Earnings Call Transcript - CUBE Q1 2024

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the CubeSmart First Quarter 2024 Earnings Call. This call is being recorded on Friday, April 26, 2024. I would now like to turn the conference over to Mr. Josh Schutzer, Vice President of Finance. Please go ahead, sir.

Joshua Schutzer, Vice President of Finance

Thank you, Lara. Good morning, everyone. Welcome to CubeSmart's First Quarter 2024 Earnings Call. Participants on today's call include Chris Marr, President and Chief Executive Officer; and Tim Martin, Chief Financial Officer. Our prepared remarks will be followed by a Q&A session. In addition to our earnings release, which was issued yesterday evening, supplemental operating and financial data is available under the Investor Relations section of the company's website at www.cubesmart.com. The company's remarks will include certain forward-looking statements regarding earnings and strategy that involve risks, uncertainties and other factors that may cause the actual results to differ materially from these forward-looking statements. The risks and factors that could cause our actual results to differ materially from forward-looking statements are provided in documents the company furnishes to or files with the Securities and Exchange Commission, specifically the Form 8-K we filed this morning together with our earnings release filed with the Form 8-K, and the Risk Factors section of the company's annual report on Form 10-K. In addition, the company's remarks include reference to non-GAAP measures. A reconciliation between GAAP and non-GAAP measures can be found in the first quarter financial supplement posted on the company's website at www.cubesmart.com. I will now turn the call over to Chris.

Christopher Marr, President and Chief Executive Officer

Thank you, Josh. Good morning, and thank you all for joining the call. As one would expect, our first quarter performance metrics were in line with our expectations. Rental rates to new customers followed their historic pattern, reaching their seasonal low in mid-February before beginning their gradual move up into the end of March. Our key metrics related to consumer health, those being write-offs, receivables, and units at auction, all remained in line with historic norms against the backdrop of a healthy consumer and typical first quarter seasonality. Asking rates, our existing customer rate increases during the quarter were consistent in both timing and magnitude. Demand activity during the quarter varied by market. Our more urban-oriented markets, such as the New York MSA and its Connecticut suburbs, Chicago, and Boston, experienced growth in year-over-year rentals. San Diego County also experienced positive year-over-year rental volumes, continuing to benefit from the Storage West transaction. Sun Belt markets, such as Atlanta and all of our major Florida markets, experienced a decline in year-over-year rentals. Some supply-impacted markets, such as Northern Virginia and Nashville, seem to be bottoming out from that supply impact and are beginning to show signs of stabilization. Phoenix is also showing signs of turning the corner with positive year-over-year growth in rentals and occupancy, albeit at rental rates well below 2023 levels. While Tucson continues to struggle to find its footing due to new supply, New York continues to be our top-performing market with consistent positive performance metrics across the boroughs and positive performance in supply-impacted Staten Island and North Jersey. Overall, trends are more constructive in our urban stores, which tend to attract customers solving for their smaller living space. As we move through April, trends thus far show our negative rate and occupancy gaps to last year narrowing from their first quarter levels. The macroeconomic data over the last few months has certainly been very volatile. It seems every week we receive conflicting data, most recently an unexpected slowdown in first quarter GDP growth. Other industries such as intermodal transportation, warehouse leasing, used car dealers, and home retailers have expressed cautionary views on consumer demand. One factor that makes our business so resilient is that there are countless life events that create demand for self-storage. One demand driver for our industry is single-family home sales. Over the last few months, the housing data has also been inconsistent. According to realtor.com, the number of homes actively listed for sale in February was 15% higher than the same month last year. I also note that the week of April 14 is the optimal time to list your home for sale as the third week of April brings the best combination of housing market factors for sellers. On the other hand, March home sales were disappointing and mortgage rates have climbed above 7%. However, yesterday's Commerce Department report shows a possible positive sign for the housing market as residential investments surged 13.9%, the largest increase since the fourth quarter of 2020. While housing stats are certainly volatile, consensus remains for modestly increased activity over the historical lows experienced in 2023. Another demand driver for our product is movement within multifamily housing. In the multifamily sector, headwinds from new supply are contributing to flat or slightly declining rents in Sun Belt markets. According to RealPage, rents are down year-over-year in Atlanta, Nashville, Austin, Dallas, Orlando, and Fort Lauderdale, which may spur existing apartment vendors to move or increase demand from first-time renters, both of which are beneficial for our industry. On the supply side of the equation, new store openings in our top markets continue their pattern of declining every year since their 2019 peak. In short, the period between now and the end of July will be illuminating and impactful on our expectations for full year 2024 performance. We remain confident in the long-term fundamental drivers of our business continuing to generate solid growth. Thank you for listening, and I will now turn it over to Tim Martin, our Chief Financial Officer, for his insights into our first quarter. Tim?

Timothy Martin, Chief Financial Officer

Thanks, Chris. Good morning, everyone. Thanks for taking a few minutes out of your day to spend it with us. First quarter results were right in line with what we expected for the quarter. Same-store revenues were flat compared to last year, with average occupancy for our same-store portfolio down about 130 basis points to 90.4%. Same-store operating expenses grew 5% over last year, driven by continued pressure on property insurance and increased snow removal costs compared to last year. Offsetting those were lower marketing expenses relative to last year. Flat revenue growth combined with 5% expense growth yielded negative 1.9% same-store NOI growth for the quarter, and we reported FFO per share at the midpoint of our range at $0.64 for the quarter. On the external growth front, we closed on the previously announced acquisition of a two-store portfolio in Connecticut for $20.2 million. We continued our disciplined approach to finding external growth opportunities that make sense for our balance sheet. On the third-party management front, we had a record first quarter, adding 68 stores to our platform, the most third-party stores added in a quarter since our debut in the third-party management business 14 years ago. As a result, our third-party platform grew to 860 stores under management at quarter end. The balance sheet remains in excellent shape; nothing to do there in the short to medium term other than to continue to look for growth opportunities to utilize the liquidity and leverage capacity we've created over the last several years. Details of our 2024 earnings guidance and related assumptions were included in our release last night; our forward guidance for the year remains consistent with the guidance we provided in late February. Thanks again for joining us on the call this morning. At this time, Lara, why don't we open up the call for some questions?

Operator, Operator

Our first question comes from Spenser Allaway from Green Street.

Spenser Allaway, Analyst

I was just wondering if you could provide some color on how move-in rents are trending thus far into the second quarter. And just any color you can share about any trends geographically. But yes, just any color on move-in rents would be great.

Christopher Marr, President and Chief Executive Officer

Sure, Spenser. So new customer rates in April are down 11% from last April, an improvement from the 13% at the end of Q1, which was at 14% negative in Q4. So we're seeing a combination of what occurred last year and an improvement this year in that negative gap on new customer rates.

Spenser Allaway, Analyst

Okay, great. And then are you able to provide or share the initial cap rate on the two assets that were acquired in the quarter?

Timothy Martin, Chief Financial Officer

Yes, they're stabilized assets that we know well, and the cap rate is in the low 6s.

Operator, Operator

Our next question comes from the line of Michael Goldsmith from UBS.

Michael Goldsmith, Analyst

My first question is just on demand and how that trended over the quarter. I think when you reported fourth quarter and provided guidance, you had good visibility into what seemed like solid trends. How did the rest of March play out? And what have you seen on the demand side during April?

Christopher Marr, President and Chief Executive Officer

Yes, Michael. As I said, it's market by market as we went through the quarter. We saw consistently strong demand in urban-oriented markets like the New York MSA and Connecticut suburbs, Chicago, Boston, San Diego County, and Phoenix. However, we faced challenges on the demand side in major Florida markets, Atlanta, and some smaller Sun Belt markets. The markets that had the largest uplift during COVID are now the ones closer to the bottom of the chart, while those that were lower beta during COVID are at the top.

Michael Goldsmith, Analyst

And my follow-up is just on the guidance. First quarter came in line with expectations. Given what you've seen since you last guided, how has that environment changed your outlook for the year? I mean you didn't move it, but as you think about the moving pieces, has anything changed on how you expect the rest of the year to play out, or is it still too early to update your expectations?

Timothy Martin, Chief Financial Officer

Yes, Michael. The latter part of your question is exactly where we are. We provided that guidance with a range of expectations six weeks ago, and nothing has happened in the last six weeks that would cause us to change that view. As we sit here still in April, we have the whole summer rental season ahead of us, and so we still have that range of expectations that we introduced six weeks ago.

Operator, Operator

Our next question comes from the line of Samir Khanal from Evercore ISI.

Samir Khanal, Analyst

Chris, maybe on guidance again. I know in the last call you spoke about the high end, assuming some sort of improvement in the housing market. Given what rates have done, how do you think about the high end today? If the housing market does not improve, do you feel that there's enough in that sort of ECRI push to make up for that difference?

Christopher Marr, President and Chief Executive Officer

As I mentioned earlier, the housing market is one driver. The beauty of our business and why we're so resilient is that everyday life events create demand for storage. Our focus is on capturing customers who have identified a need for self-storage and converting them into CubeSmart customers. So again, the housing market is one of those factors. Our range of expectations certainly implies varying degrees of demand across the spectrum at both ends. We still expect the peak listing time for existing home sales to be at the third week of April. If you think about that, a house sells quickly, you're closing in late May. That leads us into the busy season for us in May, June, and July. This timeframe will significantly impact how we see the whole year play out.

Samir Khanal, Analyst

Okay, got it. And I guess my second question, Tim, is on the advertising expense. That was down roughly about 15%. That was a little bit surprising to me given that demand is still challenging. Can you talk around that strategy?

Christopher Marr, President and Chief Executive Officer

Yes, sorry, I'll jump in for Tim there. Our investments over the last couple of years have continued as we go forward to refine the technology and the customer data platform (CDP) that we have. We are now able to avoid wasted advertising by excluding customers who are unlikely to rent within a short timeframe. We're more targeted through automated personalization using AI and machine learning to segment and identify customers on the front end to increase conversion rates. We are beginning to see the benefits of that investment in our ROI on marketing. Although I expect our marketing spend will grow from 2023 levels, it reflects our CDP investments starting to bear fruit.

Operator, Operator

Our next question comes from the line of Todd Thomas from KeyBanc Capital Markets.

Todd Thomas, Analyst

Chris, I just wanted to follow up first on move-in rents. I appreciate the detail early on here in the call that you provided. I think you mentioned that the move-out to move-in spread narrowed through April. Can you just quantify that? Where does that stand today, what the change looks like throughout the quarter and into April?

Christopher Marr, President and Chief Executive Officer

Yes, Todd, just to be clear, what I had talked about was just the new customer rates. The new customer move-in on a quarter-over-quarter basis was down about 14% in Q4, then 13% in Q1, and now 11% in April. In terms of the delta between the customer moving out and the customer moving in, that continues to be around 33%, 34%, and that has not really moved significantly since what we reported last quarter. We expect this gap to narrow as we move through the busy season.

Todd Thomas, Analyst

Got it. And then the occupancy build during the period seems a little bit below average when compared to prior years, just moving from the quarter average to the quarter end. Can you speak to where occupancy is today? And also, vacate activity was a little bit higher year-over-year. Are you seeing any change in terms of move-outs? Can you discuss vacate activity and how that has trended throughout the quarter and thus far into April?

Christopher Marr, President and Chief Executive Officer

Yes. As we moved through April, we've seen a reduction in the year-over-year gap in occupancy. As of today, we sit at 90.8%, up 40 basis points from the end of March, and the gap to last year has contracted back to about 120 basis points. Month-to-date rentals in April are flat compared to last year. Move-outs continue to vary by market, but they are relatively in line with what we experienced last year. We are seeing a return to stabilization in terms of lengths of stay following the COVID period, where stay lengths were longer.

Todd Thomas, Analyst

Okay. Does the normalization in length of stay or possible uptick in vacate activity give you pause regarding the company's ECRI strategy, or have you rethought the pricing for existing customers around sensitivity to rate increases?

Christopher Marr, President and Chief Executive Officer

We continue to pay very close attention to overall customer behavior. Length of stay remains above historical levels, and customer behavior isn't currently causing us to alter our strategy regarding existing customer rate increases.

Operator, Operator

Our next question comes from the line of Jeff Spector from Bank of America.

Jeffrey Spector, Analyst

Great. Chris, my first question, just given your experience, question on the start of this peak leasing season, it feels like there's a lot of uncertainty. If you go back to pre-COVID, is this in line with what you'd see historically entering spring leasing, or is it fair to say that uncertainty is still high for the '24 spring leasing season?

Christopher Marr, President and Chief Executive Officer

Yes, Jeff, I think it's fair to say that uncertainty is quite high. Historically, in 2018-2019, while demand was normal, we had elevated supply concerns. With COVID starting in early 2020, we saw dysfunctional times followed by a surge in demand in late '20, '21, and early '22. Today, elevated interest rates and challenges within the housing market contribute to a more muted environment.

Jeffrey Spector, Analyst

That's helpful. Just to clarify, the higher end of the guidance reflects a stronger spring leasing season and improving price sensitivity, correct?

Timothy Martin, Chief Financial Officer

Yes, Jeff, your recollection is correct.

Jeffrey Spector, Analyst

Okay. Can I ask about Florida's markets, which benefited from the pandemic? Despite healthy population growth slowing in these markets, can you provide insights on why they are more challenged, considering you didn't cite supply as a main factor?

Christopher Marr, President and Chief Executive Officer

What you're seeing in Florida is likely a combination of reduced inbound movement compared to COVID highs, new supply on the West Coast, and effects from natural disasters. Additionally, pricing strategies from competitors haven't been super constructive over the last couple of quarters.

Operator, Operator

Our next question comes from the line of Eric Wolfe from Citi Canada.

Eric Wolfe, Analyst

As part of your guidance, it looks like you're expecting the second half of the year to step up to $0.68 of quarterly core FFO versus $0.64 in the first half. Can you talk about what's driving that increase in the back half of the year?

Timothy Martin, Chief Financial Officer

It's a natural trend line for us historically that the back half tends to step up from the front half, driven by the weighting of revenue increases during the summer rental season. So it’s consistent with past trends.

Eric Wolfe, Analyst

To that point, do you think you'll see a normal step-up in the third quarter? What do you need from street rates and ECRI perspectives to reach that normal increase?

Timothy Martin, Chief Financial Officer

We expect an increase in our ability to push rates to new customers as we get into the summer rental season. The extent of that relies on the market conditions, which is what shapes the guidance range we discussed.

Eric Wolfe, Analyst

All right. If I could just ask again about the pricing environment, has there been any concern that public REITs are creating a price race to the bottom? How will you assess the effectiveness of your strategy of lower street rates at the beginning and more aggressive ECRIs versus a more traditional approach?

Christopher Marr, President and Chief Executive Officer

We are seeing a sequential improvement in the year-over-year gap in rates. Our competition has also seen seasonally increasing rates. Individual strategies will continue to focus on maximizing revenue from each customer over their lifetime. The operational gaps between larger REITs and smaller competitors are significant, especially in terms of technology and service offerings.

Operator, Operator

Our next question comes from the line of Ki Bin Kim from Truist Securities.

Ki Bin Kim, Analyst

Chris, looking at move-in rent trends from the beginning of the year until now, how does that compare to a normal seasonal pattern?

Christopher Marr, President and Chief Executive Officer

Everything feels a little more muted than what you would expect as we define normal, given the volatility in customer data and the macroeconomic backdrop.

Ki Bin Kim, Analyst

With sequential rents realized possibly increasing in Q2, would you say that's possible?

Christopher Marr, President and Chief Executive Officer

Yes, it is possible. We're gathering information over the next couple of months that will be very informative for how the year progresses.

Ki Bin Kim, Analyst

Your New York City market is performing well, but there seems to be some deceleration over the past couple of quarters. Can you provide insights on how we should think about this moving forward?

Christopher Marr, President and Chief Executive Officer

We expect the New York market to lead our portfolio in growth. However, the next few months will be highly impactful for trends in this segment, particularly due to supply effects in the suburbs.

Operator, Operator

Our next question comes from the line of Keegan Carl from Wolfe Research.

Keegan Carl, Analyst

I know you maintained your outlook on your same-store revenue range. But I'm curious if there's any change in your underlying assumptions about occupancy, street rate, and ECRIs given year-to-date performance.

Timothy Martin, Chief Financial Officer

No, there has been no change at all. The first quarter, as we mentioned, came in right in line with our expectations. The remainder of the year depends heavily on the next few months.

Keegan Carl, Analyst

Supply has been a big focus of discussion. What are you seeing for the rest of this year and 2025? Are there any particular markets where your plans or assets might be impacted more significantly?

Timothy Martin, Chief Financial Officer

Overall, supply continues to decline. In particular, we expect ongoing impacts in Philadelphia and the Philadelphia suburbs, but there won't be any situation that stands out as extremely impactful nationwide. Some developments may or may not happen due to changes in the cost of capital and raw materials.

Operator, Operator

The next question comes from the line of Eric Luebchow from Wells Fargo.

Eric Luebchow, Analyst

Last quarter, you noted that for potential acquisitions, you were seeing a narrowing bid-ask spread compared to last year. Given recent interest rate changes and market volatility, are you finding it's still difficult to find attractive M&A opportunities?

Timothy Martin, Chief Financial Officer

Yes, we had a bit of a head fake couple of months ago as rates were declining. Brokers seemed hopeful about increased availability. However, that turned out to be an overestimation. The bid-ask spread is hard to gauge due to low transaction volumes, but we continue to work on underwriting deals as they arise.

Eric Luebchow, Analyst

In terms of supply, you mentioned that 27% of stores had been impacted by supply. Do you expect that 27% to decrease in 2025 and 2026 based on what's currently under construction?

Christopher Marr, President and Chief Executive Officer

Based on what we currently see, particularly in our top 15 markets, we expect that trend from 40% in 2021 down to about 27% this year will continue to decline through 2025 and 2026.

Operator, Operator

Our next question comes from the line of Juan Sanabria from BMO Capital Markets.

Juan Sanabria, Analyst

Can you speak to the pace or predictability of demand through April? You mentioned that last year was stronger early on, but it seems March fell off. Have you experienced that, and do you see customer behavior as normal today?

Christopher Marr, President and Chief Executive Officer

In terms of demand vs. expectations, the first quarter played out as expected. There wasn't any identifiable catalyst to alter those trends during this time. As for April, we've seen flat rentals compared to last year, providing little insight into the next three months, which will be important for our outlook.

Juan Sanabria, Analyst

The new overtime pay rules recently announced could impact storage OpEx costs. Are you anticipating any concerns regarding labor costs as a result?

Christopher Marr, President and Chief Executive Officer

Nothing specific has changed for our business regarding the new rules. We do see competitive pressures for talent in our stores but are not expecting significant operational shifts due to these new regulations.

Juan Sanabria, Analyst

On the third-party management front, you experienced a strong first quarter. What visibility do you have for the balance of the year? Should we expect that above-trend growth to continue?

Timothy Martin, Chief Financial Officer

Yes, we onboarded 68 stores in Q1, the most in 14 years. We have a healthy pipeline for new stores. With transaction markets being muted, we expect fewer stores to leave the portfolio and anticipate strong growth on the third-party management front. The current market conditions make the value of our sophisticated operating platform clearer for owners.

Operator, Operator

Our next question comes from the line of Brendan Lynch from Barclays.

Brendan Lynch, Analyst

On the advertising spend decrease, can you quantify the changes you've seen and the potential opportunity going forward?

Christopher Marr, President and Chief Executive Officer

We've seen web visits rise significantly and a 530 basis points improvement in conversion rates. We're reducing our cost per clicks by around 9%. We're leveraging tools and technology that improve our marketing spend efficiently, specifically through our CDP and AI systems. As we continue refining these strategies, we expect to see further benefits in customer acquisition.

Brendan Lynch, Analyst

Regarding property insurance, is the increase more acute in markets with weather risk, or is it spread evenly? Do you offer business disruption insurance as well?

Timothy Martin, Chief Financial Officer

It's difficult to judge market by market as we look at the overall portfolio and price quotes. Pricing is influenced by areas more directly impacted by weather events. And yes, we do have business interruption as part of our coverage.

Operator, Operator

Our next question comes from the line of Tayo Okusanya from Deutsche Bank.

Omotayo Okusanya, Analyst

Can you provide some color on ECRI trends, specifically around frequency and magnitude?

Christopher Marr, President and Chief Executive Officer

ECRI continues to operate at mid-teens levels in terms of increases for customers. We've seen consistency in its frequency and magnitude over the last three quarters, which indicates stability in our rental pricing strategies.

Omotayo Okusanya, Analyst

Regarding customer behavior, have you seen any increases in bad debt or delinquencies?

Christopher Marr, President and Chief Executive Officer

No, we're seeing no significant shifts in customer health metrics regarding bad debts or delinquencies. All trends align with historical performance.

Operator, Operator

Our next question comes from the line of Mike Mueller from JPMorgan.

Michael Mueller, Analyst

Regarding the Port Chester development, it looks like the timing has been pushed back a few quarters. What caused this?

Timothy Martin, Chief Financial Officer

It's typical for developments to experience delays due to various issues, including permit timing and contractor schedules. There's nothing particularly noteworthy regarding this delay.

Operator, Operator

Our next question comes from the line of Michael Goldsmith from UBS.

Michael Goldsmith, Analyst

For street rates, can you provide the year-over-year and sequential changes for March and April?

Christopher Marr, President and Chief Executive Officer

I’m sorry, Michael, I do not have that change at my fingertips, but it has continued to move sequentially upward during that period.

Michael Goldsmith, Analyst

Just to clarify, rates improved sequentially in Q2; is that street rates or in-place rents?

Christopher Marr, President and Chief Executive Officer

Street rates should continue to grow during Q2, as should realized rents throughout the year.

Operator, Operator

This concludes our question-and-answer portion of the day. There are no further questions at this time. I'd now like to turn the call back over to Mr. Chris Marr for final closing comments.

Christopher Marr, President and Chief Executive Officer

Thank you. Thank you, everyone, for participating in the call. The industry continues to demonstrate its resilience, as our customers find us during everyday life events. Our industry delivers a valuable service, alleviating stress for our customers. We're confident in the long-term growth of our industry and in Cube maximizing opportunities presented to us. There are economic factors beyond our control, but we are focused on delivering the perfect rental experience to our customers. We look forward to speaking with you again at the end of the second quarter. Take care.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.