Earnings Call Transcript - CUBE Q3 2022

Operator, Operator

Good morning. Thank you for attending today’s CubeSmart Third Quarter 2022 Earnings Call. My name is Florham, and I will be your moderator for today’s call. All lines will remain muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. It is now my pleasure to pass the conference over to our host, Josh Schutzer, Vice President of Finance. Mr. Schutzer, please proceed.

Josh Schutzer, VP of Finance

Thank you, Florham. Good morning, everyone. Welcome to CubeSmart’s third quarter 2022 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 references 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.

Chris Marr, President and CEO

Thanks, Josh. Welcome, everyone. Thanks for participating in our third-quarter call. I’d like to start off by thanking and recognizing all of our CubeSmart teammates, who led by example and demonstrated genuine care and service to our customers during the hurricane. Thankfully, all of our teammates are safe, and we are working diligently to repair the physical damage that we experienced. I know all stakeholders of CubeSmart are proud of our truly world-class customer service teams, and we are deeply appreciative of all their hard work. Turning to the quarter and business, I would say it was a very positive quarter across all segments of our company. Our markets are experiencing the expected gradual return to more normal seasonality, albeit at a slower pace than we would have expected as we entered the year. So that’s a positive. While conditions have normalized, the baseline is so much higher, and operating metrics and cash flows are significantly above pre-pandemic levels. If you look at a few facts comparing same-store in the third quarter of 2022 to the pre-pandemic third quarter of 2019, our occupancy is up 130 basis points, our asking rates are up by 36%. The percentage of our customers who have been with us for more than two years is up about 640 basis points, and the percentage of our stores impacted by new supply has declined by about 15%. Our customer behavior continues to be quite positive. Our receivables and write-offs in the third quarter have continued to normalize but still remain at or below our Q3 2019 levels. Turning to look at specific major markets, the MSAs in Florida continue to be very strong. Given the timing, the third-quarter results did not see any impact from customers as a result of the hurricane; however, overall demand trends during the quarter were very solid. The New York MSA benefited from a relatively easier comp comparing to the third quarter of 2021, and consumer demand trends remain very solid. The Washington, D.C. MSA continues to battle with new supply, and it is certainly weighing on results. Overall, as embedded in our guidance for the balance of the year, we continue to normalize and the quarter-over-quarter comps become more challenging. We expect same-store revenues to decelerate across all of our markets in Q4 and throughout 2023. The highlight of our investment activity during the quarter was significant shareholder value delivered through the sale of the assets in one of our joint ventures. Acquisition activity was muted during the quarter, and we expect it to remain so for the balance of the year as buyers and sellers are in a period of price discovery. Our balance sheet is in excellent shape, with plenty of capacity and low leverage, and we believe this sets the table nicely for us to take advantage if and when opportunities are presented to create accretive external growth. Certainly, economic conditions are unsettled; CubeSmart is lean and agile with a great balance sheet and an experienced management team who has been cycle-tested. Historically, self-storage has been a relative outperformer during a weak economy, and we are confident we are well-positioned entering 2023. With that, I will turn the call over to our Chief Financial Officer, Tim Martin, to go into some more detail about the quarter.

Tim 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 a very constructive backdrop for strong operating fundamentals, all of that in the context of a slow return to more normal seasonality. Our results for the quarter were a bit better than our expectations, leading to an improved outlook for performance through the end of the year. Headline results included same-store revenue growth of 12.2%, expenses grew 4.3%, and NOI growth was 15.4% for the quarter. This quarter marks the sixth consecutive quarter of double-digit same-store revenue and same-store NOI growth. Same-store occupancy levels remain very healthy while continuing to return to more normal seasonal patterns throughout the year, averaging 94.4% in the third quarter and ending the quarter at 93.8%. Same-store expense growth at 4.3% for the quarter was in line with our expectations and continues to be driven by pressure on real estate taxes, utilities, and property insurance, offset by efficiencies in personnel costs and lower advertising spend. We reported FFO per share as adjusted of $0.66 for the quarter, representing 18% growth over last year. On the external growth front, no surprise and not unique to our sector, we have seen a slowdown in transaction activity over the last couple of months given interest rate volatility and macroeconomic uncertainty. That said, our investments team remains very busy underwriting a good number of opportunities. We acquired one store in Atlanta during the quarter for $20.7 million, but from a transactional perspective, as Chris mentioned, the most notable activity during the quarter was related to the sale of the assets in one of our joint ventures. Back in March of 2020, we were looking at a 14-store portfolio that was on the market and determined that it wasn't a great fit for our on-balance sheet investment strategy given the markets and asset quality. But we did see quite a bit of upside that we could capture by bringing those stores onto our platform. So as we have done many times, we looked for a creative solution and ended up acquiring the stores along with a partner, with Cube being 10% of the equity in a structure that gave us a promoted interest opportunity. Roll the calendar forward to this past summer; our partner agreed that it was a good time to bring the portfolio back to market as we had repositioned the assets, pushed rents, and improved occupancy levels. Ultimately, we closed on the sale of all 14 assets to an unaffiliated third-party buyer in August. From a return standpoint for our position in the transaction, we invested $5.6 million back in March of 2020. Ultimately, we received $51.5 million of distributions during the sale in August of 2022, for a net cash to us of $45.9 million over a two-and-a-half year period. Of course, those gains don’t show up in our same-store results, and they don’t show up in our reported FFO numbers. But obviously, it’s a transaction that created meaningful tangible value for our shareholders and provides additional capacity for us to be opportunistic moving forward. On the third-party management front, we added 39 stores in the third quarter and ended the quarter with 663 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. Subsequent to quarter-end, actually just two days ago, we closed on a new expanded revolving credit facility. The size of the revolver grew to $850 million, the maturity was extended to February 2027, and the pricing improved from our standpoint by 17.5 basis points based on our current credit ratings and leverage levels. The new revolver further improves what was already a solid balance sheet position as this pushes the revolver maturity from 2024 to 2027, leaving only about $30 million of maturities in each of 2023 and 2024. Then we don’t have another maturity until the very end of 2025 when our 2025 senior notes are scheduled to mature. The revolver recast went smoothly, and we appreciate the support we received for the relationships we have with the banks in our bank group. Details of our revised earnings guidance and related assumptions were included in our release last evening. Based on strong operating fundamentals, we have increased our guidance range for full-year FFO per share by $0.02 at the midpoint. We also provided an improved outlook for our same-store revenue growth for the year, with a new midpoint of 12.5% growth over 2021 levels, and an improved same-store NOI range with a new midpoint of 16% growth. We believe we are set up well to wrap up a strong 2022 and are well-positioned heading into the uncertainties that 2023 might bring with our high-quality platform, our high-quality portfolio, and our high-quality conservative balance sheet. Thanks again for joining us on the call this morning. At this time, Florham, why don’t we open up the call for some questions.

Operator, Operator

Certainly. Our first question comes from the line of Michael Goldsmith with UBS. Michael, your line is now open.

Michael Goldsmith, Analyst

Good morning. Thanks a lot for taking my question. Same-store revenue growth in the quarter was strong, but decelerated about 180 basis points from the second quarter, which is more than what you saw in the deceleration from the first quarter to the second quarter. The guidance for the fourth quarter implies anywhere between 8% and 9%, so that implies a larger deceleration of the same-store revenue growth. I am just trying to better understand the cadence and magnitude of the deceleration in some of the operating metrics going forward?

Chris Marr, President and CEO

Yeah. Michael, good question. I will take the beginning part of that. Obviously, for 2023, we are not at a point here to delve into details of expectations. But your math is correct, and you are going to see that deceleration embedded in our guidance across all of our markets from the third quarter to the fourth quarter. It’s driven by the fact that while occupancies are down, our expectation as of yesterday was between 85 basis points and 90 basis points below last year at this time. So occupancy has stayed pretty consistent within that range. We have talked before; we don’t guide occupancy. However, our expectation by the end of the year is somewhere between 100 basis points and 150 basis points below last year. So you are seeing that occupancy come down, which causes some of the deceleration. And then from a rental rate perspective, net effective rates for new customers are down high single digits year-over-year during the third quarter across markets, and that has persisted into this week. So the good news is that rate decline has stabilized. You should expect that as the comps become more difficult, especially given last year was an aberration in terms of limited seasonality, deceleration will continue. However, the pace will not be consistent; you will see some quarters trending a little higher than others. But we remain optimistic because we are starting 2023 with high single-digit same-store revenue growth; that momentum should carry into the first quarter and to some degree into the second quarter of next year. We are still working through the details on our expectations as we consider the economic outlook. But macro, if you think about a 20-year average of same-store revenue growth, there’s a case that 2023 results, when considered collectively, could possibly exceed the 20-year average, but certainly, there will be a deceleration from where we have been this year and last year.

Tim Martin, CFO

Just to pile on, Chris, I made a point in my prepared remarks to talk about our sixth consecutive quarter of double-digit same-store revenue growth because I might not get a chance to say that again. Those levels of growth, double-digit for six consecutive quarters, are clearly not sustainable. I think the question is the one on everybody’s mind, delving into 2023 guidance and trying to determine the pace of that. Looking back, as Chris touched on, the pace of deceleration throughout this year has been a pleasant surprise to us, and I think for the balance of the industry.

Michael Goldsmith, Analyst

That’s really helpful color, guys. As a follow-up, we have seen street rates moderate and the revenue growth has recently been driven by ECRI. So I guess the question here is, can we continue to push ECRI at a similar intensity in a more moderating and perhaps pressured street rate environment? Thanks.

Chris Marr, President and CEO

Yeah. That’s another great question, and it ties into the inputs we use to anticipate 2023 as we conduct our bottoms-up budgeting. The health of the consumer remains solid; all key metrics we use to evaluate that stay very positive. As we evaluate the future, one factor will be household savings. Many major bank CEOs predict that those savings could last through Q3 of the next year. If that pans out, while keeping employment strong and reflecting on how storage has performed during prior brief recessions, the industry appears well-positioned to yield results that, on a relative basis, will be favorable. But there is still plenty of data to collect from November and December as we refine our expectations for next year.

Operator, Operator

Yeah. Perfect. Our next question comes from the line of Juan Sanabria with BMO. Juan, your line is now open.

Juan Sanabria, Analyst

Hi. Just hopping on the back of Michael’s last question, just on the ECRIs. How do you think about street rate growth and ECRIs, the interplay between those two? It seems like ECRIs have been larger than average due to the big increase in street rates, but that seems to be waning. So I’m curious if you expect ECRIs to naturally come down due to the closed gap and slowed street rate growth over the next 12 to 18 months? Any color would be helpful.

Chris Marr, President and CEO

Great question, Juan. Typically, we consider street rate growth and existing customer rate increase as decoupled inputs. It's not the only or main contributor but it is a factor in determining rate strategies for specific customers. Several elements factor into determining the most appropriate timing and amounts of increases for each customer, such as their tenure with us, occupancy, and market dynamics. Certainly, the rates neighbors pay or new customer pricing contribute to this analysis. However, the current economic conditions may cause ECRI levels to drop, but as of now, we wouldn't expect it to diminish materially in any given month at this point.

Juan Sanabria, Analyst

Excellent. As a follow-up, could you just discuss geographic performance? Are you getting some benefit from Hurricane Ian in the Southeast, particularly in Florida?

Chris Marr, President and CEO

When considering the hurricane impact, we had limited vacancy in our Florida MSAs prior to the event. The timing suggests we will see customers with wind damage turning to storage, particularly for those whose homes remain structurally compromised, which will likely present a seasonal benefit later this year, particularly through October and November. Regarding the slowdown in the housing market, regions like Phoenix or Tucson accelerated rapidly during the growth in same-store revenue and occupancy, now showing a steeper deceleration compared to more stable markets like Chicago or New York. That’s the trend we are observing right now.

Operator, Operator

Thank you for your question. Our next question comes from the line of Smedes Rose with Citi. Smedes, your line is now open.

Smedes Rose, Analyst

Hi. Thanks. I wanted to ask you about the advertising and marketing side of the business. As trends decelerate into next year and we return to more normalcy, would you expect CubeSmart to start ramping up back to prior levels?

Chris Marr, President and CEO

That’s a tough question because we are making week-to-week decisions based on the return on each invested dollar, especially on paid search. The relationship between new customer net effective rates and any incentives or discounts is critical to understanding the lifetime value of each customer. Our peer's marketing strategies may also affect our own spend. We’d expect to see growth in marketing spend next year, but not necessarily a significant increase. Again, our 2023 planning is still in process, so we will adjust accordingly.

Smedes Rose, Analyst

Okay. I also wanted to ask about supply; it appears the pipeline is ticking up a bit, which surprised me. Are you seeing any competitive supply additions projected for the next year?

Chris Marr, President and CEO

We are not observing that in our top 12 MSAs; rather, we notice delays. Deliveries expected at the start of the year have been pushed out. This delay allows the stores that do enter the market to receive lease-up time before new competition arrives, creating a more orderly environment. Although we anticipate a slight decrease in our estimates for deliveries from 2022 to 2023 in our top markets, the bulk of expected delays should get pushed from late 2023 into 2024. Overall, we find the supply situation to be constructive in key markets.

Operator, Operator

Thank you. Our next question comes from the line of Samir Khanal with Evercore ISI. Samir, your line is now open.

Samir Khanal, Analyst

Thanks so much. Hey, Chris. Good morning. On the expense side, you have certainly done a good job controlling expenses this year. How sustainable are these low expense growth numbers into next year? I am looking at efficiencies that you have done on the personnel side. How much more can you do there?

Tim Martin, CFO

Hey, Samir. It’s Tim. Our expectation is that expense control trends will continue next year. Most pressure points will persist, including real estate taxes and personnel-related costs, especially in staffing certain markets, although not as severe as a year or 18 months ago. We continue to find efficiencies with technology and staffing to offset other pressures, but the lower-hanging fruits for improvements may be nearing their limits. Expect continued pressure on utility costs as we plan for next year, but generally more of the same should be expected over the next six to twelve months.

Samir Khanal, Analyst

That’s great color, Tim. Thanks so much. I also wanted to shift focus to New York; frankly revenue and NOI growth are showing better trends than anticipated. Chris, could you elaborate on the demand side and what supply trends you are observing in that market?

Chris Marr, President and CEO

In terms of demand, as evidenced by the physical occupancy data, we’ve seen a minor reduction in the MSA, with occupancy only dipping 10 to 20 basis points. Throughout the third quarter, our stores in New Jersey and Long Island, Westchester, and the boroughs have gained traction and leased up much better than anticipated. The consumer demand within the MSA and urban areas appears solid. We didn’t experience the same rent growth in 2020 and 2021 as other markets, which results in a slower deceleration. However, we remain cautious regarding Brooklyn and Queens, as there will be impacts when new facilities open in these competitive areas.

Operator, Operator

Thank you for your question. Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets. Todd, your line is now open.

Todd Thomas, Analyst

Hi. Thanks. I wanted to discuss investments. You have been relatively more conservative or disciplined on the investment front. Can you talk about the current pipeline of deals you are looking at and how your underwriting has adjusted?

Tim Martin, CFO

Hey, Todd. It’s Tim. As you would expect, activity has certainly slowed. The middle of summer saw competitive offers, but as we entered early fall, we began observing some deals falling apart or re-trading. That said, we find ourselves in a period of price discovery, where sellers need to adapt to conditions that differ from six months ago. The quality of opportunities we assessed in 2022 has been below that of 2021. In reviewing the performance of potential deals, we are prioritizing properties that align well with our existing high-quality portfolio and are maintaining disciplined underwriting practices. We remain patient, believing attractive opportunities will arise shortly.

Todd Thomas, Analyst

Okay. Have you changed your return requirements? Can you elaborate on price trends, cap rates, or changes in market rent growth forecasts?

Tim Martin, CFO

Yes, the process of underwriting has evolved significantly. The earlier simplicity of underwriting storage facilities has given way to complexities amid the current variability in capital markets and pricing dynamics. Our return requirements have indeed shifted, taking into account the cost of capital, whether equity or debt. We’re still seeking high-quality, complementary infill opportunities. Luckily, we maintain low leverage levels and ample capital availability, allowing us the flexibility for long-term investments without pressure from daily stock price fluctuations. Our approach will remain disciplined, while we remain patient for attractive opportunities that are likely to emerge in the coming months and quarters.

Chris Marr, President and CEO

In terms of asking rents, net effective rates for new customers in the quarter registered a decrease in high single digits as of our assessments this week. As we navigate through the year, the growing challenge posed by the comps from the previous year makes forecasting increasingly complex. This will require a more granular analysis and asset-level consideration.

Operator, Operator

Thank you for your question. Our next question comes from the line of Lizzy Doykan with Bank of America. Lizzy, your line is now open.

Lizzy Doykan, Analyst

Hi. Good morning. Thanks for taking my question. I wanted to ask about the recently extended revolving credit facility. I’m wondering what you are noticing in terms of financing conditions and your relationships with lenders?

Tim Martin, CFO

It’s a normal practice for us to recast our facility amid typically less volatile times; however, we began the process earlier due to uncertainty concerning the market’s direction. We maintain strong, longstanding relationships with a high-quality bank group, making our recasting smooth and timely. While navigating increasingly challenging financing conditions, we are pleased to have secured favorable terms, extending our maturity schedule while mitigating risk in these uncertain times.

Lizzy Doykan, Analyst

Great. Thank you. I wanted to inquire about your joint venture partnerships and how you assess capital allocation. What makes the most sense, and does opportunity influence your approach?

Tim Martin, CFO

Our strategy has been well-defined around constructing the highest-quality portfolio in premium markets. Opportunities for acquiring stabilized assets that align with our criteria are prioritized; however, we have successfully leveraged co-investment vehicles for early-stage lease-up stores on occasion. This model allows us to limit dilution while taking advantage of identified growth opportunities. The recent exit from one such arrangement exemplifies our ability to maximize value through meticulous management and successful store repositioning. We retain flexibility in our investment approach moving forward.

Operator, Operator

Thank you for your question. Our next question comes from the line of David Balaguer with Green Street. David, your line is now open.

David Balaguer, Analyst

Good morning. I wanted to touch on the New York market again. You mentioned that occupancy trends have shown resilience while rent growth has been comparatively slower. Is this indicative of differences in customer behavior in urban vs. other markets?

Chris Marr, President and CEO

I believe customer behaviors, including usage frequency and overall demographics, are variances we see across the industry. Urban customers tend to engage with our services regularly, which nurtures more stable occupancy. Overall, across major urban markets, the demand dynamics have maintained a positive pace despite recent trends in occupancy metrics.

David Balaguer, Analyst

Given occupancy dynamics, do you expect resilience in rent growth relative to cooling trends in other markets?

Chris Marr, President and CEO

Yes, I think the stickier nature in urban environments will likely result in less pronounced rent declines compared to other markets.

Operator, Operator

Thank you for your question. Our next question comes from the line of Ki Bin Kim with Truist. Your line is now open.

Ki Bin Kim, Analyst

Thanks and good morning. I wanted to ask about supply growth in New York City. Data providers show the supply growing by about 19%, but that seems incongruous with your commentary on supply risks in the market. Can you clarify this discrepancy?

Chris Marr, President and CEO

Data reports often consider broader MSAs that include areas where we don’t operate, leading to discrepancies in views of supply dynamics. Our positioning in high-density urban boroughs means we monitor localized developments closely. We remain cautious in monitoring specific competitors entering saturated markets but are optimistic about how we can manage through any arising challenges.

Ki Bin Kim, Analyst

Thanks. I have another question about expenses, particularly in Florida and Texas. We see property taxes climbing, and I wanted your thoughts on what to expect in those markets concerning asset expenses in 2023?

Tim Martin, CFO

We anticipate property tax increases, especially in high-growth areas such as Texas and Florida. As we finalize assessments for 2022, we'll aim to provide guidance in the next quarter regarding anticipated costs moving forward, but overall, we expect upward pressure in those areas.

Chris Marr, President and CEO

If we assess real estate tax trends over the last several years, they have remained consistent, and we don’t anticipate major deviations in the near future.

Ki Bin Kim, Analyst

If I could squeeze in one last question, what are the promote opportunities in your JVs going forward?

Tim Martin, CFO

Many of our joint ventures include some form of promote, whether it favors us or our partner, and generally speaking, our ventures that involve development often place the promoting interest with our partners. The structure's commonality facilitates our ability to leverage our involvement to capture value throughout our investments.

Michael W. Mueller, Analyst

I just have one question about the percentage of customers that have been in place over a year and over two years. Any material changes?

Chris Marr, President and CEO

For customers over a year, the changes have been minimal. For those over two years, it has increased around 5% comparing year-over-year.

Operator, Operator

Thank you for your participation. This concludes the CubeSmart third quarter 2022 earnings call. You may now disconnect your lines.

Chris Marr, President and CEO

Thanks everybody for a very good call. I appreciate the interest and the questions, and enjoyed sharing our thoughts with you. The team is in good shape. We have the appetite to find external growth, the balance sheet capacity to execute, but we will remain disciplined and focused on finding opportunities that are accretive. Looking ahead to 2023, the changes in debt capital markets and potential economic conditions may create attractive opportunities for us, and we are ready to leverage them. Internally, we are confident that storage and Cube will continue to perform well, and our portfolio is well-positioned relative to achieve that performance. Thank you all for your attention. I look forward to speaking with many of you at NAREIT and again when we report at the end of the year and present our expectations for 2023. Thank you again.