PSA - Public Storage: A Simple Question Of Supply And Demand

2023-09-08 04:25:35 ET

Summary

• Self-storage REITs have presented a compelling investment for the last decade.
• Public Storage, the largest self-storage player in the US, has benefited from this growth over the long term, but its stock has declined 18.5% in the past year.
• We think Public Storage will face increasing challenges with dwindling demand, oversupply, and declining population in key markets.

So. Much. Stuff.

Over the long haul, it could be said that betting on the American self-storage space has really been a bet on the American consumer: as people buy more stuff to put in their homes, eventually they'll run out of space or prefer to store some of their stuff elsewhere. For a very long time, this has been a stellar bet. Rejournals.com estimates that from 2009-2018, the industry experienced an average annual ROI of a whopping 16.9%.

A primary beneficiary of this stunning growth is Public Storage (PSA), the largest self-storage player in the United States which, as of its latest quarterly filing , boasted 206 million net rentable square feet of storage space spread across 2,888 facilities, and whose common stock sports a 4.4% dividend yield (as of this writing).

The large-scale trends across the country have led to a cottage industry of self-storage stock bulls , whose arguments in favor of the sector can largely be summed up as:

1. Americans buy more stuff than they can keep in their homes.
2. Baby boomers are downsizing while millennials prefer urban and city living, both of which are tailwinds for the self-storage business.
3. There is still plenty of runway to accommodate new self-storage space in the United States.

For all of these bullish points, however, the market seems to believe that the outlook for Public Storage is not quite so rosy, as evidenced by the stock's 18.5% decline over the last 12 months.

Over the last ten years, in fact, the stock has appreciated 77% versus the broader S&P 500's ( SPY ) return of 171%. Reviewing the stock's performance on a total return basis for the same time frame also reveals underperformance for Public Storage with a 158% return against SPY's 225%.

While it might be tempting to view the drop in Public Storage's price as a potential buying opportunity, we do not believe that the outlook for the company or the sector to be quite as strong as what the bulls contend. In fact, we think that a few key drivers will precipitate a continued slowdown in Public Storage's business and underperformance in its stock. The main points of our argument are thus:

1. Americans are seeking out storage space in fewer numbers than before while the self-storage industry (and Public Storage) are expanding capacity.
2. Prices have over-extended in recent years which is causing rents to mean revert, which is problematic for Public Storage since same store growth in the last quarter was driven through price increases.

Let's dive in.

Dwindling Demand & New Supply

On the latest conference call , Public Storage management highlighted move in volume, with CEO Joseph Russell noting that "we are driving record year-over-year growth in customer move-in volumes. Move-in volume growth has accelerated throughout the year, up nearly 14% in the second quarter."

While growing volumes of move-ins might generate excitement on a conference call, analysts had questions about the company's move-outs as well. Let's take a dive into the same store net tenant addition metrics for Public Storage's latest quarter.

Of Public Storage's 2,888 properties, 2,344 (roughly 81%) are considered same store, with the remainder in development or having been acquired less than one year ago. In our view, this reflects an aggressive growth strategy on behalf of the company (more on that later). Public Storage posted this chart in its latest quarterly filing, detailing same store data ( from page 37 ).

Note that realized rent per occupied square foot grew overall by 8.3%, average occupancy across all markets declined overall by 2.1%. This indicates that the increase in revenue in the latest reporting period was driven--at least in the same store category--by price hikes to existing customers rather than an increase in new tenants.

The picture doesn't get better when analyzing the tenants coming in to replace those that are leaving.

As can be seen in the chart above ( from page 35 of the most recent 10Q), new tenants average annual contract rent per square foot decreased year over year by 14.4%, while promotional discounts to new tenants increased by 26.4%. Additionally, the net delta between new contract rents gained year over year versus contract rents lost from move-outs widened significantly, from negative $6 million in the quarter ending June 2022 to negative $29.2 million for the comparable quarter in 2023.

In other words, it appears that Public Storage is having difficulty bringing in new tenants at full price, while it continues to raise rates for existing tenants and also experiencing a net decrease in overall tenants as expressed by average occupancy.

It is perhaps not surprising that Public Storage is having difficulty with net tenant additions, given that the industry has been building new facilities at a feverish pace to meet demand over the last decade.

In any industry, rapid build-outs of supply are driven by demand, but supply takes time to come online, and demand can wane during that time frame, causing supply to overshoot. To frame the situation for the self-storage industry, an estimated 98 million square feet of new storage facility space is expected to be completed in 2023 while the average storage unit price has dropped, according to SpareFoot.com, with the estimated cost to rent a storage unit in 2023 being $100 per month compared to $110 in 2022 .

It's also a murky proposition to assume that Americans who are not yet utilizing storage spaces will suddenly jump on board and become new tenants. Consider our chart below:

Pictured above is a monthly snapshot of the Public Storage stock price and the Google trend search term 'Self-Storage Near Me' going back to September 2010. While not a perfect correlation, it can clearly be seen that the spike in searches for self-storage (we should note that Public Storage boasts that a large portion of its new move-ins come through its online funnel) in 2021 coincided with a rise in Public Storage's stock price. Searches for storage space has since moderated back towards 2019 levels, which, in our minds, is evidence that Americans are losing steam when it comes to renting new self-storage units.

As an aside, we also believe that the stickiness of the self-storage consumer is also somewhat overstated in the bull case. While tenants who store motorhomes or other large items will likely remain for the long term, research from StorageCafe.com shows that most people using storage across the country are just storing furniture . Further, most contracts at self-storage properties are month-to-month with no penalty for cancelling (Public Storage's 10K notes on page 1 that its lease policy is month-to-month).

It isn't far fetched to think, then, that tenants could simply sell, discard, or move it back into their living space especially if they are looking to cut roughly $100 in expenses out of their monthly budget (and there is ample evidence to support the idea that American consumers are seeking to cut back on monthly expenditures).

Furthermore, the largest driver of new self-storage rentals comes from tenants moving to a new home .

This, of course, was a boon for the self-storage industry as remote work became all the rage and high-earning white collar workers fled urban cityscapes to more rural settings. However, that trend appears to be over , and there is plenty of research showing that Americans are moving less than ever .

While we aren't of the belief that mass amounts of tenants will mount an exodus from self-storage nationwide, we believe that the majority of the facts do not stand in Public Storage's favor.

Valuation

Despite Public Storage's acquisitive nature (recall that roughly 20-25% of its properties are excluded from same store sales), analysts have largely factored out future FFO growth expectations from the stock.

Against analyst estimates looking out in the second unreported year of $17.50 per share of FFO, Public Storage stock currently trades at roughly 15.6x FFO/Share on a forward basis.

Seeking Alpha's valuation grade paints a slightly worse picture, showing that the stock trades at 16x forward price to FFO, which is 30.9% above the sector mean.

Should the company see its ability to hike prices on existing renters deteriorate, and if net move-ins continue to decline (as we think both will for the reasons outlined above), this will inevitably squeeze margins and Public Storage, which could result in further gloom from analysts in the future.

For us, then, we target a 15-20% decline in forward price to FFO valuation as a good point to re-evaluate Public Storage's situation against the macroeconomic backdrop.

The Bottom Line

It is difficult to grow a business with a relatively fixed cost structure while large amounts of new supply are set to come online amidst signs of waning demand. This is the situation that we believe Public Storage finds itself in today. For the reasons outlined in this article, we remain negative on the stock.

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