties into a whole variety of markets. And we’re continuing to see very good lease-up and again, returns tied to the development activity, both new development and redevelopment.

Keegan Carl: Got it. That’s really helpful. And then shifting gears here, I know Tom mentioned a little bit about demand. I’m just curious, have you seen a material change for storage demand in L.A. on the back of the flooding? And then can you just remind us of what the typical tailwind of a natural disaster is for demand in a given market?