Summary
- In this article, we start by discussing the fundamentals of industrial and self-storage real estate.
- Thanks to strong tailwinds, Extra Space Storage continues to excel, hiking its dividend by another 8% thanks to outperforming same-store revenue growth and higher margins.
- While EXR is attractively valued, I believe that investors will get an even better entry this year to buy this outperformer.
Introduction
After covering Realty Income ( O ), it's time to talk about one of my all-time favorite real estate investment trusts, Extra Space Storage ( EXR ) . Not only because I mentioned it as a better alternative in the Realty Income article but also because we need to discuss the company's qualities as a dividend growth stock, incorporating its just-released earnings and industry fundamentals.
While commercial real estate is in an increasingly tough spot, there's plenty of good news for self-storage operators, including ongoing tailwinds in pricing and subdued new supply.
In this article, I will walk you through my thoughts and explain why I'm aiming to buy more Extra Space Storage this year.
So, let's get to it!
Strong Growth In A Competitive Industry
A closer look at the company and the industry outlook
With a market cap of roughly $22 billion, Extra Space Storage is the second-largest self-storage operator in the United States. Founded by its current Chairman Ken Woolley in 1977, the company has grown into a powerhouse operating more than 2,300 properties in 41 states. Roughly half of these units are wholly-owned. 38% are managed for third parties. 14% are operated as joint ventures.
Extra Space Storage has consistently outperformed its major stock-listed peers over the last five years, particularly in terms of revenue growth. In fact, the company has surpassed all of its competitors in this regard. Additionally, Extra Space Storage is tied with Life Storage ( LSI ) for net operating income growth, reflecting its strong financial performance and competitive position in the industry.
This has also resulted in significant stock price outperformance.
One of the reasons EXR generated more than 300% in capital gains over the past ten years (excluding dividends!) is a perfect execution in a fast-growing market.
Self-storage is a market with low entry barriers. It's highly competitive, as everyone with access to capital can buy or build self-storage properties. Even Public Storage's ( PSA ) market share does not exceed 10%. Non-REIT operators still dominate the industry with roughly 2/3rd of the market share.
Not only did Extra Space figure out how to outgrow its peers, but it also benefited from a robust market environment.
Self-storage, which is part of industrial real estate, benefited from average annual price growth of close to 10% since the housing bottom of 2012.
According to Wells Fargo , supply is currently outpacing demand in the industrial real estate market. In Q4, net completions rose 53.1% YoY, setting a new record high. However, net absorption remained solid during the same period.
Rent growth has slowed down in the industrial real estate sector, with industrial rents cooling to a 2.0% quarterly pace in Q4-2022. This marks the third consecutive quarterly deceleration.
While most major property classes experienced monthly price declines in the second half of 2022, industrial property prices have remained strong, with valuations up 12.2% in December.
In the near term, the industrial market may face challenges due to a cyclical slowdown and pullback in consumer goods spending. However, the trend towards shorter and more resilient supply chains is expected to support demand in the longer run. One major driver of this is supply chain re-shoring, which is one of my biggest macro themes. Furthermore, the growth prospects for e-commerce are seen as a long-term tailwind.
Hence, it is no surprise that vacancy rates in the industrial space continue to remain near historic lows without a meaningful increase (unlike apartment and office properties).
Wells Fargo
With that said, we can dig a bit deeper using Yardi Matrix data, which publishes monthly reports targeting specific real estate industries.
According to the Yardi Matrix February self-storage report , self-storage rates in the United States are starting to go back to normal after reaching record highs during the summer of 2022. However, this is a typical seasonal slowdown that the industry isn't worried about because there has been a consistent increase in demand over the past few years.
In fact, the report found that more households are using self-storage than ever before, with approximately 14.5 million households using self-storage in 2022. This is up by around 970,000 since 2020. The Self Storage Association conducted the latest demand study and found that the percentage of households using self-storage increased to 11.1% in 2022, up from 10.6% in 2020 and 8.95% in 2005.
Overall, the self-storage industry appears to be in good shape and well-positioned to handle any potential economic issues in 2023 due to the record demand for their services.
In other words, while the pressure on commercial real estate is rising due to higher rates and slower economic growth, self-storage remains strong thanks to secular growth and subdued new supply.
A Closer Look At EXR's 4Q22 And Dividend
While times are challenging, EXR remains in a good place
On February 16, EXR hiked its dividend by 8% to $1.62 per share per quarter. This translates to a yield of 4.1%.
Over the past ten years, the average annual compounding dividend growth rate was 21.6%. Over the past five years, that number is 14.0%. The three-year average is 19.0%, which shows that EXR's dividend growth is consistently high, reflecting the aforementioned growth rates in industrial/self-storage real estate.
The company's 4.1% yield is one of the highest since the Great Financial Crisis. Please note that the yield in the chart below has NOT been updated yet.
A few days after the hike, the company reported its 4Q22 earnings. Revenue came in at $506.7 million (+18.6%), which beat estimates by $73 million. It resulted in funds from operations ("FFO") of $2.09 per share. That's two pennies higher than expected and 9.4% higher compared to 4Q21.
Please bear in mind that the lower range of this guidance is based on below-consensus economic growth. In other words, if economic growth continues to deteriorate (which I believe is likely), the company won't be forced to adjust this guidance as quickly as companies with a more positive outlook.
Unfortunately, FY23 core FFO guidance missed estimates as management sees a result between $8.30 and $8.60 per share. The consensus was slightly above that at $8.68. However, it did not keep the stock from rising 2.8% after the earnings release.
The company reported an 11.8% increase in same-store revenue and a 13.4% increase in same-store net operating income compared to the previous year. This is due to underperforming same-store expenses growth of 6.7%, which is great news in light of the high inflation rate last year.
Moreover, despite a slight decrease in occupancy, the company still reported a high occupancy rate of 94.2%. In addition, the company acquired six operating stores and completed the acquisition of four more with joint venture partners. Extra Space Storage also originated $252.2 million in mortgage and mezzanine bridge loans, and added 46 stores to its third-party management platform, bringing the total to 1,205 managed stores. Overall, the company's earnings demonstrate its strong position in the self-storage market, which confirms the industry fundamentals we discussed in the first part of this article.
This is what Mr. Joe Margolis , Chief Executive Officer, had to say in the 4Q22 earnings call:
New supply continues to moderate from 2018, 2019 peaks, and we expect even lower competition from new supply in our markets in 2023. Customer demand has been steady, occupancy has remained high and same store revenue growth remained above 10% through December. Our strong occupancy has allowed us to sequentially increase rates month over month to new customers since November. And we believe elevated occupancy will give us greater pricing power with new and existing customers as we move through the leasing season.
With that said, the company also maintains an extremely healthy balance sheet. This is important in general, but especially in a period of elevated rates.
Federal Reserve Bank of St. Louis
As of December 31, the company's fixed-rate debt was 64.7%, which is great protection against a high-rate environment. Excluding variable rate receivables, that number is 71.3%. The weighted average interest rate was just 4.1% with an average maturity of 5.1 years. In other words, the company has a rather low average yield, a lot of time to wait for rates to come down, and protection against rising rates.
With regard to the company's valuation, we're dealing with an 18.8x core FFO valuation, based on the guidance midpoint.
The longer-term valuation median is close to 23x FFO. I would make the case that EXR is attractively valued, especially given that its dividend is now yielding 4.1%.
However, my strategy is to buy more somewhere between $120 and $140, as I believe that the Fed needs to do more damage to the economy to combat inflation. I explained that in greater detail in the Realty Income article, which I highlighted at the start of this article. Hence, I continue to give the stock a neutral rating for the time being.
FINVIZ
On a long-term basis, I have little doubt that EXR shares will continue to outperform the average REIT and the S&P 500.
Takeaway
This article highlights one of my favorite real estate dividend growth stocks, Extra Space Storage. The company is benefiting from positive self-storage fundamentals, including low vacancy rates, a strong demand fueled by secular tailwinds, and robust pricing. Additionally, the company's recently reported quarterly earnings reflect its ability to manage high inflation, with strong net operating income growth, while its balance sheet remains in excellent health, thanks to a high portion of fixed-rate debt, a low average rate, and a long average maturity.
Furthermore, the company has recently increased its dividend by 8%, with a high probability of continuing to satisfy long-term dividend growth. While the valuation is attractive, I believe we may have an opportunity to purchase EXR at even lower prices this year.
Looking ahead, I expect EXR to outperform its real estate peers and the market in general over the long term.
For further details see:
Why I'm Buying More Extra Space Storage