VNQ - Public Storage Vs. Big Yellow Group: Which Is The Best REIT For 2023?

2023-05-19 08:05:00 ET

Summary

• Public Storage and Big Yellow Group Plc are blue-chip REITs.
• They have both massively outperformed in the past.
• But which is the best opportunity today?

Public Storage ( PSA ) is the biggest self storage real estate investment trust ("REIT") in the U.S.

Big Yellow Group Plc ( BYLOF /"BYG") is the biggest self storage REIT in the UK.

Both are what you would define as "blue-chip REITs":

• They have been some of the best performing stocks of all time.
• They own Class A self storage properties that enjoy growing rents.
• They are able to develop their own properties to earn superior returns.
• They have fortress balance sheets with low debt.
• Their management teams are shareholder-friendly.
• They have grown their dividend very steadily over time.

Here you can see how Public Storage has performed relative to the S&P 500 ( SPY ) over time:

And here you can also see how Big Yellow has performed over time:

So here you have two market leaders, one in the U.S. and one in the UK, and both are high-quality REITs ( VNQ ) with seemingly attractive future prospects.

But which one is the best investment opportunity today?

This one is simple to answer.

I think that it is Big Yellow and here are four reasons why:

Reason #1: The U.S. market is getting saturated. The European market is in its infancy.

Today, there are roughly 10 square feet of storage space per capita in the U.S.

In comparison, there is only about 1 square foot of storage space per capita in the UK and even less in central Europe:

There are some cultural reasons that explain why the U.S. may need more storage space per capita, but the main factors that drive demand for storage space are the same in Europe:

• People move around
• Older generations leave stuff behind
• Couples get divorced
• Homes are only getting smaller (they are even smaller in Europe!)
• Increasingly, many want to make space for a home office
• Etc.

The main difference between the U.S. and Europe is that the concept of self-storage is still relatively new in Europe.

Today, more than half of Big Yellow's new customers are first-time self-storage users, so the concept is now growing in popularity.

I think that this is a big differentiator between Public Storage and Big Yellow.

Public Storage has already maxed out most of its growth opportunities. Self-storage properties have been built all over the place in the U.S. You see them at every busy intersection.

But in Europe, the growth opportunity is still in its infancy for Big Yellow. There is little supply even as the concept is rapidly growing in popularity and it gives it a lot of opportunities to develop new properties and earn exceptionally high yields relative to its cost of capital.

The stabilized yield on its new development projects is expected to be near 10%. That results in a large spread over its cost of capital, and since it is still relatively small in size, these new investments really move the needle.

This brings me to my next point:

Reason #2: Public Storage is getting too big. Big Yellow is just getting started.

In addition to being in a tougher market, Public Storage is also getting too big for its own good.

Today, its market cap is over $50 billion, and that makes it one of the biggest REITs in the world.

In comparison, Big Yellow is still much earlier in its growth cycle with a $3 billion market cap.

This matters a lot for REITs that attempt to grow by acquiring/developing new properties, because it means that Public Storage would need to acquire ~15x as many new properties as Big Yellow to grow.

But the number of new investment opportunities is limited, and so it makes the job of Public Storage a lot harder.

Big Yellow can be more selective, pick the properties that provide the highest spreads, and each new investment will really move the needle.

Public Storage's recent attempt to acquire one of its peers, Life Storage, Inc. ( LSI ), could be a sign that it is now turning to M&A to make up for the fact that it isn't able to find enough single-property acquisition opportunities.

Reason #3: Public Storage's valuation is not reflective of its worsening growth prospects. Big Yellow's valuation is very reasonable.

On the surface, it may seem that Public Storage is priced at a lower valuation than Big Yellow, and if you simply compare their funds from operations ("FFO") multiples, that would be correct:

But if you consider the differences in their future growth prospects, I think that Big Yellow is actually the cheapest here.

Big Yellow could grow at a fast pace for decades to come. It has not even expanded in other European markets yet.

Public Storage, on the other hand, will have a lot more difficulties due to its exposure to saturated markets and its huge size.

Reason #4: The pandemic led to a lot more supply in the U.S., but not as much in Europe.

The pandemic led to a surge in demand for self-storage space because lots of people were moving around, older generations passed away, people bought new toys like jet skis and RVs, and finally, many wanted to make space for a home office.

It also led to a surge in rents and occupancy rates across the world and both of these REITs benefited greatly.

But this surge in demand was rapidly met with a surge in new supply in the U.S. Everyone started building new self-storage properties to profit from this seemingly endless demand.

But this demand is now beginning to dry up as increasingly many people go back to the office and things return more or less to how they were before the pandemic.

I fear that this could lead to oversupply and declining same-property NOI in the U.S. in the years ahead.

Europe is less affected by the risk of facing a supply glut because demand keeps growing at a steady pace as more people become familiar with the concept, and importantly, it is a lot harder to gain permits, find land, and build in Europe.

As a result, we expect the demand/supply dynamics to remain more favorable in Europe in the coming years.

Bottom line

If you want to invest in self-storage, then Big Yellow seems like a much better investment opportunity than Public Storage.

I would even extend this to the entire U.S. self-storage peer group: Extra Space Storage Inc. ( EXR ), National Storage Affiliates Trust ( NSA ), etc. I think that Big Yellow is a better investment opportunity than any of these REITs.

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