Summary
- Extra Space Storage recently announced an 8% dividend increase, bringing the yield to the 4% mark.
- The stock is trading 27% off 52-week highs, putting shares at a double-digit discount to fair value.
- The combination of high yield and good growth makes it an attractive buy for income investors.
Self-Storage Sector A Market Outperformer
The self-storage segment of the real estate sector has produced some of the best investments in the market over the past 15 years. Public Storage ( PSA ), CubeSmart ( CUBE ), Life Storage, Inc. ( LSI ), and Extra Space Storage Inc. ( EXR ) have all trounced the total returns of the S&P over that time frame.
As good as all the companies have been, Extra Space stands far and away as the best performer of the group with a 1,700% return.
However, as good as the returns have been over those fifteen years, it hasn't performed very well lately. Shares are now trading at $162 after reaching a high of $226 in December of 2021, a drop of nearly 30%.
This is despite a 23% increase in AFFO in 2022, as the drop in share price has resulted in a P/AFFO contraction from 34.3X to just 19.4X at present.
Extra Space Storage - FAST Graph (By Author)
This large drop in price has caused the stock to go from a point of extreme overvaluation to one where it is trading at a ~15% discount to its normal valuation. Shares are now trading at the lowest valuation seen since the height of the pandemic in 2019.
Recent Dividend Increase Provides Yield Boost
Not only does the cheaper valuation create an attractive price point for those looking for capital gains, but it's also an attractive entry point for income investors. An entry point that looks even better following the company's latest dividend declaration , an 8% increase that took the yield to over 4%.
CEO Jeff Margolis spoke of this dividend increase during the Q4 2022 earnings conference call on February 22nd:
Our strong property NOI, plus our external growth efforts, resulted in core FFO growth of 9.4% in the quarter and 22.1% for the year. This allowed our Board of Directors to increase our first quarter dividend by 8%, contributing to a total five year increase of 108%. As we look forward to 2023, we are encouraged by the fundamentals of the business. New supply continues to moderate from 2018, 2019 peaks, and we expect even lower competition from new supply in our markets in 2023.
This increase marks thirteen years of dividend growth, a time during which Extra Space has grown the payout from $0.10 in 2010 to $1.62 today.
The dividend boost also brings the payout ratio up to 77.7% of its expected 2023 AFFO of $8.34. This is a bit on the high side but is in a reasonable range of where it's typically been over the last decade.
EXR Dividend Payout Ratio History (By Author via FAST Graphs)
Company Financial Position
While I wouldn't consider Extra Space a fortress type of investment, it does offer a relatively stable financial picture. The company owns a BBB rating from S&P, which is in line with Life Storage's rating, but a few notches below the A rating for Public Storage.
Extra Space has also grown in recent years without piling on excessive debt, as the company has lowered its net debt/EBITDA from the 5.5-6 range down to 4.6 in 2022 as shown on page 21 of its recent investor presentation .
EXR Balance Sheet (Page 21 - EXR Investor Presentation)
Interest coverage has also improved to 6.7x from 4.8-5.3 in recent years.
However, higher interest rates still represent a drag on the company, as ~29% of the company's debt is floating-rate debt. According to the Q4 earnings release , this will cause interest expense to grow from $219 million in 2022 to a projected $333-$336 million in 2023.
Occupancy And Price Trends
Extra Space has been able to keep occupancy high even while raising prices, as its 2022 occupancy rates are a few points higher than those seen in 2018 and 2019.
EXR Occupancy Rates (Page 24 - EXR Investor Presentation)
This is especially impressive considering it was able to put through an 11.2% rate increase in 2021 and another 17.9% increase through Q3 of 2022.
EXR Rate Growth (Page 25 - EXR Investor Presentation)
This trend of strong rate growth continued in Q4, as CEO Jeff Margolis highlighted during the Q4 conference call (Italicized highlights by me):
We had another strong quarter to cap off an exceptional year. Our 2022 same store revenue growth of 17.4% is the highest in our company's history and for the second consecutive year, core FFO growth was above 20%. I am proud of the Extra Space team for another year of strong performance across all aspects of the business. Now speaking to the fourth quarter, despite difficult comps and the return of seasonality, same store revenue growth was ahead of our expectations at 11.8%. Vacates continued to normalize during the quarter and demand remained seasonally steady, leading to strong same store occupancy levels ending the year at 94.2%. Our high occupancy allowed us to maximize revenue and grow customer rates across the portfolio. Despite offering lower rates to new customers, total net rent per square foot increased 12.8% year-over-year. We experienced expense pressure across many line items with same store expense growth of 6.7%, resulting in same store NOI growth of 13.4%.
The strong occupancy and higher rental rates are both signs of a healthy market and are great metrics to see. They should help the company continue its AFFO growth trend in 2023.
Investment Risks
The company has produced tremendous results over the past 15 years, but that comes after some difficult times during the last major recession to hit the United States in 2008/2009.
Extra Space saw a 15% decline in AFFO in 2009, which led to a temporary suspension and then a cut in the dividend as shown on its dividend history tab.
EXR Dividend History (Data by Seeking Alpha)
Of course, the dividend was reinstated shortly later and has grown sixteen-fold since then, but it is still something to keep in mind when investing in the company.
The Fed has signaled that it intends to continue raising rates through 2023, which has many calling for a recession later this year. I suspect those fears of an impending recession are a major factor leading to the recent sell-off in the company.
Also, as mentioned previously, the higher rates have already caused management to guide for $115 million in higher interest expense in 2023. The company is taking steps to mitigate those impacts and prevent them from growing:
During the quarter, we swapped a total of $400 million of our variable rate debt, reducing our floating interest rate exposure to under 29% of total debt net of variable rate bridge loan receivables. We will continue to take steps to reduce our variable rate debt and we will be methodical in our approach, recognizing that forward interest rate curves signal lower rates in the future. Subsequent to quarter end, we completed a $335 million unsecured term loan and used the proceeds to pay down our revolving balances.
With a strong financial position and comfortable payout ratio, the company should be able to head off further losses while maintaining the dividend.
Closing Thoughts
Extra Space Storage isn't a company that I see discussed very often by investors, which is strange considering it's been one of the top performers in the market since the Great Recession. An investor buying in January of 2009 has seen annual gains of 23.29%, turning a $1,000 investment into over $19,000.
While I don't expect to see those types of outsized returns going forward, I do believe that Extra Space offers a compelling opportunity at today's prices. The company has grown AFFO every year since 2009 and is expected to grow at a mid-single-digit rate in the future.
That growth coupled with a generous 4% yield makes it an attractive option for long-term dividend growth investors, which I consider myself. I remain long shares of the company and intend to continue adding to my position at opportunistic times during the remainder of 2023.
For further details see:
Extra Space Storage: A Buy Following Recent Dividend Boost