SELF - Picking A Winner In Self-Storage REITs

2023-06-11 09:00:00 ET

Summary

• Self-storage REITs have returned 7.27% this year, outperforming the REIT average and the S&P 400 and 600 indexes.
• Publicly traded REITs own only 20% of the total square footage in the US storage facilities, leaving room for growth by acquisition.
• This article examines the Self-Storage REIT sector, to identify the best poised self-storage REIT to deliver outperformance over the next 2 to 5 years.

Thus far this year, Self-Storage REITs as a whole have returned 7.27%, outperforming not only the REIT average, but also the S&P 400 and 600 indexes.

Publicly traded REITs own only about 20% of the total square footage in the roughly 50,000 storage facilities in the U.S., so there is plenty of room to grow by acquisition. As Hoya Capital puts it in their latest sector report ,

we expect these REITs to be in "growth-mode" due to a combination of factors and foresee these REITs using their stellar balance sheets to scoop up smaller, over-levered players that are seeking an exit.

Rent growth for self-storage facilities has softened somewhat from its record highs of late 2021, but remains above the 2016 peak.

Accordingly, FFO for the Storage REIT sector has tailed off, but is still on pace for double digits in 2023, after posting an overall 3.0% gain in Q1 2023.

Meanwhile, Storage REIT occupancy levels have slid back approximately to their 2019 levels.

Storage REITs have grown their same-store NOI far more rapidly since 2019 than any other REIT sector.

Hoya Capital sums up the Storage REIT investing proposition as follows:

We continue to like the longer-term prospects for the storage sector given the 'stickiness' of demand, strong balance sheets, low cap-ex needs, and impressive operational track record. Accelerated by tighter financing conditions and softer fundamentals, external growth opportunities should be plentiful over the next several years as more high-levered private players seek an exit.

This article examines 5 Self-Storage REITs, to single out the one company best poised to deliver outperformance over the next 2 to 5 years.

What the numbers say

My FROG-hunting approach to REIT investing relies on just 7 numbers:

1. Liquidity ratio (Assets/Liabilities)
2. Growth in Funds From Operations (FFO)
3. Growth in Total Cash From Operations (TCFO)
4. Growth in Dividends
5. Market Cap
6. Growth in share price
7. Volatility

Hey, what is a FROG anyway?

FROG stands for Fast Rate of Growth. FROG REITs are significant , because they usually outperform the market in total return (Gain + Yield). The criteria for identifying a FROG are as follows:

1. Positive price gain over the past 3 years
2. Liquidity Ratio >= 1.66 (preferably >=2.00)
3. FFO and TCFO Growth rate >= 10% (preferably >=20%)
4. Market cap of at least $1.4 billion.
5. Modeled Return greater than the return posted by the Vanguard Real Estate ETF ( VNQ ) over the past 3 years.

Modeled Return is my own Rube Goldberg invention that combines price gain, dividend yield, dividend growth rate, and volatility to arrive at one number, for comparison to VNQ.

The opposite of a FROG is a COW (Cash Only Wanted), which is a company notable for its prodigious stream of cash dividends and plodding or mediocre revenue growth.

How do the candidates stack up?

There are 5 Self-Storage REITs I track. The candidates are as follows:

• Public Storage ( PSA )
• Extra Space Storage ( EXR )
• CubeSmart ( CUBE )
• National Storage Affiliates ( NSA )
• Global Self-Storage ( SELF )

First we screen on Liquidity, FFO growth rate per share, TCFO growth rate, and Market Cap, using the criteria above.

Source: Hoya Capital Income Builder, MarketWatch.com, and author calculations

Note: Modeled Return is not an attempt to predict total return for the coming year, but rather a measuring stick to identify companies that will outperform. The wider the margin by which a company's Modeled Return exceeds that of the VNQ, the better its chances of outperforming in the coming year.

CUBE remains our leader, with slightly higher numbers than PSA across the board. But PSA remains in the running, with massively higher Modeled Return than the VNQ.

On to the finals: Future Growth

So far, our growth metrics have been backward-looking. Now we sort our candidates by projected FFO growth for 2023 and 2024. These analyst consensus figures (a.k.a. educated guesses) are based mostly on company guidance. Since next year's FFO is much easier to predict than two years down the road, I give double the weight to expected growth rate for 2023 versus the projected rate for 2024.

Source: Author's calculations, Seeking Alpha Premium, and Hoya Capital Income Builder

From a value investor standpoint, there is very little difference between PSA and CUBE. Both have competitive and very safe dividends (maybe a little too safe), and the slight difference in price/FFO is counterbalanced by a slight difference in premium to NAV.

From a FROG hunter's standpoint, it's a dead heat also. PSA's future growth projections point to PSA as the winner by a nose.

However, there is one caveat. PSA attempted to buy LSI earlier this year, and was rebuffed. Now that EXR has bought out LSI, PSA may be hungry to acquire either CUBE or NSA. ( Hoya Capital considers NSA to be the more likely target. ) That is pure speculation, however, and I have encountered no solid reporting of any offer to that effect as yet. If that happens, PSA will resume its former position as the largest of all the Storage REITs, but the digestion process will probably act to suppress PSA's share price growth.

May I have the envelope, please?

It is a photo finish. However, because of the risk that PSA will acquire one of the smaller Storage REITs, I am giving the nod to . . .

As always, however, the opinion that matters most is yours.

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