PSA - 1 REIT To Sell And 1 REIT To Buy

2023-09-11 08:25:00 ET

Summary

• There are 100s of REITs out there.
• Being selective is very important.
• I present one REIT to sell and another one to buy in the same sector.

The REIT market is vast and versatile.

In the US alone, there are over 200 REITs, and they invest in over 20 different property sectors:

• Office
• Industrial
• Apartment
• Retail
• Hotel
• Net Lease
• Senior housing
• Skilled nursing
• Hospital
• Medical Office
• Manufactured Housing
• Single-Family Rental
• Student Housing
• Self Storage
• Timberland
• Farmland
• Billboard
• Data Centers
• Infrastructure
• Ground Lease

That's just the US! There are today 20+ other countries that have REITs as well:

So this is a very large investment universe, and you need to be very selective to find the good from the bad companies. We invest in just one REIT out of ten on average, and it is by being so selective that we have managed to outperform sector averages ( VNQ ) over the long run.

Today, I am going to give you an example of what this means by highlighting a REIT to sell and one to buy. Both invest in the same property sector but one is a lot more compelling than the other:

Public Storage ( PSA )

PSA is one of the most popular REITs in the world. It has about 30,000 followers on Seeking Alpha, and new articles (mostly bullish!) are posted nearly every day.

It is so popular because:

• It owns a large portfolio of Class A self-storage properties.
• It has one of the strongest balance sheets in the entire REIT sector.
• And finally, it has one of the best track records of all public stocks ( SPY ). It has even easily outperformed Berkshire Hathaway ( BRK.A , BRK.B ):

It was exceptionally rewarding over the past decades because it was able to capitalize on a fragmented industry that was undersupplied but rapidly growing in demand. This allowed it to develop new self-storage properties at high spreads relative to its cost of capital. At the same time, it would also buy properties from other unsophisticated operators and would then rapidly bump up their cash flow by adding their logo, implementing revenue-optimizing systems, and adding them to their national advertising campaigns.

That worked fantastically for the past few decades, but here's the issue: everyone has now witnessed the exceptional returns of self-storage and this has attracted a lot of new competitors.

There are now many other large REITs in this sector, including Extra Space Storage ( EXR ), CubeSmart ( CUBE ), and National Storage ( NSA ), and the competition is greater than ever.

It feels as if new properties have been built on every busy intersection, and I fear that the self-storage market is now oversupplied in the US.

There is literally 10x more storage space per capita in the US than in the UK and 20x more than in the EU:

Therefore, it would appear that Public Storage and these other REITs have maxed out their growth opportunities in the US.

At the same, now increasingly many people, especially millennials and Gen Zs, are spending less money on things and more on experiences instead.

Moreover, the sharing economy is also likely to reduce the demand for storage space over time because it is now a lot more efficient and cheaper to rent things like boats and RVs.

At the same time, I also fear that the "return to the office" is going to lead to a drop in demand for storage space in the coming years. The pandemic led to a boom in demand because people suddenly wanted to make space for a home office, but as people now gradually return to the office, there will be less need for a home office, and some people will likely not renew their self-storage leases to save some money. This is especially true if times get tough, and we go into a recession.

All these headwinds are now already starting to show in the recent results of most US-based self-storage REITs, but things could get a lot worse.

This has already caused a crash across the self-storage sector, with most REITs dropping by over 30%.

Even then, Public Storage is still priced at 17x FFO, which is not expensive, but it is not particularly cheap either - all things considered.

I can think of quite a few other blue-chip type REITs that are today cheaper and enjoy better growth prospects.

For this reason, I wouldn't buy Public Storage at this time.

Instead, I think that the following company is a better opportunity:

Big Yellow Group (BYG; BYLOF )

BYG is not as well-known, but it is the biggest player in the UK.

In many ways, it is the European version of Public Storage:

• It owns Class A properties.
• It has a fortress balance sheet.
• And it has an exceptional track record:

But the big difference is that the European self-storage market is still 20 years behind. The concept is just now growing in popularity and most people are first-time users.

As we noted earlier, there is only about 1/10 of the supply in the UK even despite the fact that cities are a lot denser, homes are smaller, remote working is even more popular, people travel just as much if not more, and people also go through divorces and older generations leave stuff people.

Therefore, the demand is there, and Big Yellow is now capitalizing on this opportunity.

I think that Big Yellow still has a long runway of rapid growth ahead of it, and this is the key differentiator between Big Yellow and Public Storage.

It is also a lot smaller, which means that every new investment really moves the needle for them. The same cannot be said about Public Storage:

Despite all these advantages, Big Yellow's share price has been dragged down with the rest of the sector and as a result, its valuation and dividend yield are at similar levels today:

I think that the spread should be quite a bit larger, given that the European market is a lot stronger with better long-term growth prospects and lower near-term risk of oversupply.

For this reason, I think that Big Yellow offers better risk-to-reward for long-term oriented investors, and this is why we own it in our portfolio.

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