Thank you all for standing by and welcome to the Extra Space Management First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. As a reminder, today’s program is being recorded. And now, I’d like to introduce your host for today’s program, Mr. Jeff Norman. Please go ahead, sir.

Thank you, Jonathan. Welcome to Extra Space Storage’s first quarter 2023 earnings call. In addition to our press release, we have furnished unaudited supplemental financial information on our website. Please remember that management’s prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the Company’s business. These forward-looking statements are qualified by the cautionary statements contained in the Company’s latest filings with the SEC, which we encourage our listeners to review. Forward-looking statements represent management’s estimates as of today, May 3, 2023. The Company assumes no obligation to revise or update any forward-looking statements because of changing market conditions or other circumstances after the date of this conference call. I would now like to turn the call over to Joe Margolis, Chief Executive Officer.

Thank you, Jeff. And thank you, everyone, for joining today’s call. We have had an exciting couple of months, and a lot has happened since our fourth quarter earnings call in late February. Operationally, occupancy remained very strong through the first quarter, ending March at 93.5%, our highest first quarter result outside of the COVID years. Our strategy to maintain high occupancy through the winter allowed us to sequentially increase rates to new and existing customers through the first quarter, driving same-store revenue growth of 7.4%. Same-store expenses were lower than expected due to normalizing payroll expense growth, as well as year-over-year savings from repairs and maintenance and property taxes. As expected, our same-store NOI growth rate moderated sequentially from the fourth quarter due to an exceptionally difficult 2022 comparable and was modestly ahead of our internal projections at 8.7%. We have also been busy on the external growth front. We continued to grow our third-party management platform with net additions of 44 stores. We acquired six stores primarily in joint venture structures. We originated $53 million in bridge loans. We started our external growth phase of our remote storage strategy, approving three remote model acquisitions, two of which are in our primary markets. Subsequent to quarter-end, we closed the second preferred investment with an affiliate of SmartStop in the amount of $150 million. And of course, on April 3rd, we announced a strategic merger with Life Storage through a leverage neutral all-stock deal. We believe this combination will produce an even more formidable portfolio, team, and platform with over 3,500 stores across 43 states. We anticipate that there are at least $100 million in annual run-rate synergies with this transaction that neither company could have created on their own. So far, everything is on track to successfully complete the merger in the second half of the year. And as we continue to refine our integration plan, we are even more confident that we can achieve at least our stated synergies. Further, there are additional potential growth drivers and synergies not captured in the minimum target of $100 million. These include additional expense savings due to increased scale, a lower cost of capital, a 50% increase in data, which could further improve property performance, a larger pool of properties to evaluate opportunities, such as expansion, redevelopment, and solar installation, and finally, broader industry relationships, which will provide greater reach and scale to offer potential products and services and build our acquisition pipeline. We are working hard to complete the pending merger, and I appreciate the efforts of the teams from both companies and the way they have remained focused on driving the existing business as we enter the busy leasing season. I would now like to turn the time over to Scott.

Thank you, Joe, and hello, everyone. As Joe mentioned, we had another good quarter, beating our internal FFO projections by $0.04. The beat was driven by better-than-expected property net operating income, lower G&A, and higher management fees and tenant insurance. Interest income and interest expense both came in modestly lower than modeled, generally offsetting each other. Achieved rates to new customers have been improving sequentially since bottoming out in November. In January, year-over-year rates improved to approximately negative 14%; in February, they were negative 11%; and in March, they were negative 3%. We did see lower rental volume in March at those rates. And in April, our pricing algorithms dropped rates modestly with average achieved rates in April closer to negative 7% year-over-year, contributing to higher rental volumes in April. Turning to the balance sheet, we completed a $500 million bond offering of five-year notes with a coupon of 5.7%. We used the proceeds to reduce our revolver balances to less than $100 million at the end of the quarter, leaving over $1 billion in revolving capacity. We reduced our floating interest rate exposure to 22% of total debt, net of variable rate receivables. Shortly after the announcement of our proposed merger with Life Storage, S&P Global updated our rating to CreditWatch positive, confirming its view that the proposed transaction is credit-enhancing, given the increase in scale and potential synergy opportunities. We reaffirmed our guidance ranges for same-store growth expectations and core FFO, which do not include the impact of the proposed merger with Life Storage. We made modifications to our 2023 outlook to capture the SmartStop preferred investment, delays in bridge loan closings, the impact of our bond deal on interest expense, and other adjustments to tenant insurance in G&A. Property net operating income in the first quarter was modestly ahead of our expectations. As we progress through the leasing season, we will monitor achieved rates to new customers, rental and vacate trends, web traffic, and top-of-funnel demand before revisiting these guidance ranges after the second quarter. As mentioned on our fourth quarter call, our guidance assumes positive same-store revenue growth for and throughout the full year. It assumes the growth rate moderates more quickly in the first half of the year due to exceptionally difficult first half comps, troughs in the summer, and modestly reaccelerates late in the year. Much of our NOI growth is offset by the first-year headwind of our investment in non-stabilized properties, which carry approximately $0.23 of dilution, the modification of the NexPoint preferred investment, and higher interest rates. While each of these headwinds slows our 2023 growth, we believe they will result in stronger long-term growth rates over a multiyear period for shareholders. We’re off to a great start in 2023. We believe storage as an asset class is among the most resilient in the REIT space, and that the sector will continue to produce healthy, albeit moderating year-over-year growth. We believe our operating platform and highly diversified portfolio will become even stronger through the Life Storage merger and are well positioned for another solid year. With that, operator, let’s open it up for questions.

As a reminder, to ask a question, please press star one on your telephone keypad. And our first question comes from the line of Todd Thomas from KeyBanc.

I just wanted first to ask about occupancy in April. If you could talk a little bit about any post-quarter updates there, where you stand year-over-year and just talk about rental demand coming out of March a little bit in greater detail.

Yes. Our occupancy at the end of April increased about 30 basis points. At the end of April, we were at 93.8%. So we actually are in a good position moving into the rental season. We saw good rental activity during the month of April.

Okay. And within the guidance framework, where would you expect to see occupancy kind of peak in June, July? It seems like the quarter-end occupancy, which was about 10 basis points below the quarter average was a little unusual from a seasonal standpoint. Are you pleased with the occupancy improvements that you’re seeing, or is it a little bit below what you were anticipating? And, yes, if you could just talk about what you expect in terms of the peak during the rental season?

Yes. So, as we did our guidance, we focused obviously on revenue, but in that number, we do assume that occupancy is a negative delta compared to last year, less than 1%, you’re up against two of the toughest years, the last two years with the COVID peaks. But there is a slight negative headwind with occupancy throughout the entire year. It’s pretty consistent.

In your updated guidance, you expect the dilution from C of O and value-add acquisitions to change from $0.25 to $0.23. Can you explain what is causing this adjustment? Is this change related to your guidance for the remainder of the year, or does it reflect an increase in the full-year dilution compared to the initial estimate?

It’s actually an improvement of $0.02 compared to initial guidance, and it’s from two things. Leased up properties are filling up faster, and then it assumes that the timing on a couple of the C of O and acquisitions is bumped back slightly.

And our next question comes from the line of Michael Goldsmith from UBS. Michael, you might have your phone on mute. Moving on, one moment. Our next question then comes from the line of Juan Sanabria from BMO. Your question, please?

Joe, I think you mentioned at the top the remote storage acquisitions. Could you just talk a little bit about what you’re seeing early days there, and what the opportunity set could be going forward? And any thoughts about how that could tie in with the Life Storage, recognizing it’s early days there?

I don’t know if everyone’s having this problem. We have a very bad connection. Could you repeat the question, please? We couldn’t hear it here.

Sure. Is that better?

A little bit. Yes.

Just curious, Joe, you talked about the remote storage investments in the first quarter…

We can’t hear.

I'm curious, Joe, you mentioned remote storage acquisitions in the first quarter. What are the early learnings and what does the opportunity set look like? Additionally, do you see any connections or expansion opportunities related to the pending Life Storage transaction? What are your broader thoughts on what this could mean for you?

It’s a great question. So with respect to the opportunity set, I think it’s masked, right, the number of small stores in our market that we traditionally would not look at for acquisition, because we could not efficiently manage them without 100% on-site management, which is huge. And not only existing storage but just vacant space, we can turn into storage that is small. And then, we will undertake an effort to go through the Life Storage portfolio and see which of their stores would be candidates for this type of different management model. So, it is an exciting opportunity set that we will look at.

Is there a different margin that these remote storage spaces are capable of generating?

I think the margin is not different, but the efficiencies gained by managing them through the remote platforms make the margins acceptable. You can get to the right margin, because you have the reduced expenses, if that makes sense.

Yes, it does. And then just curious, you talked about and seemingly are very confident on the synergies from the pending LSI transaction. I was hoping maybe you could just unpack a little bit what’s driving that increased enthusiasm post the transaction being announced?

Well, we’re certainly learning more about the opportunities within the Life Storage portfolio, and the synergies we could gain by combining that portfolio with ours. I’ll give you just one simple example. In our underwriting, we assumed we would need to have six new regional offices. We’ve now gone through everything and we’re going to end up with four regional offices. So, that’s just one example of many incremental savings that we think we can achieve. And we also become more and more confident on the revenue synergies as we learn more and more.

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

Just trying to understand if there are any indicators you've observed in the markets or regionally, especially with the recent risks surrounding the banks, particularly the regional banks. Is there anything you're noticing at this point?

Samir, we only picked up about the second half of your question. Could you repeat the full question?

I was inquiring about any reactions from existing customers regarding price increases, especially in light of recent headlines about regional banks facing issues. Can you provide insights on markets where you might be observing a decline in occupancy or an increase in bad debt? I'm trying to understand if there are any negative feedback or pushback from current customers related to the price raises.

So, it’s a good kind of health-of-the-customer question. And to answer specifically your question, we have not. We peaked out at about 800 basis points greater move out from customers who received the ECRIs than those who didn’t. And that has trailed back down towards the more normal rate and it has stabilized in a number that’s a little higher than normal, but our ECRIs are a little higher than normal. So still a very manageable number and justifies the program. But, we also see signs of health in the customer in our very low bad debt under 2%, and willingness of customers on the demand side. The strength of demand, which frankly isn’t as good as it was during the COVID years, but if you look at demand statistics compared to pre-COVID years, it is pretty comparable. Demand is still strong in this sector.

Okay. Got it. And I guess, for Scott, just as a second question, I know in the last earnings call, you spoke about expense pressures that you could face this year. I mean, you’re doing about 3.5% growth in the first quarter. Maybe talk us through kind of what you’re expecting for expense pressures? And maybe what are you seeing so far sort of year-to-date?

Our payroll expenses are developing as anticipated. We expected a return to a more moderate growth compared to the previous year, and we recorded a 3.9% increase in the first quarter. We anticipate this moderation to continue throughout the year. Regarding other significant expenses, our property taxes actually provided us with a benefit this quarter, as we were in a negative situation, but we do not expect that to be the case for the rest of the year; we see it as an inflationary increase. Another positive aspect this quarter was lower snow removal costs; given our location in Utah, we did not foresee that happening, but it turned out advantageous for us. Looking ahead, we do expect some potential pressures on other expenses; we will renew our property and casualty insurance on June 1st, and we anticipate a notable increase, similar to what many are facing in the industry.

And just as a follow-up, what is the size of it? Can you quantify that as we consider it from a modeling perspective?

We’re still in the early phases, but it’s definitely double digits, and could be significant. The other expense item that ran at 11% in the quarter is marketing, and we’ll use that as needed throughout the year, if we find that we find positive returns on our marketing spend and we can spend that instead of cutting rates. Obviously, that’s the first area we’ll look.

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

Maybe first just on your same-store pool breakouts. Can you help us better understand the outperformance of the 2023 pool relative to the 2022 pool, especially given that occupancy was higher in the 2022 pool?

Yes. Your benefit comes from adding properties that are finishing the final stages of lease-up and those properties either came from C of O properties or acquisitions. And so as they stabilize, rates typically continue to outperform the same-store pool. Our definition goes back to our IPO of our same-store pool, and that’s 80% occupancy, or we have to own them for a year. So, we do see some benefit. If you look at the three pools in our subs, and each year, it gets a little slower.

Okay. No, that’s helpful. And then, I guess on the acquisition market, just kind of curious, what are you guys seeing as far as volumes and cap rates? And how should we be thinking about it the rest of the year? And I guess, as an adjacent one to that, I mean, how is it impacting your bridge lending program?

Good question. So, volumes in the transaction market are significantly down. There’s not a lot of distress in the self-storage market, so sellers don’t have to sell. And if they don’t get the price they want, they don’t sell. So, there’s a significant bid-ask spread. The deals we do see trade all seem to have some unique story. Not sure there’s enough of a market to tell you what cap rates are because everything seems to be unique. And unfortunately, our bridge loan volumes were slower in the first quarter than we expected. Now, that being said, there is some seasonality to this business. If you look back at the three or four years we’ve been doing this, we always end up closing the most loans or proving the most loans in the second half of the year. So, we hope we follow the same pattern, but we were a little slower than expected in the first quarter.

And our next question comes from the line of Michael Goldsmith from UBS. Your question, please?

Can anyone hear me?

We can hear you now.

My first question is about the trends this quarter. You mentioned that street rates decreased from 14% to 3% between January and March, then went back up to 7% in April. Many of your peers indicated that March was particularly tough. Can you share your observations on the demand side in relation to your rate settings, and how the overall demand environment in March affected the situation in April?

Yes. I don’t want to overstate the difficulties of March, right? I think we pushed a little harder with rates than maybe we should, which is fine, right? That’s what the algorithm should do. They should try to find that point of resistance. And we went from minus 11% in February all the way to minus 3% in March, and we did see that there was some weakness at that level and the systems brought things back, and we’re recovering. So yes, March wasn’t the best month in our last four months. But overall, the last four months have been strong. It’s been good for us. As Scott says, we’re overperforming our expectations.

And my follow-up is related to the bridge lending program. Can you provide a little bit more color on just kind of the reasoning why deals may have been falling out? I would think this would be a good environment for bridge lending. And sort of related to that, there was a nice pickup in the third-party management net stores that you added. So, can you just talk a little bit about the appetite for kind of independent players looking for third-party management in this environment? Thanks.

With regard to bridge loans, there are a few factors at play. First, there's seasonality, as I previously mentioned. Additionally, a couple of deals we had already signed term sheets for and collected commitment fees on were ultimately dropped, with the borrowers deciding against honoring the commitments. We also experienced some delays with a few other deals. This reflects normal volatility in the business, and we anticipate a stronger performance in the second half of the year. On the management side, we had an excellent quarter, acquiring 11 stores from NexPoint as part of our strategic partnership, along with 37 other stores. Churn in our management sector was minimal, with only 4 stores lost in the quarter, largely due to the slow transaction market, and one of those we transitioned into a joint venture. We are off to a strong start in our management business and expect continued success in the second quarter. One advantage of having multiple growth drivers is that if one is experiencing slower growth, another may be performing better, helping us achieve overall enterprise growth.

Can you provide more specifics on why some of the bridge lending deals would be dropped? Is it a reflection of the self-storage environment or the lending environment and the appetite for others to lend? I’m trying to understand the factors surrounding that bridge loan program.

So, some of our bridge loans are commitments to issue the loan upon completion of construction, right, because we won’t lend until the property has a CO and is operational. And when the project gets built and the CO is issued, if the owner has a different plan, maybe he sells the property instead of borrowing it or maybe he finances it some other way, they have the option to walk from their commitment fee and not take the loan.

And our next question comes from the line of Ki Bin Kim from Truist.

So first question, your New York City Metro area same-store revenue decelerated a little bit further than your portfolio average. I’m not sure what was the cause. If it is a comp issue, or if you’re seeing additional pressures in the new supply deliveries in Northern New Jersey, but any kind of color you can share would be helpful.

I think those certainly are both important factors to that. I think you’ve circled that, Ki Bin.

In regard to the LSI merger and the synergies you've mentioned, much of the focus has been on achieving synergies from the LSI portfolio. However, I would like to ask you to consider a different view. What are the potential benefits of the combined company in terms of enhancing the overall NOI and closing the margin gap with your larger competitors?

What was the gap in terms of margin?

Yes.

Margin comparison is complex because it varies significantly between companies. For instance, a company with a higher insurance deductible might pay less for insurance but assume greater risk. Each approach has its merits and impacts margins differently. Additionally, margin calculations depend on what costs are accounted for at the store level versus general and administrative costs. Therefore, comparing our margin directly with that of our largest competitors may not yield an accurate picture. I appreciate your question regarding potential additional synergies in our overall portfolio beyond the numbers we've provided. We do expect these synergies to exist. For example, with our district managers currently overseeing about 17 stores each, the distribution of stores in different cities can lead to inefficiencies and extra travel costs. As we expand and reduce the areas that each district manager covers, they can manage more stores, which lowers the number of district managers needed and enhances efficiency. There are many such synergies we anticipate achieving that aren't reflected in our current figures. Additionally, we are exploring the impact of a second brand to see if the revenue generated will exceed the costs associated with it, and we are optimistic about finding a successful solution there as well.

And, Joe, you talked about the benefit of having more data, but there’s obviously a diminishing return to that because this 50% more data doesn’t mean you’re 50% better. So, can you just talk a little bit more about that and what the upside looks like from a more tangible standpoint?

If you spoke with our data scientists, they might not agree with that perspective. They always want more data. However, I understand your point; it’s not a direct correlation, but there is definitely an advantage. One key benefit is the speed at which we can achieve statistically significant results. We can conduct tests more rapidly and implement the best solutions faster because having more data creates statistical significance more quickly.

And our next question comes from the line of Ronald Kamdem from Morgan Stanley.

I have a couple of quick questions. First, regarding the tenants who are engaging through online or mobile channels, after a few years and several quarters post-COVID, have you observed any behavioral differences compared to tenants who are shopping in-store? Is their behavior similar or is there a noticeable difference?

So, we’ve always observed differences in tenant behavior depending on what channel they come through, both in terms of what’s an effective tool to capture that tenant and what their behavior is in terms of unit size, length of stay, and other factors. And we’re constantly refining the differences in our different channels that are the results of those learnings.

Great. Can you provide more details about the negative growth in property taxes? Thanks.

That’s primarily appeals that we won during the quarter then revised numbers going forward. So it really relates primarily to prior periods as you win those appeals from prior periods.

And our next question comes from the line of Michael Mueller from JPMorgan.

I guess a couple of questions. First of all, going forward, should we think of the bridge loan program and balances as kind of going up and down based on acquisition opportunities, or should we really be thinking about that business as being completely independent regardless of what you’re thinking about the acquisition markets?

I think the latter. I think our capital position is such that we can fund bridge loans that we feel are good deals and do so in a capital-light manner because we can sell the A notes and not restrict ourselves from good acquisition opportunities because we’re making bridge loans and vice versa.

Got it. Okay. And second question, I apologize if it was discussed before. But part of Scott’s comments I think were a little garbled, at least on my end. But can you touch on the percentage of customers that have been in place over a year and over two years? And if you’re seeing any degradation in that ratio?

Yes. So, if you look at our customers that have been with us for more than two years, that number is now in the upper 40s, about 47%. Customers that have been with us 12 to 18 months, that’s in the low 60s. That number has actually come down some. So, long-term customers, beyond two years is increasing. That midterm customer has actually come down a little bit.

And this does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Joe Margolis for any further remarks.

Thank you. Thank you, everyone, for your time and your interest. I want to thank the LSI team for their great cooperation, professionalism, and efforts over the past many weeks. I’ve been very impressed with every individual we have interacted with, how they’ve handled themselves, and I’m very grateful. I also want to assure our shareholders that while we are spending a lot of time preparing for this merger and it’s time-consuming and a significant effort, everyone at Extra Space Storage remains focused on the fundamentals of our business, which is driving performance in our stores. Thank you very much. I hope everyone has a good day.

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.