Earnings Call Transcript - CUBE Q2 2021

Operator, Operator

Good day, and welcome to the CubeSmart Second Quarter 2021 Earnings Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Josh Schutzer, Vice President of Finance. Please go ahead.

Joshua Schutzer, Vice President of Finance

Thank you, Sarah. Good morning, everyone. Welcome to CubeSmart's second-quarter 2021 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. 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. The risks and factors that could cause our actual results to differ materially are provided in events 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. I will now turn the call over to Chris.

Christopher Marr, President and CEO

Thanks, Josh, and good morning, everyone. I wish to recognize all of my fellow CubeSmart teammates for each of their contributions to our outstanding performance in the second quarter. Broad-based consumer demand for our space, when combined with positive trends in customer behavior, has contributed to our record levels of physical occupancy and extremely strong pricing power across our portfolio. These positive trends, when combined with our award-winning customer service and innovative technology, resulted in 14% same-store revenue growth in the second quarter, the highest growth in our history. Rates to new customers were up 47% over 2019 levels during the quarter, and we were more aggressive in rate increases for existing customers. This pricing power has continued into the third quarter and is contributing to our significantly raised expectations for the back half of the year. We are growing externally in a disciplined manner. We added 45 third-party managed assets to the platform during the quarter. Our pipeline remains full, consistent with levels we have experienced over the last few years. The interest from our owners in selling has certainly increased in this compressing cap rate market, and we expect to continue experiencing a high level of churn in our managed portfolio. Our acquisition team is as busy as ever underwriting opportunities. However, we believe that the market for stabilized deals does feel a bit pricey. We were active during the quarter within our joint venture structure, focusing on lease-up opportunities. As evidenced by our increased guidance for external growth, we anticipate sourcing additional opportunities for non-stabilized assets, both on balance sheet and within our joint venture structure. Positive operating fundamentals, talented teammates, and sophisticated systems have positioned us well as we conclude the summer rental season. We believe we are well positioned to drive strong performance for the balance of the year. I'll now turn it over to Tim for a more detailed commentary on our quarterly results and improved outlook.

Timothy Martin, Chief Financial Officer

Thanks, Chris, and thank you, everyone on the call, for your continued interest and support. As Chris touched on, operating fundamentals were incredibly strong during the second quarter and are continuing into the back half of the year. All of this strength was reflected in our earnings release last evening that reported a strong beat against second quarter expectations and a meaningful increase in our guidance for the full year. Same-store performance included headline results of 14% revenue growth, 6.6% expense growth, yielding NOI growth of 17.6% for the quarter. Average occupancy in the second quarter was 95.6%, which is up 300 basis points year-over-year, and the quarter-ending occupancy was 96.1%. Strong demand was evidenced not only in physical occupancy but also in strong pricing power, higher effective net rates to new customers, and customers staying longer—all contributing to the 14% growth in same-store revenues. Same-store expense growth for the quarter was in line with our expectations at 6.6% year-over-year. Expense growth is partially due to tough comparisons from last year, continued pressure on real estate taxes, property insurance, and opportunistic marketing spending—offset, however, by efficiencies in personnel costs and lower utility costs. All of the same drivers of our same-store growth showed up in the performance of our non-same-store portfolio and third-party management business. Combining all of that growth, we reported FFO per share as adjusted of $0.50 for the quarter, which represents 22% growth over last year. Adding to Chris' comments, we remain active and disciplined in our pursuit of external growth opportunities and are extremely busy underwriting a lot of potential opportunities. Pricing on some of those we've looked at has been very aggressive, and cap rates have clearly compressed. We continue to find select opportunities that we view as attractive and that fit our disciplined investment strategy. We opened up two new developments in the quarter, one in New York and one in Pennsylvania. We closed on one wholly-owned store acquisition in Maryland for $22.1 million. On the co-investment front, we were active in three separate ventures that acquired stores in Minnesota, Connecticut, Illinois, and Florida. Looking at total investment volume so far this year, we will close or have under contract $352.7 million of transactions—$55 million of that is wholly owned, and $297.6 million is through co-investment entities. So we've been very active while remaining disciplined. On the third-party management front, we added 45 stores in the second quarter and ended the quarter with 718 third-party stores under management. Our balance sheet position remains very strong as we continue to focus on funding our growth in a conservative manner, consistent with our BBB/Baa2 credit ratings. We have continued to raise equity capital through our aftermarket equity program during the quarter, raising net proceeds of $42.4 million. Our conservative leverage levels and revolver capacity position us well to pursue external growth opportunities. Details of our 2021 revised earnings guidance and related assumptions were included in our release last night. Based on the strong operating fundamentals we've discussed, we've increased our guidance range for the full year of FFO per share by nearly 10%, or $0.18 per share at the midpoint. Much of that guidance increase is based on an improved outlook for our same-store revenue growth for the year, which essentially doubled to a revised range of 10.25% to 11.25% growth over 2020 levels. It is safe to say that it's certainly a great time to be in the self-storage business. Our team continues to work hard to best position our portfolio for growth in all parts of the cycle, and we believe our results continue to validate the strength of the CubeSmart brand and platform. Thanks again for joining us. At this time, let's open up the call for some questions.

Operator, Operator

Our first question comes from Jeff Spector with Bank of America.

Jeff Spector, Analyst

Congratulations on the quarter. I guess the first question is just kind of big picture. Again, unprecedented demand. Chris, you talked about the consumer trends and pricing power. Is there a time frame that you could compare to in the past to give us an idea of how long this may last, particularly pricing power trends or the consumer trends?

Christopher Marr, President and CEO

Yes. Thanks for the compliment. No, not really. This is hard to compare. I go back to 1993, 1994, and certainly, we've been through quite a number of cycles. But the combination of the pandemic-created need for space with movement across the United States and a very robust housing market, alongside a little bit of inflationary pressure, has absolutely created the best environment I've seen. It hasn't ever happened, and I don't see it coming to some sort of screeching halt. I think this positive momentum continues. We continue to believe that some level of more typical seasonality will eventually return to the industry; we have yet to see that occur. But I'm very optimistic about what the future holds for storage.

Jeff Spector, Analyst

I'm sorry if I missed this; just a detailed question on the marketing expenses. I think they were up about 29% this quarter. Did you comment on that? Do you see this trend continuing? And how do you think about advertising in terms of your revenue optimization?

Christopher Marr, President and CEO

Yes. Great question. Thanks. Our strategy has been to continue to increase spending where it has been efficient to do so in order to fill the funnel. We choose to limit demand through high prices rather than limiting demand through lower spend. Our pricing system, which includes a marketing spend component, suggests that with demand and pricing currently at all-time highs for the industry, spending more marketing dollars to capture higher value rentals will continue to drive top-line revenue growth over time. Our data suggests that some of our competitors pulled back significantly on spending in paid search auctions during Q2. We viewed that as an opportunity to spend a bit more at really attractive costs per click and cost per acquisition. We've got a significantly improved lifetime value of our customer, given that rates are up so significantly. From our perspective, it's really the long game. If you were to shut off first-month free in any given quarter, the growth in that quarter would appear very attractive. However, over the long term, you could potentially harm the trajectory of your revenue growth. We were pleased with our performance in the second quarter, comfortable with our spending levels, and we believe that our outperformance, shown at the end of last year and our expectations for this year, will continue to yield very positive long-term revenue growth results for our portfolio.

Operator, Operator

Our next question comes from Samir Khanal with Evercore.

Samir Khanal, Analyst

Hi, Chris. My question is a bit broad. Do you think the industry can achieve high single-digit revenue growth into next year? Occupancy will clearly normalize, but if you're still having good tailwinds from rate growth, akin to what you saw in 2016, do you think you can hit those levels of top-line growth?

Christopher Marr, President and CEO

I certainly think robust levels of top-line growth going into the beginning of next year appear to be reasonable. The challenge to answer is just the nature of our business—it’s difficult to predict when we might see a return to more typical seasonality and how that would impact the overall pricing environment. However, I am quite bullish that these positive trends continue into the beginning of next year. Assuming they do, we are set up for a great summer rental season next year, but that circles back to the question of what happens in August and September of 2022, when we may see a return to some typical seasonality.

Samir Khanal, Analyst

Got it. Can you provide an update on supply? With strong fundamentals, you'd expect some indications of new supply, maybe not in '22, but what's your updated view?

Christopher Marr, President and CEO

From the '21 and '22 perspective, we expect lower deliveries than '20 and '19, consistent with our expectations. I believe 2022 will be constructive regarding new supply as well. Continuing robust operating fundamentals will draw more attention to the industry. An offset, however, is cost—construction is extraordinarily expensive nowadays with difficulties in sourcing raw materials and hiring labor. That will serve as a buffer to interest. Also, I think there's been a shift from primary to secondary markets regarding that supply, which should continue to be the case. We will continue to watch this, but my expectation would be if at all, new supply will be more of a '23 occurrence.

Operator, Operator

Our next question comes from Todd Thomas with KeyBanc Capital Markets.

Todd Thomas, Analyst

Chris, you mentioned the growth in rates during the quarter. How did that trend throughout the quarter and into July? Also, can you provide an occupancy update as we are nearing the end of the quarter?

Christopher Marr, President and CEO

The trend relative to 2019 accelerated through the quarter: high 30% in April, high 40s in May, and high 50s in June. As for occupancy, we have grown occupancy to 96.3% physical in same-store as of yesterday, which is about a 20 basis point growth from the end of June.

Todd Thomas, Analyst

I'm just curious, looking out at where rates are currently, there seems to be a significant mark-to-market with customers moving in paying much higher rents than customers moving out. How many years would it take to churn through the portfolio so that in-place rents catch up to asking rents?

Christopher Marr, President and CEO

That's an interesting question, Todd. With a 13-month average length of stay, it would take about a year until you lap that. I might not be thinking about it exactly right, but you are correct in that we have seen a flip where typically our in-place customers have had higher rates than asking rates to new customers, but that has inverted in the current environment. However, it would likely take longer than that average length of stay to fully address your question.

Todd Thomas, Analyst

Can you speak to the performance of New York in the portfolio? There's a solid result, but I think one of your peers indicated that it was a slightly more challenging market for them. How is the New York MSA performing regarding return to the office and population movements?

Timothy Martin, Chief Financial Officer

New York, as you can see from our supplemental performing report, is quite strong for us. The situation varies by borough. For example, in the Bronx, there's no new supply, showing why we're bullish on the market overall. Queens has had some supply; however, that’s been a little more spread out. Brooklyn is experiencing impacts from new supply but still recorded 10.5% revenue growth, and our single store in Staten Island performed very well with 17% same-store revenue growth. We are not seeing consumer behavior in New York that is different from the rest of the country.

Operator, Operator

Our next question comes from Smedes Rose with Citi.

Smedes Rose, Analyst

Are there changes in the tax laws and the ICAP that might have been affecting new supply that was in the pipeline?

Timothy Martin, Chief Financial Officer

Yes. All of that activity is influencing any new projects that weren't already approved before all that happened. Those are few and far between. The impact will be felt as we get into '22 and '23 when all existing projects that were ahead of that cutoff get delivered. The real benefit will emerge two or three years out when the existing supply stabilizes, leading to a landscape with little to no new competition.

Smedes Rose, Analyst

On the acquisitions front, with cap rates compressing, are you leaning more towards properties in lease-up or focusing on joint ventures? How do you plan on meeting your slightly raised target for the year in a potentially tougher environment?

Timothy Martin, Chief Financial Officer

It's exciting because there's a lot of opportunity. Many transactions will happen in this environment. However, we face a significant challenge with a deep pool of buyers and a high level of interest in the sector given its recent performance. While we're not focused on pursuing any particular type of opportunity, we will look at those that complement our portfolio and have attractive risk-adjusted returns. We're seeing opportunities in the short term weighted more towards lease-up rather than stabilized due to strong competition for stabilized opportunities.

Smedes Rose, Analyst

Are you seeing any issues on the wages or staffing side with the labor shortages we've been hearing about?

Christopher Marr, President and CEO

Hiring is certainly a challenge both in stores, our sales center, and corporate office. Like many businesses, we've pushed for teammate referrals and are looking into other methods to attract talent. We're hopeful that as we approach a post-Labor Day period, with the elimination of additional unemployment payments, it will encourage more people to return to the workforce. It's a challenge we face as most industries do today, but our team is committed to assisting us through it.

Operator, Operator

Our next question comes from Spenser Allaway with Green Street.

Spenser Allaway, Analyst

Regarding your third-party management platform, you sourced 45 stores in the quarter, but it looks like there was some attrition as well. Is this a function of continued selling into strong private market pricing?

Timothy Martin, Chief Financial Officer

That's correct. It's part of being in the third-party management business. We aim to create value for our third-party customers, which is exactly what we've done. So while we don't like when our managed stores change hands, it is a positive sign of the value we've created. The attrition we've seen is mostly from stores that have changed ownership, though we have opportunities to be the acquiring party as well.

Spenser Allaway, Analyst

Can we circle back to ECRIs? I know you can't provide specific numbers, but can you give us a sense of how the magnitude of increases this year compares to prior years?

Christopher Marr, President and CEO

In terms of our pricing system, it considers all factors, including the lack of inventory, asking rates for new customers, and how long existing customers have been with us. Given the high occupancy and rates currently, the ECRI raises higher. So the momentum has moved up. Previously, we saw high single digits and low double digits in terms of increases, and that has increased a few percentage points now.

Operator, Operator

Our next question comes from Ki Bin Kim with Truist.

Ki Bin Kim, Analyst

Regarding underwriting acquisitions in this market cycle, how do you approach it? If you're buying something at an inflated rent, do you normalize it back down?

Timothy Martin, Chief Financial Officer

Our underwriting approach remains unchanged over the years. We're underwriting based on our expectations for how the property will perform in the future under our management. However, the variability and volatility of some variables can dramatically impact individual underwriting. There’s no specific benchmark we follow for growth, as it varies by the opportunity.

Ki Bin Kim, Analyst

In terms of same-store revenue performance across markets, is there any noticeable common denominator that explains why some markets are performing better than others?

Christopher Marr, President and CEO

It's unique to each market. In some cases, it’s driven by supply or a lack thereof. In other instances, it's about stickiness in storage needs but nothing beyond that.

Operator, Operator

Our next question comes from Jonathan Hughes with Raymond James Financial.

Jonathan Hughes, Analyst

Could you share where move-in rates are today versus your in-place rents across the portfolio?

Timothy Martin, Chief Financial Officer

We discussed how move-in rates are trending positively versus typical negative trends. Our current rates are currently positive, and we are about 3,500 basis points higher than last year, placed in the mid-teens.

Jonathan Hughes, Analyst

Personnel expense growth was basically flat in the quarter. What should we expect for that line item growth through year-end?

Christopher Marr, President and CEO

I would expect personnel expenses to remain flat to slightly up as we progress to the end of the year. The main challenge remains filling vacancies.

Jonathan Hughes, Analyst

On capital allocation, why did you choose to raise equity via the ATM this quarter? Your leverage today is under 4.5 turns.

Timothy Martin, Chief Financial Officer

It positions us to have a lot of optionality going forward. We expected 2021 to be robust for acquisition opportunities with the recent development cycle deliveries. Given our operating environment right now, a lot of owners of the first-wave development will come to market, and we want to ensure we are best positioned for attractive acquisitions, allowing us to remain conservative in our credit metrics.

Jonathan Hughes, Analyst

Could you remind us what the target leverage is?

Timothy Martin, Chief Financial Officer

The target is consistent with being at the very conservative end of strong BBB to Baa2 rating metrics, generally in the range of 5 to 5.5.

Operator, Operator

Our next question comes from Michael Mueller with JPMorgan Chase.

Michael Mueller, Analyst

What's implied in your same-store revenue guidance for the back half of the year concerning moving rates or market rent growth? Are rates expected to stay steady?

Timothy Martin, Chief Financial Officer

We do not guide on individual components of revenue growth. Our assumptions take into consideration a range of occupancies, rates, and how they align with marketing spending expectations. We expect continued strength in pricing power, but with some seasonal return to more typical occupancy patterns as well. Implicit in our guidance is the expectation for continued growth in the back half of the year by 10% to 12%.

Christopher Marr, President and CEO

I expect there will be some slight moderation in asking rate growth in the back half of the year due to expected typical fall and winter seasonality.

Operator, Operator

Our next question comes from Kevin Stein with Stifel.

Kevin Stein, Analyst

How much of the pricing power is coming from low vacates versus a surge in demand?

Christopher Marr, President and CEO

We're seeing success on both fronts. Customer interest is up, and our rentals are increasing while vacates are lower. This situation is beneficial across the board, positively affecting rate increases as well.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Marr for any closing remarks.

Christopher Marr, President and CEO

Thank you, everyone. We appreciate all of the positive comments shared today. We are pleased with the quarter, and the industry is performing well. We look forward to a strong back half of the year and a robust 2022. I'll leave you with our best wishes for your health and safety. We look forward to speaking with you after our third-quarter results. Take care.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.