Earnings Call Transcript - CUBE Q3 2021

Operator, Operator

Hello, and welcome to the CubeSmart Third Quarter 2021 Earnings Call. My name is Elliot, and I will be coordinating your call today. I will now hand over to our host, Josh Schutzer. Josh, please go ahead when you're ready.

Joshua Schutzer, Host

Thank you, Elliot. Good morning, everyone. Welcome to CubeSmart's Third 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 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 third quarter financial supplement posted on the company's website at www.cubesmart.com. I will now turn the call over to Chris.

Christopher Marr, CEO

Thank you, Josh, and good morning. We are pleased to wrap up a very successful quarter for the self-storage industry. Operating fundamentals continue to maintain their positive trajectory supported by our sophisticated systems and solid consumer demand. We have been able to leverage that demand by growing occupancy and maximizing rates for both new and existing customers. The benefit of the positive consumer demand backdrop is evident in our same-store metrics. The impact of the solid operating environment is also being experienced in our nonsame-store and recently developed properties. Physical occupancy, realized rent, revenue, and net operating income in our nonsame-store and development properties well exceeded our expectations during the quarter. We are particularly pleased with the accelerating same-store revenue performance we have experienced when considering the positive same-store revenue growth we produced in the back half of 2020 and the teeth of the challenges created by the pandemic. Our same-store revenue growth during the quarter and our outlook for the full year reflect our strategy of balancing marketing, occupancy, rental rates, and discounting to produce the maximum sustainable revenue growth over the long term. Looking forward, we remain bullish on fundamentals as evidenced by our increased guidance, which Tim will get into with more detail in his commentary. Our thesis on supply for the balance of '21 and '22 remains intact. Our current data supports our expectation that supply in our top 12 markets peaked in 2019. We continue to expect new supply in those markets to decline in 2022 compared to the 2021 expected deliveries. Specific to the outer boroughs of New York, we expect new deliveries to contract significantly from what we have experienced over the past 3 years. Currently, our data suggests 3 openings across Brooklyn, the Bronx, and Queens in each of the first and second quarters of next year, dwindling to one in the third quarter of next year and no further openings after Q3 of 2022 currently on our radar. I want to take this opportunity to thank our store teammates for their dedication to customer service and tremendous resiliency in the face of what seems to be multiple once-in-a-lifetime events. Our team continues to navigate through the pandemic with grace, flexibility, and genuine care for our customers. I want to especially thank our team in the New York MSA for their customer service during and after tropical storm, Ida. We experienced significant water intrusion at several of our stores in Queens, the Bronx, North Jersey, and Westchester County. Our teams did an outstanding job assisting our customers in navigating the operational challenges created by the flooding. I also want to recognize the collaborative efforts of our third-party management and information technology teams who introduced SmartView during the quarter. SmartView is our first-of-its-kind proprietary mobile app, designed to connect our third-party customers seamlessly to key performance metrics for their stores. Yet another example of how we are serving our third-party management clients in innovative ways so that we may continue to keep ahead of the fast pace of change. The spotlight shining in our industry has increased investors' interest in owning self-storage. This has had a positive impact on our third-party management business as our pipeline of future opportunities remains solid. This wonderful operating environment has also had a positive impact on the acquisition environment and our deal flow is quite robust. We continue to evaluate our external growth opportunities with a focus on achieving attractive risk-adjusted returns and maintaining our position as the highest quality portfolio in our business. Our balance sheet is well positioned to capitalize on opportunities. Finally, I wish to point out that we published our inaugural sustainability report this morning. We are proud of our work to date and are committed to continuous improvement as sustainability efforts play a key role in our long-term value creation. Thank you. And I will now ask Tim to share his comments on our quarterly results and outlook. Tim?

Timothy Martin, CFO

Thanks, Chris, and thank you to everyone on the call for your continued interest and support. As Chris touched on, results in the third quarter continue to reflect incredibly strong operating fundamentals across our portfolio, leading to another quarter of results that were better than expectations and again, led to a meaningful raise in our earnings guidance going forward. Same-store performance included headline results of 15.6% revenue growth and 3.9% expense growth, yielding NOI growth of 21.1% for the quarter. Same-store occupancy levels remained unseasonably strong, averaging 95.6% in the third quarter, which is up 150 basis points year-over-year, and we ended the quarter with physical occupancy at 94.8%. Strong demand continued to be evidenced not only in high levels of physical occupancy but also on strong pricing power. Higher net effective rates to new customers, existing customer rent increases, and elongating lengths of stay all contributed to the 15.6% growth in same-store revenue. Same-store expense growth of 3.9% for the quarter was in line with our expectations, driven by continued pressure on real estate taxes, property insurance, and opportunistic marketing spend, offset by efficiencies in personnel and lower utility costs. Similar performance drivers drove results across our nonsame-store portfolio and our third-party management business. And combining all of that internal growth, we reported FFO per share as adjusted at $0.56 for the quarter, representing 27% growth over last year. Our continued meaningful growth in cash flows led to our announcement earlier this week of a 26.5% increase in our quarterly dividend, resulting in an annualized $1.72 per share, and that's up from the previous rate of $1.36 per share. We remain active in our pursuit of external growth opportunities and continue to be busy underwriting a lot of potential deals. We continue to find select transactions that we find attractive that fit our disciplined investment strategy. During the quarter, we acquired 2 stores on the balance sheet for $33 million and another 3 stores in JVs for just under $90 million. We have $85.8 million of on-balance sheet stores under contract and $66.3 million of stores under contract through joint venture investments. During the quarter, we were active on selective dispositions. We sold 4 stores for $38.6 million and have another store in the contract to sell for just over $5 million. Additionally, subsequent to quarter end, we sold 7 stores from a joint venture for $85 million. On the third-party management front, we added 33 stores in the quarter and ended the quarter with 706 third-party stores under management. Our balance sheet position remains strong as we continue to focus on funding our growth in a conservative manner that's consistent with our BBB/Baa2 credit ratings. We continue to raise equity capital through our at-the-market equity program during the quarter, raising net proceeds of $57.9 million. Our conservative leverage levels and revolver capacity have us well positioned 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 full-year FFO per share by 4.2% at the midpoint. Much of that guidance increase is based on an improved outlook for our same-store revenue growth for the year, which expanded to a revised range of 12.5% to 13.5% growth over 2020 levels. As Chris mentioned, again, I'd like to thank our teams across all functions of the company as they continue to work hard and ensure that we're maximizing all of the opportunities that the current environment is presenting. And our results continue to validate the strength of the CubeSmart brand and the CubeSmart platform. So thanks again for joining us on the call this morning. At this time, Elliot, let's open up the call for some questions.

Operator, Operator

Our first question comes from Smedes Rose from Citi.

Smedes Rose, Analyst

I wanted to ask just a little bit, I guess, about how you're thinking about occupancy at this point, kind of the peak to trough and kind of what's in your revised guidance?

Christopher Marr, CEO

Yes, Smedes, this is Chris. Welcome to the call. I'll take that and Tim can pile on. So what we're seeing is that the demand is there, vacates from students certainly were there in August and September as school returned to its more normal schedule. So we saw that in some of our student markets such as Boston. And what we're seeing now as we get into the post Labor Day timeframe is a bit in certain markets of the return to work, return to home type thesis. So we would see the gap to last year. And again, we don't guide specific to the occupancy relative to rate or other levers, but broadly, we would envision that occupancies continue to move back towards last year's level and that the gap to last year will continue to shrink. And I think by the time we get to the end of December here, our expectation is that we will be plus or minus a few basis points to where we ended 2020 in physical occupancy. And then as we move into next year, again, we would consider that gradual return to a more typical pattern to continue up until the beginning of the busy season. Given where we are in the housing market, in particular, we would envision quite a robust busy season for the industry starting in the typical March, April timeframe of next year.

Smedes Rose, Analyst

Okay. Can you share what October occupancy was?

Christopher Marr, CEO

I can share what the end of October occupancy was. The end of October occupancy was on hand.

Timothy Martin, CFO

Chris, 94.4%.

Christopher Marr, CEO

Yes, 94.4%. Thank you.

Smedes Rose, Analyst

I wanted to ask a broader question. Many other public storage REITs have significantly increased their overall acquisition forecasts for the year, while you have maintained yours. I'm curious if this is primarily a pricing issue, or if there are other reasons for your more cautious approach to external growth expectations.

Timothy Martin, CFO

Smedes, I can't speak to what others are doing. What I can tell you is that you have likely grown to expect and should continue to expect that we will remain incredibly consistent in our external growth strategy, focusing on opportunities that complement or enhance our high-quality portfolio, both in asset quality and market quality. We do continue to find stores and transactions that fit strategically at risk-adjusted returns that create long-term shareholder value in our view. If you think about our growth over the past rolling 4 quarters, we've acquired about $1 billion of real estate. So we've been pretty busy and have transacted on things that fit our strategy. As we mentioned in the opening remarks, our balance sheet is well positioned. We continue to underwrite a lot of opportunity at this point. What we've provided in our guidance is what we found that makes sense for us.

Operator, Operator

Our next question comes from Elvis Rodriguez from Bank of America.

Elvis Rodriguez, Analyst

Tim, you mentioned opportunistic marketing spend. And if you look at the year-over-year same-store marketing spend for Cube versus peers, it increased while others decreased. Can you just talk a little bit about what you're doing on the marketing side? And where the benefits are coming from?

Timothy Martin, CFO

I would love to address and answer your question, but Chris really wants to do it. So I'm going to let him do it.

Christopher Marr, CEO

I do really want to take it. So I'll take that question. Yes. I mean, obviously, there are some differences in how folks are thinking about balancing the levers of marketing investment relative to price relative to discounting. When we look at our incremental spend, which is almost entirely in the paid search channels, we look at our incremental spend and the rates then that we are able to get. And so we're looking at it to say, we're getting somewhere between 8% and 10% higher rates based on the incremental spend. If you look at it over a longer timeframe, we believe that the return we are getting on that marketing spend is creating those higher rental rates, and we will continue to produce very attractive returns and higher revenue over the next couple of quarters.

Elvis Rodriguez, Analyst

You briefly mentioned supply and your expectations in the boroughs. Can you elaborate on the situation regarding the one store in the third quarter of 2021? You indicated there hasn't been any additional store openings since then. What are your projections for the next six months?

Christopher Marr, CEO

Yes. So again, to clarify, my commentary was that we only see one store in Q3 of 2022, and then no stores thereafter. So if you look at expectations that we would have, and again, these are based on openings projected as of now, they may happen sooner or later. The reality is that we are looking at supply where there are, let's see, 2 or 3 stores in Brooklyn, 2 or 3 in Queens, coming in the first and second quarters of next year, one store in Brooklyn in the third quarter next year, and then right now 0 thereafter.

Operator, Operator

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

Todd Thomas, Analyst

First question, I wanted to point out that New York City performed well in the quarter, but it was one of the few markets where growth slowed by about 430 basis points on a revenue basis. Chris, you mentioned the supply in some boroughs and also the rains and floods that occurred during the quarter. Can you discuss what you're observing in the New York City MSA within your portfolio?

Christopher Marr, CEO

Sure. Thanks for the question. So let's do take a look under the hood at the New York MSA performance during the quarter. In the back half of last year, New York MSA performed exceptionally well, which made it more difficult to generate outsized growth this year. As you touched on, there are a few other factors to evaluate. We've got the impact of Ida and new supply, the performance of our nonsame-store pool and the consumer demand picture. If you start with the rain, the heavy rain from Ida, we had water damage at 9 of our stores in the MSA: 2 in Queens, 3 in the Bronx, 2 in Westchester County, and 1 each in Brooklyn and North Jersey. Unfortunately, the nature of that storm led to isolated pockets of water intrusion, and it was largely as a result of the source systems incapable of absorbing that much rain that quickly. So those 9 stores, we really experienced no new demand for about a month as we cleaned up. We did experience resulting vacates because sadly, many of the customers' possessions were at a total loss. We had a bit of an occupancy decline at those impacted stores. On the supply side, we've been consistent in our messaging regarding the impact, especially in Brooklyn and Queens, which was as expected and factored in our expectations. While our same-store results in Brooklyn and Queens are outperforming our expectations on occupancy rate revenue, much like Washington, D.C. and Nashville MSA, they're dealing with the headwinds that we're not experiencing markets that are not seeing new supply. The upshot to this is that the new development stores are continuing to lease up in those markets, particularly in Brooklyn and Queens, well ahead of our expectations. The customers that we can't accommodate at our highly occupied same-store, we're getting them at the lease-up stores in the boroughs, and those stores are experiencing physical occupancy revenue higher than planned. Our acquisition last year in the fourth quarter of the Storage Deluxe assets are well outpacing our underwriting. Those are in the same-store pool. So I think you got to look at this holistically. Looking at the consumer demand picture, demand remains very solid. We obviously have all-time high physical occupancy. I think it's basically 95.5% in the outer boroughs. We do see the returning population to New York City impacting the vacate side in our Manhattan store and then some of the immediately adjacent stores. We view that actually as a long-term positive. Near term, we're seeing some vacates from people who would have stored at the beginning of the pandemic. Long term, that returning population and what we're seeing on the multifamily side, particularly in rate on the multifamily side, we view as a long-term positive as people return to the city. We are encouraged by the overall results for the quarter and year-to-date.

Todd Thomas, Analyst

Yes, that's helpful. Are you seeing occupancy rebound in New York City a bit in October and early November? And has there been any change to your ECRI program? Or has there been any resistance to rent increases to in-place customers in that region? And then, Tim, within the revised guidance, do you anticipate growth to continue to moderate in New York City in the near term?

Christopher Marr, CEO

I'll address the first part of your question. When we look at trends, occupancy across the boroughs is at 95.5%, so we are fully booked. That's not a concern. As I mentioned, occupancy in the stores affected by water damage from Ida dropped by about 170 basis points. However, we are recovering as those stores have been cleaned and repaired, and they are now fully operational again with demand returning. Regarding the Manhattan store and a few in Long Island City and Park Slope, most of which are not included in the same-store pool, we are seeing lower physical occupancies as people come back to New York. The stores in the outer boroughs that were not impacted continue to perform well. Additionally, we are not facing any challenges with existing customer rate increases at our locations. Specifically, there's no significant pushback aside from the usual resistance in the New York City stores. As for Tim, while I can't provide more details, we anticipate continued solid growth as we progress through the year.

Todd Thomas, Analyst

I have a question regarding acquisitions. While I understand your focus on investments and maintaining discipline, it seems there's been a reduction in the emphasis on yields due to expectations of upside and significant growth potential in the near future, or perhaps due to stabilization in occupancy rates. Are you not identifying the same opportunities? When engaging with others on investments, do you find that you're not seeing the same upside or growth potential over the next few years compared to what others may be considering when evaluating potential acquisitions?

Timothy Martin, CFO

Yes, that's a difficult question to answer because we have our own perspective. I can’t comment on the views and calculations of others in their underwriting processes. We are primarily focused on achieving overall returns that are adjusted for risk. Unfortunately, your question has multiple facets, many of which relate to the actions and thoughts of others, which I can't address. What we have engaged in and what we have under contract are outcomes of our efforts, aligning with our strategy that makes sense to us while accounting for risk.

Operator, Operator

Our next question comes from Juan Sanabria from BMO Capital Markets.

Juan Sanabria, Analyst

Just wanted to follow up on the New York City stuff you guys were talking about. Do you have a sense of what the impact to same-store revenues was from Ida? And second part of the question, should we expect any incremental benefit from the eventual inclusion of Storage Deluxe? I think that will happen in the first quarter '22 once that enters the same-store pool.

Christopher Marr, CEO

I'll take the first part of that one. In terms of just broadly, the impact was negative. It's hard to put basis points on what could or could not have happened at those stores had they not closed down and not had to deal with the cleanup. Certainly, again, we lost occupancy. We were unable to accept new customers, and it was difficult to accept new customers for a short period of time. So I don't know how to quantify the basis point impact to it. They certainly were amongst the poorer performing stores for the quarter.

Timothy Martin, CFO

And on the impact of stuff coming in or out of the same-store pool next year, we are not going to get into stuff related to 2022 guidance. Things that come into our same-store pool are stable when they come in. So happy to try to provide some color on that next quarter when we get into '22 guidance.

Juan Sanabria, Analyst

Okay. And then just one follow-up question for the third-party management business. Do you expect, as you look forward and kind of have a sense of what's either on the market today for sale or what could be coming based on your discussions that we'll see continued churn in '22? Or do you expect that to level out to have more net growth going forward?

Timothy Martin, CFO

Great question. We certainly expect, I think, 2021 has obviously, as you know, been an incredibly active and robust transaction environment. We've seen a lot of stores come on to our platform, and we've seen a lot of stores come off as many of our owners have monetized a lot of the value that we've helped to create for them on our platform. Many of the stores that are on our platform are stores that were newly developed 3, 4 years ago. Many of the owners that we manage for are not forever holders. When the right time comes for them to monetize and sell to us or take it to market and potentially sell to somebody else, I think that is a continued trend that is just the reality of the landscape for the third-party management business for us and others who are in it. Difficult to predict whether there would be net growth or net contraction. We work hard on continuing from a new business development standpoint to attract new customers to the platform. We're still seeing great inbound activity on folks who are interested in our platform. And so that part we can control. The other part candidly is that we're doing a really good job capitalizing on the opportunities that are in the markets, and we're getting the stores leased up for our owners and helping them create value and monetize, which is what they hired us to do.

Operator, Operator

Our next question comes from Joab Dempsey from Truist.

Joab Dempsey, Analyst

Chris, in your prepared remarks, you spoke about supply being manageable going into next year. Clearly, the fundamentals being so strong, you think you start to see some supply coming online. But is there anything in terms of whether it's the entitlement process or the supply chain disruption, making it harder to source construction materials that are keeping a lid on new supply?

Christopher Marr, CEO

Yes. Thanks for the question. I think you have a nice balance at the moment where operating fundamentals are spectacular, to say the least, and that will inevitably attract folks to our industry. Folks who wish to think about participating in this via development are offsetting that with some continued trends, which is in several western markets, particularly in California. It is incredibly challenging for a whole host of reasons to develop a new product, and therefore, you've seen it be fairly muted, and we would expect it to continue to be fairly muted. You have the issues, obviously, we've talked at length in New York City with the changes in tax law that make it much harder to develop there. I've outlined our expectations that that drives up over time there. You also have the new issues of cost of raw material, cost of labor, inability to source raw material, and inability to get labor in a very, I think, continued constructive, meaning rational lending environment. All of those factors then make a decision around new development more difficult. I think that all of those things balance out. That being said, you can still generate attractive returns in many markets if you find the right piece of land or if you've owned that land for quite a while and have a reasonable basis. If you're patient, you might see some of these supply chain issues work themselves out mid to end of next year and lead to supply in '23 or '24. I think it's manageable. I think that tells you the industry is performing quite well. We've demonstrated as a sector that we can absorb it, and it's not a doomsday scenario and we'll be just fine. I think there will be supply, all things being equal, but it will be manageable.

Joab Dempsey, Analyst

Okay. Great. And then it looks like you sold 4 properties this quarter. With cap rate compression across the industry, how do you think about further recycling of assets and possibly putting that capital to work in other areas, particularly joint venture structures where you're focused on lease-up opportunities?

Timothy Martin, CFO

Maximizing return on capital and recycling when appropriate has always been part of the playbook. What we did recently was to do just that. We had some assets that on a longer term, if you think about the next 5 or 10 years, we thought that we could redeploy that capital into other opportunities and get a better risk-adjusted return over time. We don't have a lot of those opportunities because we've worked hard to assemble a portfolio of really high-quality assets, and they're not easy to find. So we're not looking to sell tens of properties, but when we find particular situations where we think we can recycle that capital, we're anxious to do so.

Joab Dempsey, Analyst

Okay. And maybe I could sneak one final quick one in. How did rate growth trend throughout the quarter and in October?

Christopher Marr, CEO

Yes. Rates continue to be very solid over last year and over 2019. In October, we were asking that effective is up right about 29% or so over 2020 and 55% over 2019.

Operator, Operator

Our next question comes from Hong Zhang from JPMorgan.

Hong Zhang, Analyst

So you've kept a pretty tight lid on personnel expense so far this year. I guess just looking towards fourth quarter next year, do you expect that to kind of reverse and trend up just given where wage pressures are?

Christopher Marr, CEO

Thank you for the question. Yes, we have faced challenges with hiring, which is something that affects not only our industry but many service industries. We have consistently focused on offering a competitive rewards package for our store teammates, which means we generally provide higher pay and benefits compared to others in our field. So far, we haven’t made significant changes to our overall compensation, but we are monitoring hiring trends and making adjustments as needed. Looking ahead to next year, we will need to consider how inflation develops—whether it is temporary or long-lasting. While there are specific market challenges, overall, our goal is to retain our valuable employees by providing a comprehensive rewards package that is competitive. In short, I believe that personnel expenses will inevitably increase as we enter 2022, and we will concentrate on what measures we can take to manage or limit that growth.

Hong Zhang, Analyst

Got it. And I'm not looking for guidance, per se, but just even if you end the year at a flat year-over-year occupancy compared to 2020, you still be, call it, 300 basis points higher than where you were going into COVID. Just given where kind of move-in and move-out trends are, do you expect to retain a portion of that through 2022? Or do you expect to kind of give it all back?

Timothy Martin, CFO

Yes, boy, it's hard to answer that question. Even with your preamble that you were trying not to get into '22 guidance, I'm not sure how to talk about that question. The reality is occupancies are contagious; they continue to be unseasonably high. I think we have been, as an industry, all of us on our side of the table or your side of the table have underestimated the strength and quality of the demand of the customer that has come to us here since the beginning of the pandemic. All of these are considerations as to how we think about the sector and how we think about our projections for next year. Occupancy is only one part of the equation.

Operator, Operator

Our final question comes from Spenser Allaway from Green Street.

Spenser Allaway, Analyst

Amongst your peers, we've heard mixed reviews on existing rates compared to market rates today. I was just wondering if you could provide some color on whether you've caught up with market rates across most of your portfolio? Or is there still some room to kind of catch up here?

Christopher Marr, CEO

Yes, Spenser, this is Chris. So specifically related to in-place customers versus where we are pricing for a new customer?

Spenser Allaway, Analyst

Yes.

Christopher Marr, CEO

Yes. The move-in rate continues to be in that kind of 6% to 8% range higher than the in-place customers.

Spenser Allaway, Analyst

Okay. And then can you give us an idea of how much of the revenue growth during the quarter was driven by the ECRIs versus those higher move-in rates that you were just speaking about?

Timothy Martin, CFO

Spenser, we don't typically get into trying to break that out, but one thing that's fairly predictable is you can see how much of the revenue growth comes from occupancy. Everything else is in that mix of a combination of the things that you're talking about, we haven't historically broken it out.

Operator, Operator

We have no further questions. I will now hand back to Christopher Marr for any closing remarks.

Christopher Marr, CEO

All right. Thanks, everybody, for participating in our call and wrapping up the self-storage earnings season with us. It has been a spectacular earnings season, to say the least. It's been a spectacular year for our industry. It's been 27 years since I participated in my first call. This year has been the best I've ever had the fortune to participate in from a self-storage perspective. We are quite bullish on the industry as we move into next year. Thank you all for joining us, and we look forward to talking with you at the end of the year. Be safe.

Operator, Operator

This concludes today's call. You may now disconnect your lines, and we thank you for joining.