Image Source: CubeSmart – November 2019 IR Presentation
By Callum Turcan
With housing costs rising aggressively in “Tier 1” and “Tier 2” cities across the East and West coasts in the US, that has created an immense need from households for additional storage space but at a much lower cost than simply buying a larger home, apartment, or condo. This has created a major secular growth trend that we’ve highlighted repeatedly in our High Yield Dividend Newsletter (‘HYDN’) by including shares of CubeSmart (CUBE) and Public Storage (PSA) in our HYDN portfolio, both of which are self-storage focused real estate investment trusts (‘REITs’). Click here for more information on our HYDN. Both self-storage REITs have steadily grown their already sizable payouts over the past several years and we expect that to continue to be the case going forward, with shares of CUBE and PSA yielding ~4.2% and ~3.6%, respectively, as of this writing.
Tough 2020 Ahead
Weak 2020 guidance put out by Extra Space Storage Inc (EXR), which includes forecasts that call for -0.5% to +1.0% same-store net operating income (‘NOI’) growth due largely to relatively modest same-store revenue growth being offset by significant same-store expense growth (as forecasted), which has spooked investors. Extra Space Storage’s management noted supply growth was an issue as the industry is expanding to meet expected future demand. Here’s a brief excerpt from Extra Space Storage’s latest quarterly conference call:
“Most of the headwinds faced in 2019 will continue to be present in 2020. The supply cycle we find ourselves in will continue to dampen performance, but it is moderating and will reverse.” — Joseph Margolis, CEO of Extra Space Storage
Pivoting to CubeSmart, the firm had a similar forecast for 2020, with the company forecasting -1.5% to flat same-store NOI growth this year. Revenue growth is expected to be very modest with forecasted rising operating expenses eating up those expected incremental sales and then some. Here’s what CubeSmart’s management had to say during the firm’s latest quarterly conference call (emphasis added):
“We reported a solid quarter yesterday [February 20, 2020] and a continuously challenging operating environment. Throughout the year, in spite of the internal growth headwinds caused by the ongoing impact of new supply, we generated growth in our funds from operations through expansion of our third-party management program, the utilization of joint-ventures, the lease-up of our non-stabilized portfolio and successful capital raising in both the debt and equity markets.
2020 will be a year of transition, as our industry absorbed the new supply delivered over the last several years. Our outlook for the future remains positive, as our current supply data for our top 12 markets points to 2019 being the peak year for new deliveries, markets that experienced the impact of new supply early in the cycle are seeing a solid slowdown in expected future deliveries.” — Christopher Marr, CEO of CubeSmart
Public Storage didn’t provide same-store NOI guidance for 2020 in its press release or during the quarterly conference call, and please note the company bid to acquire National Storage REIT which owns self-storage assets in Australia in early-2020 through a deal reportedly valued at ~$1.9 billion. The firm has various international operations along with its core US operations (38 states and the District of Columbia according to its website), particularly in Western Europe, so this acquisition fits in with its long-term goals. Public Storage noted that 2020 would be another tough year, largely due to ongoing supply additions, but that the market was showing signs of adjusting. Here’s what Public Storage’s management team had to say during the REIT’s latest quarterly conference call:
“We feel like we have a strong tool kit to continue to maneuver through higher supply markets… some of that is shifting the supply picture nationally. We’ll have another strong year of deliveries in 2020. It could be plus or minus say 10% down from what we saw in 2019. Again, these are elevated levels of construction that we’re now going into the fourth year of a range of anywhere from $4 billion to $5 billion in deliveries…
The interesting thing and it ties to the resiliency of the product overall the resiliency of our own brand, et cetera is we are seeing deliveries come down in markets like Denver, Charlotte, Houston, Austin and Chicago; and not ironically those are some of the markets now that we’re actually starting to see some decent percolation, and we’re encouraged by that.
Now going into this next year, we’ve got our eyes wide open on markets like Portland, Boston, Seattle, Miami, D.C. and New York, because there’s more deliveries coming to those markets, some of which haven’t had the kind of development activity in quite some time…
…the outlook beyond even this year is more murky… It’s too soon to tell. But again, we’ll continue to use all those tools that we’ve got.” — Joe Russell, CEO of Public Storage, responding to an analyst’s question
What we take away from these comments is that 2020 will be tough or at best middling time for the US self-storage space. However, given ongoing demand growth for self-storage facilities in the US (particularly in high-growth and expensive major metropolitan markets), the additional supply brought online over the past few years will be absorbed and the industry’s near-term outlook will look far different by the end of this year (or possibly a bit later) than it stands at the start of 2020. Pushing into international markets is a smart way to get around this temporary headwind.
Given the strength of CubeSmart’s and Public Storage’s free cash flow profiles, made more impressive by the fact that most REITs aren’t free cash flow positive, we are comfortable waiting out short-term turbulence given the nice medium- and long-term upside the self-storage REIT space provides. Here we would like to highlight that most REITs are not free cash flow positive due to the enormous investments they tend to make in new properties that often consume virtually all of their net operating cash flows, generally speaking, which sets firms like CubeSmart and Public Storage apart from the rest of the REIT world.
Image Shown: The self-storage industry in the US is supported by powerful secular growth tailwinds. Image Source: Extra Space Storage – January 2020 IR Presentation
According to third-party data cited by Extra Space Storage, it appears the relatively younger demographic groups in the US offer the most upside when it comes to growing self-storage demand going forward. In the meantime, the “Baby Boomer” demographic is still a big source of demand for self-storage facilities, highlighting the widespread appeal of these properties as relatively cheap storage options.
Image Shown: Younger demographic groups in the US are increasingly utilizing self-storage options. Image Source: Extra Space Storage – January 2020 IR Presentation
Financial Overview
In 2019, CubeSmart generated almost $332 million in net operating cash flow and spent a bit over $140 million on capital expenditures (defined as ‘additions and improvements to storage properties’ plus ‘development costs’, we wouldn’t consider ‘acquisitions of storage properties’, ‘cash paid for partner’s interest in real estate venture, net of cash, cash equivalents and restricted cash acquired’, or ‘investment in real estate ventures’ to be capital expenditures as those are activities within the realm of M&A), allowing for just over $191 million in free cash flows.
Those free cash flows covered most of CubeSmart’s $246 million in ‘distributions paid to common shareholders’ during this period, keeping in mind CubeSmart is a capital market dependent entity. CubeSmart exited 2019 with $55 million in cash and cash equivalents along with $4 million in restricted cash versus over $1.8 billion in senior unsecured notes net and $96 million in mortgage loans and notes payable.
For clarity, for capital market dependent entities like CubeSmart, we also take their ability to issue equity and tap debt markets into account when evaluating their payout coverage on a forward-looking basis. As it relates to our Dividend Cushion ratio, the numerator in that metric on an adjusted basis includes a REIT’s expected proceeds from equity issuance over the relevant five-year period. CubeSmart carries investment grade credit ratings (BBB/Baa2) and recent financing activities indicate the REIT retains quality access to debt markets at attractive rates.
Pivoting to Public Storage, that REIT generated $2.1 billion in net operating cash flow in 2019 while spending $0.5 billion on capital expenditures (defined as ‘payments for capital expenditures to maintain real estate facilities’ plus ‘payments for development and expansion of real estate facilities’). Approximately $1.6 billion in free cash flow roughly covered $1.6 billion in ‘distributions paid to preferred shareholders, common shareholders and restricted share unitholders’, keeping in mind Public Storage is also a capital market dependent entity like CubeSmart. At the end of 2019, Public Storage carried $0.4 billion in cash and cash equivalents versus $1.9 billion in notes payable. Like CubeSmart, Public Storage carries investment grade credit ratings (A/A2) and recent financing activities indicate the REIT retains quality access to debt markets at attractive rates.
Concluding Thoughts
The payouts of both CubeSmart and Public Storage are still well-protected after considering both firm’s ability to tap capital markets, in our view. While there are risks if capital markets freeze up, given that both entities generate meaningful free cash flows, carry solid investment grade credit ratings, and have seen their equity prices perform quite well relatively speaking, we view CubeSmart and Public Storage as high quality income generating entities that should retain access to capital markets going forward. 2020 may be tough compared to years past, but as supply growth cools off, secular growth tailwinds continue to support the domestic self-storage industry’s promising long-term outlook. International markets offer additional upside, which Public Storage has been actively capitalizing on and we appreciate that.
Rental and Leasing Stocks – UHAL CAR PSA R URI
Related: CUBE, EXR, VNQ
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Callum Turcan does not own shares of any of the securities mentioned above. CubeSmart (CUBE), Public Storage (PSA), and Vanguard Real Estate ETF (VNQ) are all included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Vanguard Real Estate ETF is also included in Valuentum’s simulated Best Ideas Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.