Extra Space Storage Inc (EXR) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the second quarter Extra Space Storage Incorporate Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's conference, Mr. James Overturf, you may go ahead sir.

Thank you Jackie, good morning and welcome to Extra Space Storage's Second Quarter 2006 conference call. With us today are Extra Space Storage's CEO and Chairman of the Board Kenneth M. Woolley, Senior Vice President and CFO Kent Christensen and Senior Vice President of Operations Karl Haas.

A couple of items for me to mention before management begins their remarks. In addition to our second quarter press release, we have also furnished additional unaudited financial information about the operating results for the company's property portfolio on our website at www.extraspace.com. Click on the investor info section and then on the financial reports and the document entitled Q2 2006 supplemental financial information.

Please remember that management's prepared remarks and answers to your questions contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters which are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward looking statements include statements related to Extra Space Storage's development and acquisitions programs, revenues, net operation income, FFO and guidance. We encourage all of our listeners to review a more detailed discussion of the risks and uncertainties related to these forward looking statements that is contained in the company's filings with the SEC and in particular our 10-K ended for the year December 31, 2005.

These forward-looking statements represent management's estimates as of today, August 4, 2006. Extra Space Storage assumes no obligation to update these forward looking statements in the future because of changing market conditions or other circumstances.

I'd now like to turn the call over to Extra Space Storage's CEO and Chairman, Kenneth M. Woolley.

Thank you James and good morning everyone. This morning we sent out our second quarter earnings press release that showed we achieved fully diluted FFO of $0.24 per share for the quarter which was in line with our expectations. Our same store revenue and net operating income growth was strong and we once again showed solid overall portfolio growth in most every region of the country.

It's been over a year now since the acquisition of Storage USA from General Electric. As we move forward, it's becoming more evident that the acquisition has been valuable for the shareholders of Extra Space. The synergies that have emanated from this acquisition, especially on the operations technology and revenue management fronts, have positioned us well for the future and our increased scale continues to be an asset that we can leverage further.

Our expanded team has allowed us to be focused on operations this year and our property level performance has responded positively with increases in occupancy, revenue and net operating income over the same periods last year. Our 103 same store property portfolio, which are all former Extra Space properties, had a solid quarter with a 6.6% increase in revenues and a 7.6% increase in net operating income compared to the second quarter last year. Our NOI growth was suppressed a bit due to uncontrollable increase in property taxes and utilities.

In our search for growth beyond our existing portfolio, we continue to acquire quality properties that meet our criteria. We remain committed to taking a systematic, disciplined approach to acquisitions and sometimes the best acquisition decision we're making is to say no to deals that do not meet our return or quality or market requirements.

The acquisitions market is still very competitive and seller expectations remain high. Even so, we continue to find quality, well located properties that we believe will bring value to the company. During the second quarter, we closed on the acquisition of 8 properties for approximately $58 million at cap rates ranging in the low 7%.

These properties are located in Arizona, California, Kansas, Tennessee and Texas. Five of these acquisitions were what I described in last quarter's call as opportunistic. These properties were previously held in joint ventures with a portion of the debt provided by Extra Space. We were able to convert our interest into equity and extinguish the mortgage balances as part of the transactions.

In addition, just last week, we closed on a property located in California for another $7.3 million and another property located in the Atlanta area for $5.1 million. Including these properties, we've acquired a total of 17 properties for approximately $110.3 million to date in 2006.

Eleven of these properties are off market deals originated through our strategic partners program first established by Storage USA. We continue to see this channel providing further acquisition opportunities into the future. We currently have three properties under contract for $25 million and five properties under letter of intent for $36 million at this time.

Closing on all these deals would bring us to approximately $170 million in acquisitions for the year and place us well in the range of our stated 2006 goal of $150 to $200 million. Our acquisitions goal is to acquire high quality properties in good locations. In some cases, our acquisitions are properties in lease up, which in the first quarter or two of the purchase are dilutive to the REIT on an earnings basis. We're looking at the long range value of our acquisitions and as a result, we're not projecting a huge amount of accretion this year from our acquisitions effort.

Our development program continues to move forward. We completed six properties during the second quarter at a total cost of $47 million. Two of the projects are located in New England, two in Southern California, one in Phoenix and one in Chicago. We have completed eight properties so far this year for a total of approximately $70 million. To provide you more detail in regards to our development program we have provided two tables in our supplementary package available on our website.

As a note, the majority of the development projects from this point forward will be developed on balance sheet. In related news, we've made the decision to combine our acquisitions and strategic partner business development program. This merging of departments will make us more cost effective.

We remain absolutely committed to getting the best performance from the current Extra Space property portfolio. Kent, Karl and I have been traveling the country, looking at properties, talking with managers and holding town meetings. So far this year, we have personally visited over 400 properties and these visits have helped to educate me as the CEO about the nature and quality of our portfolio.

It has helped us personally motivate our management team and it's helped us in projecting forward the attitude of clean and green which is the extra space motto and helped us again in making decisions on our CapEx program. We believe that this has been very helpful to us and I think it will pay dividends in the future as we go forward as a company.

With that, I'd like to turn the call over to Karl Haas, our Senior Vice President of Operations to talk a little more detail about our property level performance. Karl?

Okay, as Kenneth said at the beginning of the call, our properties continue to perform well during the second quarter. The second quarter is a very busy time operationally as everybody knows. Our people did an excellent job and it is reflected in our results.

One of the most comparable views of our performance is to look at same store group of the 103 same store stabilized properties which were wholly owned and held in the REIT before the storage acquisition last July. As in the first quarter, these properties had great performance.

Revenues were up 6.6 and net operating income was up 7.6% over the same quarter last year. We were able to raise occupancy, which went from 87.7% to 88.9, and raise rents to existing and new customers at the same time. For the first six months, revenues were up 6.5% and net operating income up 7.4%.

The combination of Extra Space's best practice technology revenue management and operational processes are having a positive impact on these properties. Expenses on a year-over-year basis for the quarter, our same store properties were up 4.8%, mostly due to property taxes and utilities.

Approximately $170,000 of the property tax increase was attributable to the reassessment on properties purchased in August 2004. If we were able to take this amount out of the same store expense growth, our expense increase would have been in the 3% range and our net operating growth would have been about 8 to 9%.

That said, the properties we purchased are subject to potential property tax reassessments. We can not be sure exactly when the assessment will take place of the magnitude of that reassessment. However, we are constantly tracking this issue and doing our best to budget in a way that reflects most likely outcomes.

The next properties I'd like to discuss are 57 Storage USA stabilized properties that Extra Space acquired in July 2005. As with our same store group, this group of properties also had a good quarter. Average occupancy increased to 86% for the quarter versus 83.5% in the same time 2005 which strongly contributed to revenues being up 5.2% and net operating income being at 9.1% versus last year. For the year, revenues are up 5.6% and net operating income up 8% at the Extra Space Storage USA properties.

Our final group of properties is our entire stabilized group of owned and managed which currently consists of 566 properties. This group includes 185 wholly owned, 339 joint venture and 42 managed properties. The average occupancy was 85.8% in the quarter compared to 84% in the second quarter 2005. For the quarter, revenue increased 5.1% for these properties, expenses were up 3.4% and net operating income increased 6.1%. For the first six months, revenue has increased 5.2% and net operating income is up 5.9%.

Our top performing regions, based on year-over-year revenue growth continue to be Florida, Northern California, the Southeast and Southwest regions. Regions performing below our portfolio average are the Central U.S. and New York/New Jersey areas.

At a more micro level, our top performing MSAs where we have significant presence of properties are Atlanta, Chicago, Dallas, Northern California, Southern Florida and Phoenix. MSA is performing below expectations were Detroit and Philadelphia.

As we continue in the second half of the year, positive momentum remains and it feels to me that we are in stride. We've made impressive progress since the acquisition of Storage USA and I feel very good about where we are right now. We've made marked improvement in many areas.

Our employee satisfaction has increased with top ratings for job satisfaction growing 34% from the beginning of the year. This is a metric that we measure on a regular basis and will use as a benchmark to ensure that we are successful in maintaining and improving employee satisfaction.

The increase or improvement in employee satisfaction I believe has also increased our customer satisfaction. We use an outside third party research firm that has helped us to benchmark our customer satisfaction on all aspects of the storage experience.

This is part of the pulse program that is guided in the first quarter. Right now, Extra Space Customers are rating their experience with us more positively than their previous experience with their peers, 53% of our customers give us the highest rating possible, our closest peers 40%.

When you combine the top two ratings, the difference is even more dramatic. This bodes well for our future return business. Our operational team is strong with great bend strength. We are not the only ones who value and respect our team as shown recently when we lost one of our veteran players to a competitor.

His division is currently being managed, his former division is currently being managed by two of our senior district managers and we have several strong candidates we are considering for his permanent replacement. We expect to have a decision made on the replacement DVT in the next few weeks.

The work on capital improvement campaign of the Storage USA assets is at its peak right now. As of the end of July, signage conversions have been completed at 30% of Storage USA sites. By the end of August, we expect to have the signage completion at over 40% of the sites.

Our current projection completion dates for the conversion of all Storage US signs to Extra Space Storage is October 31st. Our rebranding and capital improvements such as painting, interior signage, roofing and asphalt work are being completed as we speak. Our goal is to complete all the $48 million in improvements in the end of the year, though in all probability we have some carryover into 2007. Once these efforts are complete, we anticipate the annualized run rate for CapEx going forward to be about $0.25 per square foot which is in line with what it has been running in the past.

On the marketing front we're testing advertising in Boston, Baltimore/Washington D.C. area and Philadelphia. This advertising has been running since mid-July and will continue through this week. Initial results have been encouraging with plenty of traffic generated to our website and dedicated 800 numbers. The Boston market has responded the best to date but we are still in the early stages of analysis and will take several weeks before we can understand the full impact of this advertising.

The use of television advertising is something new for Extra Space Storage and is one of the potential advantages of our new nationwide scale. We will analyze the results carefully before making a go forward decision with respect to the roll out of this program into other markets where we have significant presence.

We also expect to roll out a new ExtraSpace.com website next month. This website we believe will be the most technologically advanced in the industry and will provide account information, pricing promotions and rental activity real time for our customers. We continue to see the web as a growing source of customers. There were 15% of our customers indicated that they first learned about Extra Space Storage through the internet. That's up from 11% late last year.

With that, I'd like to turn the call back over to Kent Christensen, our Chief Financial Officer who will comment on our financial results in more detail.

Thanks Karl. Our financial statements covered in this report are for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005. We finished the quarter with 208 wholly owned properties and 348 joint venture properties.

As of the end of the quarter, we also managed an additional 82 properties as part of our property management program. Results for the three and six months ended for June 30, 2006 included the operations of 556 properties, 208 of which were consolidated and 348 of which were held in joint ventures compared with the results for the three and six months ended June 30, 2005, which included the operations of 148 properties, 130 of these properties were consolidated and 18 were held in joint venture.

Total revenues for the three and six months ended June 30, 2006 were $48.5 and $93.9 million compared to $24.6 and $47.5 million for the same periods 2005. Net income for the three and six months ended June 30, 2006 was $3.1 million and $3.8 million respectively compared to a net loss of $1.2 and $1.9 million for the same periods of 2005.

G&A was $8.7 million for the quarter and included $629,000 of non-cash compensation related to the expensing of options and grants. Total G&A for the first six months was approximately $18 million and includes $1.02 million of non-cash compensation expense relating to options and grants.

Our estimate for the full year 2006 G&A remains at $36 million including $1.8 million in non cash expenses. The $36 million is net of our development fees as we consider our development department to be self-funded from the fees built into the costs of the individual development projects.

Our interest expense for the quarter was $13.4 million and was approximately $537,000 higher than we had estimated due to the active usage of our line of credit for acquisitions, higher than forecasted interest rates and the write-off of a loan fee that was refinanced of approximately $190,000.

Our financial position is strong and flexible and provides a solid platform for growth opportunities. As of June 30, 2006 our outstanding debt was approximately $950 million which includes the $119 million of notes payable to trust, approximately $803 million of our total debt is longer term CMBS and has an average maturity of over five years.

Our level of fixed rate debt to total debt is approximately 89.1%. Our debt structure is predominately fixed rate has helped us manage interest expense even in the current rising interest rate environment. Our weighted average interest rate is 5.4 for fixed rate loans and 6.7 for variable loans. The total weighted average interest rate of all of our debt is 5.5%.

Our fixed charge coverage ratio as of June 30, 2006 was 1.91, this was up from 1.63 a year ago and our projected fixed charge coverage ratio for 2006 is 2.01. Our revolving credit facility provides us a versatile source of capital upon which to capitalize on growth opportunities and fund our business.

As of June 30, we had $76 million of capacity in our line of credit, of which $25 million was drawn at a variable interest rate of approximately 7%. We currently have a pool of properties that is not leveraged, that if mortgaged, we could increase our borrowing capacity by about $100 million.

In our earnings release, we reported second quarter fully diluted FFO of $0.24 per share which is in line with our guidance announced in the first quarter conference call of between $0.23 and $0.25. This is 71% higher than in the second quarter 2005 FFO.

Our captive insurance business is performing below our initial forecast. We have not increased rates as quickly as we would have liked and our penetration percentage is running behind. In all, the insurance business contributed about $250,000 less than we expected during the quarter.

In terms of guidance for the third quarter, we estimate our fully diluted FFO per share to be in the range of $0.26 to $0.28 per share. For the full year, we continued to estimate our fully diluted FFO per share to be in the range of $0.97 to $1.01.

Though fundamentals remain positive, we are being marginally more conservative on overall revenue growth while staying well within our stated 4 to 6% growth rate for our stabilized property portfolio. We are also watching interest rate and the performance of our captive insurance business, both of which are currently difficult for us to predict. With that, I'd like to turn the call back over to Ken for some closing remarks.

Thanks Kent. Extra Space Storage property performance was positive and I believe is further proof that the integration of Storage USA properties and business processes have been successful. As I said in the first quarter conference call, our focus this year is on operations and on our properties.

This strategy has paid off in the first two quarters as our results at the same store level are strong. There is, however, continuing integration efforts, particularly in the resigning and re-imaging of all the properties. Many of the properties are still marketed under the Storage USA brand name.

By the end of October, that will all be completed and we'll have one name and one operating philosophy. This we believe will pay further dividends as it will make our customers realize there is only one company, Extra Space Storage. We're expecting even higher NOI growth, however, due to the above average tax increases and utility costs, results were lower than we had hoped.

With all that's been accomplished in the past year, the question is what's next? Complacency is not what Extra Space is about. We continue to grow through development acquisition and we will continue to challenge ourselves to make the most of our scale as the second largest operator in the business.

In my view, we have only just barely tapped the synergies of putting Extra Space Storage together with Storage USA. This is the first year. I see continuing benefits in the years to come of our scale and our size and the quality of our properties.

With respect to acquisitions, cap rates remain very low. However, we believe they are bottoming out and we're seeing more properties come to market. I wouldn't say it's a buyers market yet, but it may become a buyers market. And that will be good for our acquisition efforts.

Our development program is about to enter a new phase, both in scale and structure. Our goal in 2008 and beyond is to develop an average of 20 properties per year. We're beefing up our development team in our core markets as we speak.

From a structural standpoint, the majority of the properties developed by Extra Space from this point forward will be wholly owned. As Kent stated before, we're finalizing the structure of on balance sheet development that we believe will add to the REIT while at the same time eliminating the FFO drag resulting in the three to four year average lease up time from for newly opened properties.

This structure will probably include a harvest strategy for a few selected properties. On July 14, we celebrated the one year anniversary of the Storage US acquisition. It has been a very busy year for us. Not many companies can say they acquired an entity triple their size and improved its operating performance.

I want to thank all of the Extra Space employees who are listening for their tireless efforts this year. I want to close by saying I remain positive about our business. I've been involved in the industry since 1969 and I believe this year is one of the strongest that I've seen.

How long this will continue? I don't know. But I do believe the American consumer will continue to buy things and as long as he continues to buy, he'll continue to create more goods that need to be stored in our storage facilities. Storage is a great business, we believe our company is a great company today, particularly with the combination of Storage USA and we believe we're uniquely structured to take advantage of any level of demand through our dedicated and talented people, our best in class processes and of course the quality of our portfolio.

And in the long run, we believe this will generate long term shareholder value. With that, Karl and Kent and I are ready to answer any questions which you might have.

[OPERATOR INSTRUCTIONS] Your first question will come from the line of Ross Nussbaum of Banc of America, you may proceed, sir.

Hi, it's Christy McElroy here with Ross. Some of your peers are expecting or are already seeing a significant pick up in insurance expense this year. Have you, are you expecting that pick up as well at some point or when do your policies roll?

Christy, this is Kent, our policy expires on October 15th and we have been notified by our insurance carrier that we will be seeing an increase in our insurance also. That will only impact us in the last two and a half months in the year.

We are taking a number of steps already to see what we can do to minimize those increases. But same kinds of increases that Public Storage and Auburn has reported is what we have been told. It appears the insurance companies are trying to recapture some of the losses they have had in the past two hurricane seasons. We don't know now what the full impact of that will be but we would expect an increase that will take effect in October of this year.

Is your estimate for that impact included in your guidance?

Yes it is.

And then your comment in the press release that your guidance assumes a 25 bp increase in LIBOR per quarter. Is that from June 30th so you're assuming a year-end LIBOR of 6%?

Yes.

The CCS and CCU those assets appear to be performing pretty well. It looks like you now have force stabilized. Has there been any change in your expectation for when those shares will be issued and can you just remind us of what that timeline is?

Right now, in fact, in the last two months in May and June, those properties performed at the numbers whereby the, the trigger for the exercise of shares would begin. The program requires that there be 12 months backward looking before anything can happen.

So our estimate of the first that shares would convert would be as of the end of this year, with the quarter ending December 31st of this year, so shares issued early next year. Right now, the information that we've done have very few shares being issued this year but we would expect to begin hitting the numbers so that next year more of those shares are issued.

So, a minimal amount of shares issued in the fourth quarter and then more start to hit in '07?

It would be minimal amount of shares that would be as a result of the fourth quarter's earnings. We have to work with our accountants as to how that would be reported. It could be that some minimal number would be shown in our fourth quarter numbers. But it would be very small if we would get it.

The shares would actually be issued after the fourth quarter numbers were verified so it would be probably in February. We would be the first shares actually issued. But they could be accrued.

They may be accrued.

Okay and then in terms of the low 7s cap rates in your acquisitions properties, can you provide a breakout in the cap rates between the assets you bought from any franchisees or JV Partners and those you bought on a one off basis?

Well, we bought three or four properties that were in lease up that were clearly, cap rates, one of them had cap rates of like 3% on an actual quarter basis and they were diluted, if you consider the capital that was put in at the very time that were done. But they were high quality and their stabilized cap rate were in the high 7s or low 8s.

The other properties, the cap rates ranged from a low 6.5, or 6.6 up to a middle to a high of 7.5 with the average being in the high 6 to 7%, 6.9 to 7. Actual numbers, actual cap rate on a quarterly basis, when we looked at the actual income achieved in the second quarter.

The cap rates for the properties purchased in our, that we bought from strategic partners were slightly higher, slightly better than the cap rates on the open markets. And of those properties, those stabilized properties they were all in excess of 7%.

Okay, so the low 7s, is that a stabilized number?

Well those are stabilized properties.

Okay.

So you're looking down, it's in that range. The, you have to ask yourself, well, what is a cap rate, is it forward looking, is it backward looking, is it current current. We were just looking at based upon the actual second quarter income achieved which may not be represented of the forward looking cap rate which would probably be just a little bit higher during the coming year.

We're achieving sort of 6% annual growth and these properties are the same, so if you add that onto the first quarter, then your, so the actual results of the second quarter, you're going forward for a year cap rate, maybe more closer to 7.2, 7.3.

Okay, that's helpful, thank you.

And your next question comes from the line of John Sheehan of AG Edwards, you may proceed sir.

Thanks, you mentioned the combination of the acquisition group and the strategic business development program. Were there any, are there going to be any combinations or reductions in the senior personnel in those groups?

Yes, [Lee Harcavey] who was heading our acquisitions group has left the company as of July 31st and he was heading acquisitions and Kenneth Woolley who was in charge of strategic partners and was formerly in charge of acquisitions has taken over that department to manage both departments.

Okay, that's what I wanted to know, thanks.

And your next question comes from the line of Michael Knott from Greenstreet Advisors, you may proceed sir.

Hey guys, first of all thanks for the improved disclosure on the pro rata NOI and the development schedule, that's helpful. On the development strategy, can you just help us understand your thought process with respect to on the merchant building side, how you would differentiate between which properties would continue to be held and which properties would be sold just for offsetting the FFO dilution?

We have not yet determined the criteria of which ones would be sold and which ones would be held. But the ones that would be sold would be put into the TRS and would be sold out of the TRS and they would be sold approximately upon completion of construction so that the profits from the sale would be included in FFO.

And our idea is basically to take two or three out of 20 properties per year and sell them that it could counteract or help counteract the negative FFO drag that you get from the lease up of brand new properties. We believe that one of the conundrums or one of the problems of being a REIT is that we're graded on FFO.

On the other hand, is what we're trying to achieve is long term shareholder value. And there's a lot more long term shareholder value and there is more return on investment from building and developing new properties than there is from acquiring existing properties.

But the problem has always been for self storage REITs that the lease up time for new properties can be as long as four years. And as a result, there can be a significant drag; I think this is exhibited by the performance of Sure Guard over the years which struggled with the same problem, particularly in Europe, by not having any FFO but having created a huge amount of value in Europe which is now just barely being realized.

We propose to effectively do this on a modest scale, but to counteract it, and we will as we go forward report the negative drag of the development properties so you can see what it is. We'll also report specifically the FFO gains that we make from the sale of certain development properties.

We haven't started that yet, we haven't sold any properties and we just think, I think our first properties, first two properties have come online and one in Phoenix and one in, where's the other one?

The other is in San Bernardino.

And the other is in San Bernardino, California. So we had two properties that came online in the last quarter which are brand new, which we own 100% of and will cause an FFO drag. It's not very significant yet but in the future, as you get 15 properties and then 30 properties and then 50 properties, it could become significant.

We believe, however, having properties wholly owned on a development basis, gives us a higher quality portfolio, it gives us the ability to locate and decide where the property is going to be and frankly, we think in the long term it will create more shareholder value.

And when will that bifurcation of development start? Was that in '07 timetable?

I'm not sure what you mean by bifurcation?

Well, between folding and selling the development?

I would guess the first developments we sell will be sometime next year, but I don't know when. Maybe second quarter, third quarter next year.

And I guess, this is just for Karl. Just doing some back of the napkin math, it looks like the rental rate increases for the legacy store, maybe in the 5% range versus call it maybe 2% for Storage USA. Can you just help us understand if that math is close and if so why is that the case?

What you're saying is for existing customers and street rates, the increase, the rate increase is higher for the extra space legacy stores than Storage USA?

Just looking at the revenue changes you presented and then trying to back out the percentage change in the occupancy was, just trying to back into it that way.

Yeah, because we've had more opportunity for growth and occupancy at the Storage USA properties and we've been more aggressive on the Extra Space properties as far as rate increases for existing customers. Because we were already doing aggressive increases on the Storage USA existing customers and so the change is more the more aggressive increases for existing customers on the Extra Space portfolio.

Mike, this is Kent, what Extra Space has experienced is that Storage USA with their revenue management team headed by [Sam Ratt] was doing an great job early last year in raising customer rates. And were actually ahead of Extra Space and their ability to push rental increases in their customers.

We've been able to now employ that team's expertise in what we're doing and do a lot more aggressive rental increases on the Extra Space sites this year than we've been able to do at the Storage USA because last year a lot of that was already done.

Okay and what's your pro rata share of what's left to spend on the original cap ex budget for Storage USA?

Our pro rata amount was about $7 million and about half of that has been spent. But again, all of the cash is set aside for all of that in a bank account that was set up at the time of the closing. So there's no funds that Extra Space is having to use to pay for any of the cap ex expenses because the money is already reserved.

Okay and then last question, just on the 2002 developments, just curious, it looks like the second quarter annualized yield is call it 7.3 on the costs you presented? How is that compared to what you underwrote at the time and sort of your target development yield?

You're looking at the 2002 developments and what the current quarter's yield is on those developments?

Right.

Yes, those, our expected yield on the properties has been between 8 and 9%. We're hoping that those properties get up to the 7, the 8 and 9, they are currently at 7.3. We hope that once, we think there's a little more upside to go on those properties, it will get us up to about the 8. Now, second, there's a big difference between the properties, the development properties on the East Coast and the West Coast.

West Coast properties have performed much better at achieving their development yields than the East Coast. And so we're also very focused on the developments that we can do in the future on the East Coast while still looking at the West Coast, our West Coast is where we're focusing, West Coast and Florida.

Okay, thank you.

I think if you look at the 2002 group and you take the East Coast properties, by and large they are not yet mature. It's not that their development yield is off or low, it's that the maturity just takes a lot longer and it won't be probably until next year which is really after the fourth year that you'll see more of a stabilized yield.

Okay, thank you.

And your next question comes from the line of Michael Salinsky from RBC Capital Markets, you may proceed sir.

Good morning guys, I'd like to additionally thank you there for the additional disclosures and on the joint ventures and on the development cycle and that's really helpful. First question, if your results in the first two quarters of $0.44 and at the midpoint of at your 3Q '06 guidance right now of $0.27, that implies about a $0.28 raise in the fourth quarter. Given the additional insurance costs and a little bit of development drag, do you feel comfortable with that range right now?

Yes we do.

Okay.

We've taken a very hard look at the performance of all of our properties and all of our line items in the first two quarters and reforecasted our budget for the last two quarters to determine whether or not our guidance that we have given is achievable.

Second one is then I guess, the add back for amortization of intangibles has dropped off pretty significantly over the past few quarters. I guess as you're looking ahead to the third and fourth quarter, what's a fair run rate for that at this point?

I'll have to, we'd have to get back to you about what the run rate would be. Let me explain the concept and why it has dropped off. The amortization of intangibles is the percentage of the purchase price that's allocated to the tenants rent roles when we acquire properties.

And for accounting purposes amortize those over an 18 month period of time. So all of the acquisitions that occurred in 2004 and 2005 have a very short time frame as toward the amortization. And once those drop off you see obviously the amortization of that go down pretty dramatically.

So with the acquisitions we did when we went public, those have dropped off. And when the amortization of the properties we acquired from Storage USA later on this year drop off that number is going to dramatically fall off. I don't know what the exact number is because I don't have the quarters right here in front of me as to when that drops off.

Let me comment on that further. One of the things that is interesting about this, this is an accounting rule that has been instigated in the past few years. For GAAP accounting, for determining our net income, we have to create this artificial depreciation or amortization of a portion of the purchase price of a property which we allocate to this value of its rent role.

We have done very large acquisitions right after we went public and so we had huge amounts of this amortization which tended to depress our GAAP net income. What's interesting is that it is not the same kind of income that would be considered for tax purposes.

So our taxable income, for analysis of taxes was very different from that. And it is unique to the storage industry and it is in my view ridiculous but it is a ridiculous accounting, the thing that has been thrust upon ourselves, public storage, Sovereign and the rest of the public companies to report it this way and so we have to report it this way. But it is basically accounting mumbo jumbo and nonsense.

Okay, with your development pipeline ramping up over the next couple of quarters, what kind of spreads are you guys targeting for new development as opposed to acquisitions?

New development is probably 200 basis points higher than acquisitions.

Okay and I guess as a final question, with the robust level of acquisitions completed in the first half of the year and development spending expected to ramp up here, specifically on the balance sheet, what leverage levels are you guys comfortable with at this point? I know you guys have about $75 million of cash [inaudible] so?

First of all let me, the way that the verbiage in our conference call reiterated it, we don't have $75 million of capacity, we have about $50 million capacity on a $75 million line, because we used up $25 million of it. But we have another $110 million of capacity by just leveraging properties that are currently not leveraged.

So really our true capacity today is about $160 million of further debt that we could just borrow right now to do whatever we want to do with without going to the general capital markets for some sort of a bond offering. We have reiterated this in the past that we had planned to keep our debt levels under 60%.

When they get into the high 50s, we will consider some kind of equity offering, that will depend on our need at the time. So our comfort level is between I would say 45% and 57% is sort of where we plan to operate the business. Also with respect, when you mention the development yield difference, I just want to point out that the difference between a 7 cap and a 9 cap on value is very substantial.

It's nearly 25% or it's even more than 25%. And when you consider an equity leverage rate of 50% in the REIT, when you create a development project of say $10 million at cost, you create a value stream of $13 million or $12.5 million based on that $10 million investment.

But when you buy a $10 million property that yields you 7%, you haven't really created a much larger value stream. You may get some accretion because of the leverage and because of the REIT is trading and because you can operate it better. But you don't have anywhere near the $3 million pick up in value that you get from the development deal.

No further questions guys, thanks.

And your next question comes from the line of Eric Rothman from Wachovia Securities, you may proceed.

Yeas, I'm wondering if you could talk a little bit more about this plan to ramp up development, in particular selling off some of it. Have you looked at, rather than putting it on the balance sheet, doing it through a series of joint ventures, kind of a accomplish the same type of goals.

Eric, that is exactly how we've been doing development in the past and that is by doing it through joint ventures with either Prudential or other joint venture partners. And that was our program for the last two years. But what we've found is that getting these development deals done is very difficult, it's very time consuming, it usually takes in the range of a year and a half to two years just to get the permits to build a project.

We're trying to build them in very high dense markets in great locations in Chicago and San Francisco and Los Angeles and New York and Miami. And once we finally get these permits, we frankly hate to give away in excess of 50% of it to a development partner who doesn't appreciate the value in my view and we'd rather keep that value for the REIT.

And in order to keep it off balance sheet, the reality is you have to give up really over 50% of the economics. So that's why we are kind of turning away from that. We feel that it will be better for our shareholders long run to create that value. And if we need to counteract the FFO drag by selling a few of them, then so be it, that's what we'll do.

So I guess help me understand how you're able to counteract that FFO drag which is presumably with [current].

It's very simple. If you build a project for $10 million and you sell it for $13 and you do it in the TRS, you pick up $3 million worth of FFO on that one project.

In that one quarter?

That is enough FFO to counteract the drag of seven or eight new projects.

It will make our quarterly earnings when we sell that one property a little lumpy but on a yearly basis we hope for it to be smooth.

So our anticipation is to have no FFO drag from the development pipeline and yet create a lot of long term value much more than we'd create if we just did joint venture development deals.

Are you concerned that as a result of bringing it on the balance sheet you're also bringing a good deal more risk on balance sheet?

With more risk you have more upside. I mean, to get the same amount, you could argue that you should do then is just do 10 development deals instead of doing 20 development deals in joint venture fashion.

Interesting. Thank you very much, I appreciate the answers.

And your next question comes from the line of Rick Murray from Raymond James, you may proceed, sir.

Hey good morning. Quick question, I know that you guys collect and analyze probably a lot more of your customer data then perhaps some of your peers and I was curious if you could give us just a brief kind of demographic profile in terms of your typical customer in terms of income, perhaps education levels, whether they are a homeowner or renter.

Karl, do you want to take that one?

I don't have the information, we can provide it, but I don't have the information readily available right at this minute.

We do have that information and we could certainly provide it.

I can tell you one piece of information that is sort of interesting. And that is if you look at the demographics around our properties, take one property and you look at the homeowners versus renters, our customers are slightly skewed more towards the homeowners, which is sort of an interesting fact.

We always think of this business as being focused on rental apartments. But the reality is, our product is very much in demand for homeowners who tend to maybe want to get some things out of their garage so they maybe want to move their car in or whatever.

But I don't have facts ready to give you, if we could have a further discussion about that and maybe put a report together from the data that we have. But I don't have a lot to give you on this conference call.

And I think the other piece of that Ken is that it really does vary by market and that's why it's not something that one statistic that you could hang your hat on and say well that applies everywhere. The demographics, the income levels, all of those things really vary pretty significantly depending on where the property is located.

So we could provide you with the overall statistics and we have plenty of that, but you do have to keep in mind and I know, you're probably aware of this, but it varies dramatically by the location of the property and kind of what is going on around the property.

Rick, one of the things that is very interesting is that if you take properties, and I want to give you an example, if you take a property in a lower demographic inner city area in Los Angeles, versus an upper demographic suburban place like say Thousand Oaks, there's a marked difference in the bad debt ratio which can be as high as 2% in the urban property and as low as less than a half a percent in the suburban property.

There's also a marked difference of cash collected in the property. This is a cash business and in the inner city properties, we find that the consumer is using $100 bills and in the suburban property the consumer is using credit cards and a few checks.

And it is very marked. The cash at a upper demographic property might be as low as 7 or 8% of the revenues and it might be as high as 70% of the revenues in a property that is in an inner city area. And this is, what's interesting about our product is it cuts across all demographics, people in all walks of life in all income statuses, from the most highly paid movie stores or are storing with us in Sherman Oaks to frankly the homeless people who might be storing with us in Harlem. And it's an interesting business from that standpoint.

Thanks, I think if you guys did have a chance to release some of that data, perhaps I'll follow up with you afterwards, I think it would be pretty insightful. Thank you.

Yeah, one other interesting thing, that continues to be, one statistic that we've been monitoring for a long time continues to be 50% right around that range of customers that rent from us every day have never used self storage before. Which, we continue to be amazed that and it also bodes so well for our industry.

Great and at this time, you have no further questions so I'd like to turn the call back over to Kenneth for closing comments. You may proceed.

Well, thank you very much for your questions and for your interest in our company. And we appreciate you listening in on this conference call and we expect to be talking to you again in another quarter and we're having a good summer and we hope we'll have some good results to report to you in about three months. Thank you very much.

Thank you ladies and gentlemen for your participation and your time. Please have a wonderful day.