National Storage Affiliates Trust Q3 FY2020 Earnings Call

Greetings, and welcome to the National Storage Affiliates' Third Quarter 2020 Earnings Analyst Call. Please note, this conference is being recorded. I will now turn the conference over to our host, George Hoglund, Vice President, Investor Relations. Thank you. You may begin. We'd like to thank you for joining us today for the third quarter 2020 earnings conference call of National Storage Affiliates Trust. Now that the presidential campaigning is over, we'd like to remind you that Self Storage is available to save those Biden and Harris signs for another run in 4 years. And if Donald Jr. ever pursues a campaign, those Trump signs and t-shirts may be worth storing away too. In addition to the press release distributed yesterday, we filed an 8-K with the SEC containing our supplemental package with additional detail on our results, which may be found in the Investor Relations section on our website at nationalstorageaffiliates.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties, including uncertainty related to the scope, severity and duration of the COVID-19 pandemic and the actions taken to contain or mitigate the direct and indirect economic impact. The company cautions that actual results may differ materially from those projected in any forward-looking statement. For additional detail concerning our forward-looking statements, please refer to our public filings with the SEC. We also encourage listeners to review the definitions and reconciliations of non-GAAP financial measures, such as FFO, core FFO and net operating income contained in the supplemental information package available in the Investor Relations section on our website and in our SEC filings. On the line with me here today are NSA's CEO, Tamara Fischer; COO, Dave Kramer; and CFO, Brandon Togashi. Following prepared remarks, management will accept questions from registered financial analysts.

Thanks, George, and thank you, everyone, for joining our call today. I'll begin by acknowledging our pros and our many team members who worked so diligently to deliver our strong third quarter results and to provide us solid momentum for continued improvement in the fourth quarter and into 2021. The quick rebound to slightly positive same-store NOI after just one quarter of negative growth attests to the resilience of the Self Storage sector as well as the strengths of our portfolio and our PRO structure. We are benefiting from increased customer demand for storage driven by a handful of factors, which include: The timing of our peak leasing season shifted to later in the year given the pandemic-related restrictions on movement earlier in the year and increased customer demand as a result of pandemic and recession-related needs, including working from home, which is causing people to clear out a room for a home office and spending more time on household projects, in general. Remote learning is likely driving the need to clear space for home classrooms. A variety of circumstances, including financial hardship, are causing people to double up or move back to a parent's home, placing their furniture and other items into storage. We're also seeing that certain businesses are storing inventory and furniture as they create extra open space for social distancing purposes. Finally, there is a migration shift to suburban, secondary, and tertiary markets that has benefited our portfolio, which is heavily weighted in those markets. This increased demand accelerated over the course of the third quarter throughout October and continues into November. Our core FFO per share increased 10% in the third quarter compared to the third quarter last year. This growth is primarily driven by a combination of our ongoing robust acquisition volume, which is consistently accretive to FFO per share and the internalization of our SecurCare PRO in April of 2020. Our outstanding performance, despite pandemic-related economic turbulence, gave us the confidence to increase our third quarter dividend to $0.34 a share, representing growth of 6.3% year-over-year. As you saw in our release, we also reinstated full year 2020 guidance, which Brandon will address in more detail. However, I'd point out that the top end of our guidance on core FFO per share of $1.68 is the same as the top end of the range in our pre-COVID guidance. The midpoint of our reinstated 2020 core FFO per share guidance is above analyst consensus and represents 8% growth over 2019. In the context of a pandemic and recession, this serves to remind investors and analysts of the fundamental strength of the Self Storage sector and the benefits of both our differentiated PRO structure and our exposure to secondary and tertiary markets. On the supply front, we've seen completions trending down on a year-over-year basis, while an increase in abandoned projects is reducing the forward pipeline. We already forecast that total deliveries will steadily decline through 2024. However, we think we'll continue to face headwinds from new supply in Portland, Phoenix, certain submarkets in Dallas, and West Florida. Fortunately, though, the current boost in demand is alleviating some of that pressure, especially in Portland. On the acquisitions front, transitional activity is strong, and we currently have a solid pipeline of about $300 million of properties under contract or LOI. We expect to close nearly half by year-end, and it's also worth noting that these pending acquisitions will put us somewhere near the middle of our original pre-COVID acquisition guidance. During the third quarter, we acquired 4 wholly owned properties for a total investment of $24 million. Subsequent to quarter end, we acquired 2 additional stores valued at $9 million. Three of these assets were from our captive pipeline, which remains a strong source of acquisition opportunities for the future. We are extremely well positioned to take advantage of additional acquisition opportunities with full capacity on our revolver, following our private placement of $160 million of pending proceeds from our forward equity offering and OP equity that serves as attractive acquisition currency. We're encouraged by our third quarter results and the momentum we felt early in the fourth quarter. Things have clearly moved in the right direction, which gives us the confidence to reinstate our guidance for full year 2020 and also gives us optimism heading into 2021. I'll now turn the call over to Brandon to discuss operating results and balance sheet activity.

Thank you, Tammy. Yesterday afternoon, we reported core FFO per share of $0.44, which represents an increase of 10% over the prior year period. As Tammy mentioned, this growth was fueled by a combination of strong acquisition volume over the past year and accretion from the internalization of SecurCare. For the third quarter, same-store NOI increased by 0.2% over the prior year, driven by flat same-store revenues and a 0.4% decline in property operating expenses. Same-store occupancy averaged 91.1% during the third quarter, an increase of 100 basis points compared to the same period in 2019. This occupancy improvement was offset by an average rental revenue per occupied square foot that decreased 1.4% year-over-year. One nuance to point out is that the rental revenue per square foot metric includes auction, admin, and late fees, which accounted for approximately 90 basis points of that decline, with the remainder attributable to rental rate declines. Similar to last quarter, same-store OpEx growth benefited from diligent cost control measures across the board. Specifically, personnel costs declined 2.7% as we optimized staffing hours early in the quarter, with those expenses starting to normalize toward the end of the quarter. Utilities declined 4%, partially attributable to the benefits from our LED lighting initiative, and repairs and maintenance costs decreased 2.4%. These favorable expense controls were partially offset by property taxes that grew 2.2% from the prior year period. Next, let me give some color on the positive trends that continued in October. Move-in volume continued to be higher year-over-year, while move-outs continue to be lower, which drove same-store occupancy at the end of October to 92.4%, which is up 420 basis points compared to the end of October 2019, and up 50 basis points sequentially from the end of September. This is an all-time high level of occupancy for our same-store portfolio. As for Street rates, they turned positive in October, just under 1% year-over-year versus down about 3% in Q3. Our customer acquisition strategies are clearly proving effective at capturing demand while we remain disciplined on starting rate and discounts. Now as Tammy noted, with only 1 quarter of the year remaining, we've reinstated full year 2020 guidance, which includes positive growth for both revenue and NOI in our same-store pool. For full year 2020, we expect the following: core FFO per share of $166 to $168 or 8.4% growth over the prior year at the midpoint; same-store revenue growth of 0.75% to 1.25%; OpEx growth of 1.5% to 2%; NOI growth of 0.25% to 1%; and wholly owned acquisitions of $400 million to $500 million. Additional guidance assumptions are outlined in our earnings release. I would like to highlight that we have a challenging year-over-year expense comp in the fourth quarter, primarily due to favorable property tax adjustments last year, which will mute same-store NOI growth for the quarter. But importantly, the midpoint of our revenue range implies growth of over 2% for the fourth quarter. These positive expectations should set us up well for continued strong performance in 2021, assuming the current fundamental recovery is not derailed by a resurgence of COVID infections or material impacts on our business from the economic recession. Now turning to the balance sheet. In September, we entered into an equity forward sale agreement to issue 4.9 million common shares for proceeds of approximately $160 million. We have 6 months from the time of the agreement to settle the forward, and we plan to use proceeds primarily to fund acquisitions. Further evidencing our access to multiple sources of capital, during the third quarter, we issued 182,000 shares of common stock through our ATM program at an average price of $34.36 per share for gross proceeds of $6.3 million. We also issued $3.4 million of OP and SP units in connection with our acquisition activity. Subsequent to quarter end, we funded our previously announced $250 million private placement, which extends our weighted average maturity to 6 years, lowers our average fixed rate borrowing cost, and replenishes the capacity on our $500 million revolver. Our balance sheet is well positioned with only $4 million of debt maturing through 2022, healthy access to multiple sources of capital, and a net debt-to-EBITDA ratio of 6.0x at the end of the third quarter, down from 6.3x at the end of the second quarter. The strength and flexibility of our balance sheet positions us well to take advantage of the pickup in acquisition activity we're seeing. We remain committed to delivering our investors stable cash flow from an outstanding property type combined with disciplined external growth through accretive acquisitions. Thanks again for joining our call today. Let's now turn it back to the operator to take your questions.

Our first question comes from Neil Malkin with Capital One Securities.

George, first off, with your comment about the storage facilities, maybe you should check to see if there's any missing mail and ballots in there.

Yes. That's something we can focus on.

People worry about that creating some significant issue.

Yes, I hear you. So first one, you just mentioned, I think, Brandon, that it's about 2% implied growth for the fourth quarter. I'm just wondering if you could maybe elaborate a little bit about what the assumptions are. I'm assuming the occupancy higher year-over-year will help. And I imagine, is it the renewals being in full force, accelerating Street rate growth, any of those things, if you could walk through, that would be great.

Yes, Neil, I mean you pretty well captured it all there, but I'll try to add some color. I mean, the cadence of revenue growth as we went through Q3 was such that we were negative to start the quarter and ended positive to give you that flat growth. And so we have a very solid trajectory going into Q4. I spoke about the occupancy at the end of the month for October, which is an all-time high. It's certainly the peak for 2020, and we're typically declining in occupancy sequentially at this point in the game. So it's really those things, which I think you summarized, but just reinforcing here that we're seeing Street rates, as I mentioned, have turned slightly positive in October. So that's in lockstep with the velocity of leasing. And right now, we're just not seeing any signs of it abating. So we're very, very optimistic about Q4 and heading into 2021.

No. I would agree. I think what you touched on is important, and we're happy with rental velocities. The move-outs are remaining muted as well. So we think that's a positive sign. And Neil, the team is very focused on what we can do with in-place rate changes and looking at Street rates.

And Neil, I guess the one other thing I'd say is that we talked last quarter about the various ways that we've been restricted. But by and large, across our portfolio, there's very few geographies where we're restricted on things. You still have some price gouging and rate restrictions or caps, predominantly in California. So we're dealing with that. The state of Oregon for the entirety of Q3, we still had restrictions on the ability to charge late fees and run our auction process. But starting in Q4, some of those activities can resume. And so that also plays into the color commentary on October and going forward.

Got you. All right. And then another question I had is just based on credit card info about the people who are moving in. Does anything point to, maybe, accelerating in migration from some of those higher-priced coastal cities now that working from home is very widely accepted? Any commentary or anything that you've discerned when looking at that just to maybe see the trends or how or where people are moving, that would be great.

We've certainly heard the stories, and we've seen some of this happen anecdotally. There's nothing substantial in our credit card data indicating a tremendous amount, but in states like Florida, Phoenix, and Nevada, we've observed some increase from the inward migration into those areas. However, in my opinion, nothing has significantly tipped the scales based on the credit card data we are analyzing. All the narratives are there, as Tammy mentioned in her prepared comments, including the various factors related to the pandemic and some of the trends we've observed.

Okay, I appreciate that. Regarding the LOI, the acquisitions in the portfolio you have lined up, could you discuss the pricing and the composition in terms of portfolios, one-offs, and pricing related to those aspects?

Sure. Neil, this is Tammy. Yes. So we have about $300 million of deals in the pipeline, either under contract or under LOI moving forward contract. We saw a little bit of a flurry of activity. We thought it might have to do with potential changes in tax law, but the activity continues, so we're encouraged by that. For us, it's mostly one-off deals. There are a couple of smaller portfolios. And I think we do have an opportunity to look at any portfolio that hits the market. But pricing is right around the 6 cap range, I'd say. For some portfolios, it's a little bit lower than that and one-offs, especially on assets that come out of the captive pipeline a little bit higher than that. So that's kind of the long and short of it.

Our next question comes from Smedes Rose with Citi.

I wanted to ask you for more details about the percentage changes you observed in move-in and move-out activity during the quarter. It seems like there may have been a slowdown in move-out activity. Do you view this as part of a normalization process as we return to a more typical environment? How should we consider occupancy trends moving forward?

It's a great question. I agree that move-out activity is becoming more normal as we saw coming out of the third quarter, and October has shown a bit more improvement. While it's still somewhat muted, it is trending towards normalcy. The encouraging aspect is that rental velocity remains very high, which is a positive sign. I believe rental velocity will continue to be strong, and I do agree that move-outs will gradually approach normal levels as we move through the end of this fourth quarter and into next year.

Okay. And then you put in the guidance for this year. So will you now be reinstituting guidance going forward?

I don't have any reason to think that we wouldn't. I mean that's something that we have done since our IPO. And based on everything we know right now, Smedes, I would fully expect that we'll guide out for 2021 with our year-end earnings release in February.

Okay. Fine. Tammy, I wanted to ask you about the recently traded Simply Self Storage portfolio. It seems like it would have been a good addition to the assets you purchased earlier. Was the size of that deal too large for the company to consider, or was it more about the pricing? I would be interested to hear your thoughts on this.

Not at all. I mean, I think it's safe to say that we have an opportunity to look at any portfolio that hits the market. And certainly, that would look like a great portfolio. The pricing would look, to me, was quite aggressive. And for us, it's a matter of remaining disciplined and acquiring assets and portfolios that are accretive over the long-term for our shareholders.

Do you see institutional capital coming in when you're looking at smaller deals? Or is it mostly in these kind of larger portfolio-type transactions, just sort of thinking about people who are coming to the table as you're trying to get acquisitions done?

We're seeing more institutional capital, really, transaction-to-transaction. I think that our PRO structure gives us some opportunities to see deals that others may or probably don't see, and that gives us an advantage in the acquisitions market. To a certain extent, some of the markets that we've been focused on over the years are not as appealing to the institutional capital, but it's definitely competitive. There's no question about it.

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

Just curious on the acquisition funding, how you're thinking about funding that given where your balance sheet today is and your willingness to kind of use the equity at this point and/or lever up to effectuate this transaction.

Juan, it's Brandon. Thanks for the question. So we've positioned ourselves throughout this year to be ready for exactly what we're seeing this fourth quarter and going into '21 with the pickup in acquisition volume. We did, as I mentioned in the opening remarks, get funding on our private placement transaction, which takes down the revolver balance to completely undrawn today. So we have $500 million on the revolver. We have the $160 million equity deal yet to fund, and we have through March to take that down. So putting it in relation to the $300 million of acquisition activity, Tammy spoke about, that will be equity funded by about half. And then we'll certainly use that revolver. And then going into '21, it'll be the same strategy that we've stated. We run a net debt-to-EBITDA range of 5.5 to 6.5x. We've been within that through this year and expect the same going forward.

Great. And then just a question on the deals you have sourced. Were those to the PRO structure, the $300 million that you referenced?

It's a combination of assets coming from our captive pipeline, assets identified and sourced by our PROs, and assets underwritten by our corporate acquisitions team. It's distributed fairly evenly, except when looking at portfolios that, from a volume standpoint, begin to occupy lost space.

And then just finally, just on the rent bumps to existing customers. With the occupancy being at all-time high levels, are you more likely to push kind of the boundary there and see if you could become more aggressive, maybe taking people up to Street or even maybe higher kind of quicker? Or just your thoughts on that would be appreciated.

That's a good question. We're evaluating all of those scenarios. We have some test programs that have been pretty aggressive. We certainly feel like it's a good opportunity for us to maximize as much as we can. We did a good job coming out of the no increases in the second quarter. We used the third quarter to really work hard at trying to get caught up, and that's carrying a little bit into the fourth quarter. But yes, I think we're looking at all those pieces and then we're pushing where we can.

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

Just first, following back up on investments. I'm just curious, in terms of the funding those acquisitions, is the forward equity to be used sort of dollar-for-dollar with the first $150 million or so that you expect to close before the end of the year, is that how we should think about funding those? Or will you look to settle those, sort of, unevenly over the next several months?

Yes, Todd, this is Brandon. I would consider it more like a 50% match. This aligns well with the $300 million that Tammy mentioned and the $160 million. I can tell you that with the current volume we are seeing, there are definitely sellers who are eager to close in 2020, mainly due to potential tax law changes. We are working to facilitate that, provided we can navigate our normal diligence process. Therefore, some of the expected funding will depend on how successful we are in closing by the end of December, while some of it may extend into January.

Okay. And then it sounds like you're still seeing stabilized deal pricing in the 6% range, which is about where you've been buying for some time now, it seems. Are you starting to see some cap rate compression at all on single assets? And what do you think the premium is for a portfolio today? What's the difference in pricing look like?

I think we are definitely experiencing some cap rate compression, and it's very specific to the market. In larger and denser markets, cap rates are slightly lower, while in some secondary and tertiary markets, we are still seeing cap rates above 6%. The portfolio premiums seem to be in the range of 75 to 125 basis points. That's our current perspective.

Okay. And then just a question on the simply transaction, I guess, and there being sort of a new entrant in the space. There have been many new entrants in the space over the last several years, quite a bit of capital coming into Self Storage. But do you think that the landscape changes at all now? Do you think it becomes more competitive for acquisitions for you to compete with, with sort of a platform buyer and sort of Blackstone and the mix here?

Blackstone has been acquiring assets and investing in self-storage for a few years now, and we are accustomed to seeing them with the new platform they have acquired. They may be more aggressive, but ultimately, they are buyers like the rest of us. They do have the advantage of using more leverage, and it's clear they will be aggressive. However, I believe our PRO structure will continue to provide us with an advantage, especially paired with our focus on secondary and tertiary markets. We will remain focused, and perhaps next quarter we can provide a clearer answer based on what unfolds in the coming months. While I am not certain about their exact strategy for deploying capital, I think they will aim to close before the year ends, so we may start to see competition with them at the beginning of next year.

Our next question comes from Ronald Kamdem with Morgan Stanley.

Two quick ones from me. Just staying on the acquisitions, just keep beating that dead horse, I guess. But maybe can you talk a little bit more about sort of the pipeline? I know historically, you've only looked at mostly stabilized assets with maybe a few in lease-up. But has that changed at all? And is there sort of a $500 million, $600 million opportunity every year in your markets to do stabilized assets? Or what is that mix? What could that look like sort of going forward, as this environment gets a little bit more competitive?

There are still many assets available for acquisition. If we consider that there are approximately 50,000 self-storage facilities in the United States and around 18% to 20% are managed by the leading four or five operators, we believe there is still substantial opportunity to acquire assets within the $400 million to $600 million range. Our focus remains on stabilized assets, although we are seeing offers that involve non-stabilized assets, and we are open to those acquisitions even though they are not part of our core strategy. Additionally, a unique aspect of our company is our captive pipeline. We currently have 140 assets valued at about $1 billion, and we feel confident about the opportunity to acquire those assets over time. By combining our strategy for external growth through third-party acquisitions with our captive pipeline, we believe we can achieve our targets within the $400 million to $600 million range.

Great. That's helpful. And then just circling back to some of your opening comments, I think, provide some really helpful color. Just thematically about maybe what's driving the strength and demand that we've all seen, whether it's small businesses or work-from-home or people leaving the cities and so forth. My question is really, as we sort of think of next year, presumably, when we have a vaccine and things normalize, how is the company thinking about which of those demand drivers are sort of a one-time versus which could go away? And the other piece of that is, what's the market maybe not thinking about that could be a potential demand driver, again, in a more normalized environment?

That's a great question. As hopefully, we get a vaccine and then we start to go back to what the new normal is, I don't think there's any guarantee that everybody goes rushing back to work. Work-from-home may stick. Certainly, you might see classrooms come back to normal. You would see the restaurant owners and some of these small businesses be able to pull some of their items back. I like the diversity in our portfolio. And so we don't particularly think we have one particular market that's going to go quickly rushing back or you're going to see a significant occupancy drop because of where we're at and where we're located in the country. So we do think there's some stickiness here. We believe that new people have gotten introduced to Self Storage, who have never used it before, understand the convenience of it, and understand the benefit of it, which we think is a long-term positive. It's hard to know how soon it's going to come and how quick it's going to come. But I think for us, we're pretty happy with where we're positioned. And if you look at the housing market, the job market, and some of this relocation that's going on in the country, I think that also favors our portfolio. And in the long term, through next year, I think, helps us as we move forward.

Our next question comes from Ki Bin Kim with Truist.

Just sticking with the whole PRO commentary, what are the prospects of internalizing any PROs over the next year?

Ki Bin, this is Tammy. Back at the time of our IPO, we talked about the notion that maybe half of our PROs would be retired within 10 years. So that would put us out to, call it, 2025. This year, with the internalization of SecurCare, our largest PRO, I think what they did, what SecurCare did, is they demonstrated how it could work and how it would play out to other PROs. Right now, today, I can't tell you that we have any indication that any other PROs are planning to retire. But I will say the success of the SecurCare internalization shows some leadership and some opportunity. But no way of predicting when it might happen. Well, I guess I would wrap up by saying, I don't have any reason to think that what we thought back at the time of the IPO won't still happen, maybe half of our PROs will be retired by 2025. But again, no clear line of sight on that today.

Okay. And in terms of the existing customer rate increase program, I was wondering if you could just put it in perspective. I know you and all the other companies have reengaged it. But there's a little bit of a timing element, right? When you send it out, it doesn't click in, I mean, it doesn't turn on right away. So in the third quarter, I guess, from the eligible pool of customers that should have gotten one, how many actually got one? And if that actually converted to cash flow.

Good question, Ki Bin. It's Dave. We definitely focused on this in the third quarter, particularly in the latter part. In July, we were just testing the waters, and in August, we ramped up our efforts in September, fully committing to putting everything in place and implementing our rate increases. Looking ahead to the fourth quarter, we expect the revenue aspect to become more significant as it typically takes about 35 to 40 days for rate increases to be fully implemented. We have been both aggressive and assertive. Based on occupancy levels and the metrics we're observing, we believe we will continue to be quite aggressive in the fourth quarter, which has historically not been a strong period for IPRC. So, that's how we see it. We're actively exploring and believe there are still opportunities in the fourth quarter.

There are no further questions at this time. I'll turn the call back to Tamara Fischer for closing remarks.

Thank you. And now that the bell has rung, the party is over. And I'd like to thank everyone again for your interest in NSA. And to reiterate, we're pleased with our third quarter results and the fact that Self Storage continues to demonstrate its resilience in the face of challenging times. We're optimistic about the fourth quarter, and we're looking forward to 2021. Be safe and healthy, everyone. Bye.

Thank you. This concludes today's conference. All parties may disconnect. Have a good day.