Ladies and gentlemen, thank you for standing by and welcome to the Public Storage Third Quarter 2020 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode. And the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Ryan Burke, Vice President of Investor Relations. Ryan, you may begin.

Thank you, Christy. Hello everyone. Thank you for joining us for our third quarter 2020 earnings call. I'm here with Joe Russell and Tom Boyle. Before we begin, we want to remind you that aside from those of historical fact, all statements on this call are forward-looking in nature and are subject to risks and uncertainties that could cause actual results to differ materially from those statements. The risks and other factors could adversely affect our business and future results as described in yesterday's earnings release and in our reports filed with the SEC. All forward-looking statements speak only as of today, November 5, 2020. We assume no obligation to update or revise any of the statements whether as a result of new information, future events or otherwise. A reconciliation to GAAP of the non-GAAP financial measures we provide on this call is included in our earnings release. You can find our earnings release, SEC reports and an audio replay of this conference call on our website at publicstorage.com. [Operator Instructions] With that, I'll turn the call over to Joe.

Thank you, Ryan, and thanks for joining us today. We had a solid quarter and now we'd like to open the call for questions.

Thank you. [Operator Instructions] And your first question is from Alua Askarbek of Bank of America.

Good morning everyone. Thank you for taking the questions. So just looking at the transactions market, it seems like there was a good amount of activity in 3Q and you guys alluded to that during your 2Q call. But there was also a surprising amount of portfolio deals. Can you give us some color about what you're seeing in the market currently and any of the opportunities going forward? And then also any color on cap rates and the recent 30 property portfolio deal under contract right now?

Okay. Sure, Alua. The acquisition market clearly has opened up. We've been tracking it through the pandemic and spoke about the early months where a number of sellers paused and were reticent to bring properties into the market. But we've clearly seen many more do the reverse where they've looked at this environment as an opportune time to bring assets into the acquisition arena. A number of things are continuing to fuel that. One is it's still a very good time to do a trade. There's very low interest rates, availability of capital, and a lot of capital sitting on the sidelines that has been anxious to get into the storage sector. The storage sector continues to perform well, so there's been a window of opportunity that we've seen increase over the last month, particularly in the quarter that sets us up well to have a very active 2020. We continue to look for assets that are well positioned from a location and quality standpoint that meet our requirements relative to location and opportunity to round out presence, whether they're in our prime core markets or other markets where we want to add additional product. We're also encouraged to have a sizable single portfolio under contract that we think is a great set of assets to bring into the portfolio. This portfolio consists of 36 properties across 15 markets, in 13 different states. 24 of the assets are open and operating, but they're relatively new, with an average age of two to three years, I would call them Class A properties in very good locations. We're very excited to bring them into the portfolio knowing that we're looking for opportunities to lease up properties due to good customer demand. Therefore, they'll be easily integrated, and we anticipate closing the first 24 of those assets by the end of the year. With that portfolio, we are also well poised to capture and look for interesting growth and performance opportunities, as we have 12 additional properties in various phases of development that will be completed through 2021. Again, these are Class A well-located assets, and we're really pleased by our ability to capture that total portfolio. Another interesting part of the portfolio is that this is an off-market deal, which speaks to the level of relationships we continue to build across the storage sector. This relationship has evolved over a longer period of time, and we're continuing to look for those opportunities where they may play through. Beyond the large portfolio that I just discussed, we're also seeing a number of smaller opportunities which we've been encountering throughout 2020 and frankly what we saw in 2019. So with that, we're poised to have a very strong acquisition year this year. From a cap rate standpoint, with the amount of capital and the cost of that capital, we're really not seeing any easing of cap rates and will have to continue to monitor that. We clearly have good access to capital, and our own cost of capital continues to be very attractive. Tom can give you a little color later in the call about what we see relative to funding through either the preferred market or the debt markets. But we're clearly seeing good opportunities to put that capital to work and we are continuing to hunt for additional acquisitions going forward.

Great. Thank you. And then just a little bit on rent increases to existing customers. I know in the beginning you guys noted that you're not going to be increasing rents as much as you did in prior years. But with, I guess now cases are going up, is there an expectation of when you might be able to get back to your historical norms?

Yeah. Well, let me provide a little bit of context, this is Tom, around what we've been doing through the quarter on existing tenants and what we think the outlook is. As we noted in the 10-Q, we did resume and we discussed on the last call, we resumed existing tenant rate increases in the third quarter. We did so initially on a test basis and have since increased the volumes of those rental rate increases that we've sent out as we've grown more confident in the performance of our existing tenants. Since we didn't send any increases in the second quarter, we had a backlog of potential tenants to increase rents on in the third quarter, and we did send those catch-up rental rate increases. As you noted, those increases went out with a lower magnitude of increase given the overall mindfulness of our customer base in this crisis environment, which remains very dynamic, as well as state and local price regulations in many of our markets. We expect some of that to continue as we move through future quarters, certainly navigating this dynamic healthcare environment is unpredictable. We would expect that the existing tenant rate increases will continue to be a modest drag on in-place rent growth as we move forward. Stepping back, customer activity has been solid, and I just highlighted that the existing tenant performance has been good. That's across the board. Collections are better, payment patterns have accelerated, move-outs are down, lengths of stays are extending, and new customer demand is solid. So we're seeing good trends there, and overall move-in activity has been good. But existing tenants will continue to be a modest drag going forward.

Great. Thank you.

Thank you. Your next question is from Smedes Rose of Citi.

Hi, thanks. My question is really just about move-out activity. Your portfolio has generally had an upward bias in occupancies, but you noted that move-outs have slowed. I'm wondering as things normalize, do you have a sense of how much occupancy might be higher based on the slowdown in move-out activity? I'm trying to think about how your occupancy may change over the next few quarters if things get back to normal? And what might you do to encourage some of those customers to stay, I guess?

Sure. I'll provide a little context around the move-out activity, because it has been one of the surprises as we move through this pandemic period. As we rewind to April and early May, we had move-in volumes and move-out volumes that were lower. But as we moved into May and June, and then into the third quarter, move-in activity has increased, but move-out activity has remained muted. Dissecting the geographies, customer tenures, and customer segments with lower move-outs has been broad-based and is clearly being driven by the current healthcare environment. We've discussed in the 10-Q and the MD&A that the likelihood at point that rate of deceleration will moderate, and we talked about in previous calls that in other recessionary environments, we've actually seen the opposite play out with higher move-outs given consumer stress. However, we've not experienced that at this time. In fact, it was pretty consistent through the third quarter. Each month in the quarter saw a 12% to 15% decline in move-out volumes. As I mentioned, this has been consistent across geographies, customer tenures, and customer segments. So we have a broad-based decline in move-outs, paired with good collection activity and acceptance of the rental rate increases that we've sent to date. So, we're encouraged by the existing tenants, and we are paying close attention to what could play out as we move in this dynamic environment.

And yeah Smedes, what's advancing right now is that month by month, we're seeing more sustained and consistent consumer behavior. Work from home is additive, which is another factor that we're seeing from survey standpoint relative to customers coming into our portfolio. In markets categorized as urban or high-density, such as the Bay Area where we see system-wide our highest level of occupancies, thousands of employees have been allowed to move out of that market, either temporarily or potentially permanently. They are shifting and amplifying the need for self-storage as they're handling the health crisis and have the flexibility to work either at home or from a different location. We see similar impacts in the heart of New York. The housing market is very strong right now, which has traditionally driven our business. Housing sales are up over 20% year-over-year. These multiple layers of consumer patterns are contributing to a sustained and prolonged need for storage space. We don't know when and to what degree it will shift back to a 'normal environment,' but the sustained activity we are seeing continues to be quite good.

Okay. That's great color. And then, I'm just wondering broadly, have you talked before about what you're seeing on the supply outlook overall? Or are you seeing any changes regarding your last update on nationwide supply dollars in development?

Yeah, not -- I wouldn't say anything to point to that is materially different. We do think that 2020 will calculate to be about a $4 billion set of deliveries across all of our markets in the United States. The anticipated shift down into deliveries in 2021 is projected to be around 15%. So, we could still see that reduction in deliveries, but frankly, it's still high. With continued interest from investors wanting to get into the self-storage sector and the performance that the product type itself continues to have even in this challenging environment, there is still a fair amount of capital that wants to get into the space, whether it's through acquisitions or even development. So, this is something we are keeping a close eye on, but it really hasn't changed much from our previous outlook.

Great. Okay. Thank you guys.

You bet.

Thank you. Your next question is from Spenser Allaway of Green Street.

Thank you. Can you provide a bit more color on what drove the material deceleration of marketing spend in the quarter? And where do you see this trending for the balance of the year?

Sure. So, stepping back on marketing spend, it's been a tool we've used, along with promotional discounts and move-in rates over the past several years, especially in a tough customer acquisition environment due to new supply in many of our markets. We did increase our spend over the last several years and have liked the returns we've seen from utilizing advertising spend across paid search, social media, and television. In the second quarter we had a broad-based advertising approach to attract new customers, and our brand name presence online also gives us a competitive advantage. In the second quarter, given lower top-of-funnel demand, we were more aggressive on marketing spend. As top-of-funnel demand improved moving into the third quarter, we reduced some of that advertising support. But as you note, our advertising spend was up about 8% or 9% in the quarter. We will continue to use that tool as we navigate this dynamic environment, but we did not need the level of support we saw in the second quarter due to improved top-of-funnel trends.

Okay. And then maybe just lastly, we recently saw a large storage transaction with Blackstone acquiring the Simply portfolio. Was this a deal you guys looked at? Can you comment on whether the portfolio would have been of interest to you?

We’re active in all markets and have the opportunity to look at most deals. I’ll comment on the fact that we're highly entrenched in nearly all deals occurring in various types of transactions, both large and small. We're continuously tracking the level of activity. I'm not going to comment on our view and perception of that particular portfolio, but as I mentioned, we are highly entrenched, and our acquisition team is incredibly engaged in both marketed deals and those that are not marketed which points back to the portfolio I discussed earlier.

Yes. I view that transaction as emblematic of Joseph’s earlier highlight on institutional capital looking to invest in self-storage because of its strong performance through cycles. It's interesting to see another institutional player put a significant amount of capital into the sector.

Thank you.

Thank you. Our next question is from Todd Thomas of KeyBanc Capital Markets.

Hi thanks. Tom, helpful color on some of the move-out trends. Can you comment on move-in trends throughout the quarter and through October what the cadence was like? The strength in move-in rates was rather significant, higher than they've been in several years. Did you push move-in rates above market during the quarter given where your occupancy is? Or was that increase more in line with the market rent growth in your view?

Sure, Todd. Stepping back on the move-in trends, we saw initial activity surge in March, followed by a slowdown in April. We entered a recovery phase that we internally term as such in May and June. Then since July 1, we've seen an improvement in top-of-funnel demand. This, paired with reduced move-out activity as I highlighted, means that occupancy has moved higher across nearly all of our markets nationwide. Improved occupancy has reduced inventory levels. We finished the second quarter up about 50 basis points in occupancy, and we finished the third quarter up 200 basis points. As of October, we finished up 230 basis points in occupancy. Both move-in and move-out trends have been positive, with lower inventory allowing us to achieve higher rates. Our move-in rates were up 8.2% in the quarter, and as of October, move-in volumes were up about 1%, with move-in rates up by about 10%. The trends have been consistent with positive demand for storage from both existing and new customers.

Okay. Given the dynamics you just shared, I'm curious about markets like New York and San Francisco, where a lot of workers have the flexibility to work from home and move out of some high-cost markets. Why is that out-migration activity translating into strong demand?

It's a spectrum of different drivers, Todd. Part of the flexibility, for instance, in the Bay Area, is influenced by big employers announcing time frames for not requiring employees to return, not for one or two months, but for six months to a year. Some employees will return, but it may take several months or quarters considering the uncertainty around the pandemic. The extent of these changes can be unpredictable, fortunately. In the Bay Area, our portfolio stands out with limited new supply, and the long-term demand for that space is expected to remain strong. We don't have any specific concerns regarding oversupply. This is indeed a unique situation where demand has shown high levels of activity as we maintain system-wide occupancies of 97% to 98% across the board, which we’ve never seen before. It remains difficult to predict how these trends will evolve or the changes in how employees engage, but we are seeing healthy demand across the entire portfolio.

Yes, Todd. Additionally, in markets like Charlotte, we've seen really strong inbound demand despite the recent challenges due to new supply. Similarly, in the San Francisco Bay Area, while urban areas had seen decline, we see great strength in our lease-ups in San Jose due to a strong regional housing market. We have a well-placed portfolio across the nation, and we're fortified in markets with both inbound and outbound demand.

Right. That's interesting. Are you seeing an increasing demand for larger units due to individuals looking to rent larger spaces for their homes during this time?

Actually, it's the opposite. The strength year-over-year has actually been in smaller spaces rather than larger ones.

Correct. If we consider the demand tied to work from home, it doesn't necessarily mean a complete relocation of an entire house or apartment, but the demand for an extra closet or room. We’re tracking many layers and factors for demand, but overall, it’s solid.

Okay. Thank you.

Thank you.

Thank you. Your next question is from Ki Bin Kim of Truist.

Good morning. Just going back to some of the acquisitions you made in the quarter and fourth quarter, can you provide more color or parameters around yields, at least for your stabilized portion?

Ki Bin, I'm not going to give specifics about the actual yield. I would tell you, it's similar to ranges we've looked for over time, which on a stabilized basis would be around 5% to 6% cash-on-cash yield, or north of that. The portfolio that we'll be closing this quarter has occupancies of about 35%. We see this as a good opportunity to lease up this space based on demand factors rising from these quality Class A assets. We anticipate overall returns will be strong once we get these assets stabilized, which can take anywhere from three to four years.

Okay, thanks. When I look at your same-store revenue, it improved slightly to negative 2.7% from minus 3% last quarter. It's clear that the underlying drivers point towards a much better place, especially with fee-based rates up 8%, better occupancy and similar trends. Could you just provide more details on the transitory nature of the underlying drivers and how that might benefit same-store revenue going forward, especially regarding existing customer rate increases?

Sure. Ki Bin, it's Tom. We previously talked about the cumulative impact of the pandemic, which is likely to continue to affect revenue growth trends as we move forward. Indeed, operating metrics have improved faster than financial metrics, as occupancy and rate equations play out. Occupancy trends improved as a result of a better top-of-funnel both in terms of activity and lower move-out volumes. As you highlighted, and we've spoken about earlier, the existing tenant rate increases are not contributing to improving rent trends given the lower magnitude of increases. However, looking at in-place rents from June 30, we'd seen a decline of 3.1%, which improved to a negative 1.8% as of the end of the quarter. By the way, existing tenants are not contributing to that improvement, showing the negative impact has been offset by improved customer activity and reduced rent roll down. Rent roll down was about 15% in the third quarter of 2019, but narrowed down to about 4% in the third quarter of 2020. Aggregate contract rents recovered, with occupancy and rent combined yielding positive 20 basis points at September 30. Overall, we continue to see strong customer trends through October, leading to better rental income trends.

Okay. Thank you.

Next?

Your next question is from Steve Sakwa of Evercore ISI.

Thanks. Good morning, everyone. Just a quick question on the balance sheet, Tom. You've got about $1.2 billion worth of preferreds that are callable throughout 2021. I'm curious about your thoughts on replacing them with new preferreds, especially since your last deal was sub 4%. How do you weigh this against putting more debt on the balance sheet considering how lowly leveraged you are? Where do you think the comparable 30-year debt issuance would be for you today versus a preferred offering?

So, Steve, you’ve highlighted a good opportunity for 2021, which will likely be another year where we can look for potential preferred refinancing, either through debt or new preferreds. Looking at our preferred balance, we like having around $4 billion preferred within the capital stack; it’s good for business through cycles. There’s an optionality when interest rates decrease over time, allowing us to call them, as we did this year, and you're highlighting the opportunity for next year. Throughout this year, we redeemed about $1.2 billion of preferreds and we haven’t issued that much yet. We were active in the bond market in Europe in January. Financing markets, as Joe highlighted earlier, are as attractive as they've ever been. Preferreds are sub-4% for us today, which presents a fantastic opportunity, and we have great access to debt capital too. As we said in previous settings, we'll consider using both preferreds and debt for incremental financing activity as we move through 2021 for both preferred refinancing as well as for potential acquisition opportunities and development which clearly, as Joe highlighted earlier, is accelerating as we move through the fourth quarter. So, good access to capital, and we'll utilize both. We hope to refinance in 2021 as we've done in 2020 and 2019.

So do you have a sense of where a 30-year bond offering might compare with a preferred offering?

A 30-year bond is going to be cheaper, and a 10-year bond will be even cheaper than that; a 5-year bond will be cheaper still. We have lots of tools in our toolkit.

Okay. On the acquisition front, you guys have looked outside the U.S. in the past, and spent some time in Australia. Joe, I'm curious about your current views on seeking international opportunities outside of the domestic market.

Yes, Steve. We will continue to evaluate both domestic and international opportunities. We have learned significantly from our involvement and success through the Shurgard investment, and we feel over time we can continue to grow both here and abroad. This will depend on opportunities that may arise, both here domestically and internationally.

Great. Thank you.

Thank you.

Thank you. Your next question is from Ronald Kamdem of Morgan Stanley.

Hey, thanks for the time. The first question, circling back on demand, I'm trying to understand the overall demand driver during this period, whether college students, small businesses, or people leaving the city. One question we get is, once the vaccine is here and things normalize, which drivers will remain versus those that might be more of a one-time phenomenon?

That's something we will closely track, as these different demand factors play out. It's hard to predict their sustainability or likelihood to continue after the pandemic. Work-from-home demand has upwardly changed, and many companies are looking to enhance productivity through new remote structures. However, we also must consider that previously, we experienced higher move-outs during recessionary environments due to consumer stress. The future remains unpredictable, but we continue to see good performance. The pandemic has introduced new customers into the storage sector, increasing adoption of storage products. Many of the technological advancements we've deployed into our channels are yielding positive customer responses. About 40% of our move-in volume in the third quarter came from our e-rental platform, which we tested prior to the pandemic. This facilitates a seamless experience; consumers appreciate the simplicity, leading to enhanced utilization of storage units.

Great. My second question is about acquisition metrics. Is there a specific value you’d assign to acquisition opportunities annually for PSA?

It's not as simple as flipping a switch and going on a buying spree. We employ disciplined analytics to inform our capital deployment strategy. This is an opportune moment for us, given our favorable cost of capital and market knowledge, enabling us to optimize capital allocation towards acquisitions, development, and redevelopment activity. Our balance sheet is capable of accommodating significant acquisitions, and we continue to evaluate timing, quality, and fit for all opportunities that arise.

Thanks for that detail.

Thank you. Your next question is from Jonathan Hughes of Raymond James.

Hey. Good morning. Just an extension on Steve's question. What does the Board believe is an appropriate amount of leverage? Given the current range from three turns for PSA to over six at peers, do you feel views on leverage have shifted over the past months?

We maintain a long-term conservative stance on leverage to ensure we can invest through various cycles, and this year demonstrated this notion clearly. Our capacity allows us to raise incremental leverage as we see fit while pursuing acquisition opportunities in the months ahead. Predicting optimal leverage remains challenging, though maintaining a strong investment-grade rating is our goal.

Are there any indications of how much further leverage can be adjusted in the capital stack, versus considering raising common equity, even if it hasn't been done in the past decade?

Common equity is certainly part of our financing toolkit, but using debt and preferred remains cheaper. It provides us suitable resources for strategic opportunities. Equity is an option for financing, but due to our ample capacity with preferreds and debt, we have chosen to focus on those areas.

Got it. Thanks for your insights.

Thank you. [Operator Instructions] Next question is from Juan Sanabria of BMO Capital Markets.

Hi, good morning. Can you discuss the move-out behavior you've seen historically in your cycles? I’m trying to assess how trends might progress once conditions normalize.

We find ourselves in an ongoing situation where consumer reactions are unpredictable and heavily influenced by the current healthcare crisis. Historically, we've seen mid-single-digit move-outs during past recessions, but we can't predict how this crisis will unfold, as each situation varies. We are closely monitoring movement patterns in this dynamic environment.

What is the current average length of stay in your portfolio?

It's about 10 months.

Did you mention that the average occupancy for the portfolio you’re acquiring was about 35%?

Yes, that's correct. The 24 properties that are operating have an average occupancy of approximately 35%. They're relatively new, allowing for significant lease-up opportunities.

Is that set to yield anything currently from an NOI perspective?

No, it requires stabilization before we realize significant NOI, but we are confident in the high quality of these locations which should drive good returns over time.

Thank you.

Thank you. Our next question is from Rick Skidmore of Goldman Sachs.

Good morning, Joe and Tom. A quick question. Operations saw a decline from the second to the third quarter, which is atypical seasonally. Can you explain what prompted this? Looking ahead, do we expect declines or are we moving towards normalized patterns?

Rick, we see opportunities to optimize pressure tied to payroll across the board, which we've been working towards. We are targeting improvements in payroll costs, utilities, and maintenance, driven by initiatives such as transitioning to LED lighting, yielding savings. We’re actively pursuing different avenues to optimize performance and costs overall.

Thank you, Joe.

Thank you.

Thank you. Our next question is from Mike Mueller of JPMorgan.

Hi. Most questions have been answered, but can you provide a quick update on how third-party management has been trending?

Sure, Mike. We currently have 113 properties in the program and added seven this quarter. The ongoing activity and deliveries align with our acquisition activity. This trend matches the interest we have seen from property owners to join our system, enhancing our development pipeline. Most growth originates from new deliveries, adding newly constructed assets to our portfolio.

Thank you.

Thank you.

Your next question is from Jon Peterson of Jefferies.

Thanks. Was the portfolio you’re acquiring derived from your third-party management business, and how is it currently branded?

These properties have their own branding and are not part of our management business.

How should we view the pipeline for third-party management acquisitions going forward?

This represents a natural extension of our business. We are engaging property owners, regardless of their size, to form a larger, more robust management network. The portfolio closing this quarter doesn't originate from our platform, yet we continually seek to develop relationships with one-off owners and larger market participants.

Alright, thank you.

Thank you. You have a follow-up from Steve Sakwa of Evercore ISI.

Thanks. I wanted to circle back on late fees and try to understand how much of the decline was due to the pandemic's impact on customers, and how much was driven by changing payment patterns such as auto-pay essentially lowering the number of customers paying late and thus reduced fees.

Steve, overall customer collections since the second quarter have been strong and persistently remain good through the third quarter. Several factors are leading to lower fees, primarily the late fee structures, as we are charging fewer fees for customers not paying their rent on time due to improved collections. Our receivables are down roughly 30%, and this has not resulted in a significant proportion of late fees. These trends have continued into October and the early part of November as well, showing steady patterns even as government support structures have transitioned.

Would you characterize this as more of a structural change or cyclical? Do you expect this behavior to be a permanent shift?

In the early days of the pandemic, there was concern that government support would drive consumer behavior, influencing payments. However, as we see patterns persist without significant changes in change, we perceive this as indicative of a sustained increase in health among our customer base. We will continue monitoring these patterns closely.

Okay, great. Thank you.

Thanks, Steve.

Thank you. I will now hand the call back over to Ryan Burke for any additional or closing remarks.

Thank you, Christy, and thanks to all of you for joining us today. Have a good day.

Thank you. This does conclude today's conference call. You may now disconnect.