Extra Space Storage Inc (EXR) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen. And welcome to your fourth quarter and year end 2006 Extra Space Storage earnings conference call. My name is Jean. I'll be your conference coordinator for today. [OPERATOR INSTRUCTIONS].

At this time, I'll turn the call over to your host, Mr. James Overturf, from Extra Space Storage. Please proceed.

Thank you, Jean. Good morning and welcome to Extra Space Storage's fourth quarter and year end 2006 conference call. With us today are Extra Space Storage's CEO and Chairman of the Board Kenneth M. Woolley, Executive Vice President and CFO Kent Christensen, and Executive Vice President and COO Karl Haas.

A couple of items for me to mention before management gets started this morning, in addition to our press release, we have also furnished additional unaudited financial information about the operating results of the company and company's property portfolio on our website at www.extraspace.com. We advise everyone to look at that for some additional information regarding the performance of our properties.

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 acquisition programs, revenues, net operating income, FFO, and guidance. We encourage all 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.

These forward-looking statements represent management's estimates as of today, February 27, 2007. 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.

Thanks, James. Good morning, everyone. I'm very pleased to announce that we've had a very excellent year and an excellent fourth quarter. Our fully diluted FFO for the quarter was $0.26 per share compared to $0.23 for the fourth quarter of 2005.

This is above our guidance of $0.23 to $0.25. And the primary reason for the better-than-guidance performance is that our properties performed better than we had expected when we gave the guidance of $0.23 to $0.25.

For the year, our FFO was $0.95, up from $0.70 the previous year, an increase of about 36%. This amount includes approximately $0.01 of drag from the wholly-owned developments we opened this year, and an additional $0.005 drag from acquisitions that we purchases that were in lease up.

Same-store performance was excellent for our 103 properties during the quarter. Revenues were up 6.3% and net operating income up 10%. Same-store performance for the year was also good with revenues up 6.6% and net operating income up 7.9% for the full year.

In the fourth quarter, we closed on the acquisition of five properties for $36.3 million, located in Florida, New Jersey, and Texas. And we finished 2006 with a total of 25 property acquisitions in $167.1 million.

You may remember that we had previously given guidance at the beginning of the year that we expected to acquire between 150 and $200 million.

Of the $167 million, $38.5 million, representing six properties, were properties that were in lease up. So the result is that the lease-up properties caused drag which caused the accretion effect of the other 19 properties not to be beneficial to the company this year.

However, because the lease-up properties are brand new, they're in excellent locations, we expect the growth for next year to be enhanced from our acquisition activity this year.

Subsequent to year end, we've acquired three high-quality, well-located properties in Arizona, New Jersey, and Tennessee for $22.2 million. In December, we announced our agreement to purchase 5A Rent-A-Space in the Bay Area and Hawaii for $150.3 million. We're progressing towards a second quarter close on that portfolio. In addition, we have another three properties under contract for $46 million in San Francisco and Washington, D.C.

On the development front, in the fourth quarter, we completed the development of one wholly-owned property in Massachusetts for $6 million. Also, we completed the expansion of four properties for $8 million. We opened a total of three wholly-owned development properties for approximately $16.4 million during the whole of 2006. In all, including wholly-owned projects, we completed 15 development projects this year at a total cost of $103 million.

Our current 2007 and 2008 development pipeline consists of 19 projects at an estimated cost of $163 million. You can find much more information regarding our development programs in our supplemental package on our website. For those of you who are modeling our business, I encourage you to take a look at that information as I believe it will be helpful for you as you consider discounted cash flow and net asset valuation methods alongside FFO and overall prospects.

We've made one change on our board. Joe Margolis has been moved from the Compensation Committee to the Audit Committee. And Tony -- Anthony Fanticola has been moved from the Audit Committee to the Compensation Committee. With this, I'd like now to turn the time to Karl Haas, our Chief Operating Officer, who can talk a little more about the operational performance of the company. Karl?

Thanks. As Ken said, operational performance in the fourth quarter continued to be very good. We're well positioned with our people, operational processes, and pricing strategies to perform very well in 2007. Our 103 same-store group of properties finished the year strong. Revenue was up 6.3% for the quarter and finished up 6.6% for the year.

Due to the year-on-year drop of expenses, mostly in advertising, net operating income for the fourth quarter was up 10% and finished the year up 7.9%. Our average occupancy for the quarter was above last year by almost 1 percentage point.

Weighted average revenue per available foot, RevPAF, for the same-store pull for Q4 was $12 which was 6.9% increase year over year. Most of the increase, 6%, came from the increased rates.

Our portfolio of 193 stabilized wholly-owned properties also finished the year with solid results. This group of properties generates the majority of earnings and includes the 57 stabilized legacy Storage USA properties that we acquired in July 2005. For the quarter, revenues were up 5.7%. And net operating income was up 9.9%. For the year, revenues were up 6.4 and net operating income up 8.4%.

Our entire stabilized group of 564 properties managed by Extra Space had revenue and net operating income increases of 4.5% and 6.3% respectively for the quarter. For the year, revenue increased 5.1%. And net operating income was up 6.1%.

For the quarter, Northern California and Phoenix were the top performers with increases in revenue of nearly 10%. Atlanta, Dallas, and Miami also had a good fourth quarter. For the year, Chicago, Dallas, Miami, Northern California, and Phoenix all had revenue growth greater than 7%.

The initial capital improvements campaign for the legacy Storage USA properties is essentially complete. Our primary signage installations were completed in late December. We have some capital expenditure carryover into 2007 of various projects not completed in 2006, such as office remodels, major paving, and roofing projects. However, during 2006, we really have made significant progress in catching up on deferred maintenance, especially on the former legacy Storage USA properties.

In 2007, we will be doing a good deal of work on our wholly-owned properties. We expect our total CapEx expenditures to be about $0.57 per square foot. This is higher than our historical average due to the aforementioned carryover projects not completed in 2006 plus re-signage of some of our properties and marketing materials, rebranding, office upgrades, and some selected high-dollar capital improvements, such as roofing and façade work. We believe these improvements will make our property even more competitive within their respective markets.

In the long-term, we expect our CapEx to be in the range of $0.35 to $0.40 per square foot. This includes approximately $0.25 in recurring CapEx and $0.10 to $0.15 in extraordinary repairs and upgrades.

As many of you have seen, we recently launched a new website. In addition to a new look and a feel, we have added many real-time data functionalities that make our site as good if not better than any other website in our industry.

Customers can get prices for multiple properties at one time. And they can choose a unit based on price or distance from their home or place of work. You can also select unit attributes, unit upstairs, downstairs, climate control, to further refine your particular unit search.

Initial results are very encouraging. Our conversion ratio of turning website visitors into reservations has improved by more than 50% since we've introduced the website.

We're also busy rolling out a value days selling model to the field that we call Sizzle. It is our goal to change our sales culture to focus more on features and benefits and less on price and discount. The training will focus on tangible and intangible differences between Extra Space and our competitors. This training will be rolled out before the end of the first quarter. And we expect it to have a positive impact on our phone and in-person closing rates.

From my own point of view, I saw a tremendous amount of progress in 2006. Our executive team personally visited over 500 properties. We held over 30 town hall meetings and met with over 1,300 employees. We have seen progress in the people, the properties, and the way we do business. Our people have now embraced their new policies and procedures and the Extra Space Clean and Green Mantra.

As tangible evidence of our progress, we've seen a dramatic improvement in our employee satisfaction. It's gone from 47% of our employees rating their job satisfaction as high, one year later in January 2007, 74% of our employees are rating their job satisfaction high.

We always have work to do. But the employee buy in is evident. And we're entering 2007 with excellent operational momentum. With that, I'd like to turn the call over to Kent Christensen, our Chief Financial Officer.

Thanks, Karl. We finished the year with 219 wholly-owned properties and 348 joint-venture properties. We also manage an additional 74 properties as part of our property management program.

Results for the three months ended December 31, 2006, include the operations of 561 properties, 213 of which were consolidated, and 348 of which were held in joint ventures, compared to the results for the three months ended December 31, 2005, which included the operations of 546 properties. 192 of these were consolidated and 354 were held in joint ventures.

Total revenues for the three months ended December 31, 2006, were at $52.2 million and $197.3 million for the year compared to $44.9 million and $134.7 million for the same periods of 2005. Net income for the three months ended December 31, 2006, was $6.7 million and $14.9 million for the year compared to losses in 2005 of $200,000 for the quarter and $5 million for the year.

G&A for the third quarter was $9 million which included $348,000 in non-cash compensation-related expense related to options and grants. Total G&A for the year was $35.3 million, including $1.7 in non-cash compensation. G&A finished below our stated range of $36 million.

As a reminder, our G&A is always given net of development fees. Furthermore, our combined G&A for both Storage USA and Extra Space was $50 million. And we've been able to bring that down to the $36 million amount.

Total outstanding debt as of year end was approximately $948 million, including $120 million in notes payable to trust. Approximately 91% or $863 million of our debt is fixed long term with an average maturity of five years and an average interest rate of 5.4%.

The total weighted average interest rate of all of our debt is 5.5. Our total debt as a percentage to market capitalization, including OP units, was 43.3% as of year end. And our fixed charge coverage ratio as of December 31st was 2.27 up from 1.57 as of December 31, 2005. For the year, our fixed coverage charge ratio was 2.03.

Interest expense for the quarter was $12.8 million and $51 million for the year. Our line of credit had $81 million of capacity with none drawn as of the end of the year. We have plenty of firepower for acquisitions with over $300 million available utilizing our current cash, our line of credit, and our unleveraged properties.

As part of the compliance with Sarbanes-Oxley, the effectiveness of our internal controls over financial reporting is continually evaluated. Based on this evaluation, no material weakness have been found to exist. And management concluded that internal controls over financial reporting were effective as of December 31, 2006. Management has reviewed the results and testing with our Audit Committee.

Now as for guidance for 2007, our guidance for the next quarter, the first quarter of 2007 is between $0.23 and $0.25. And for the calendar year 2007, we expect between $1.06 and $1.12. This includes a 4% increase in our G&A costs.

But when you take into account our G&A cost and net out our management fees and franchise fees that are paid by our joint venture partners, our G&A will come in between 15 and $16 million. With that, I'd like to turn over the call back to Ken Woolley.

A lot of people ask me what is the essence of Extra Space Storage. And if you look at it today, we have 640 properties. But the real guts, the real income producing properties for this company are the 219 wholly-owned properties.

If you look at our financial statements, you'll see that from those properties, our wholly-owned properties, we received about $107 million worth of net operating income. And we received cash flow from our joint ventures of about $9.5 million, so that the income from our company, our FFO, or our real income, is accounting about 92% from our wholly-owned properties. And so when you consider or evaluate the company, we need to consider more carefully the wholly owned than the properties as a whole.

People have asked me what is the value of having 640 properties when you only have 219 that are wholly owned and that's where most of your income's coming from. Well, the answer to that question is as follows -- first of all, we have 74 properties I think that we manage. Those 74 properties are a potential pipeline for us to acquire. In fact, we acquired quite a number of managed properties during this past year.

Secondly, the larger footprint with the joint venture properties gives us economies of scale in advertising and brand recognition which is a powerful mover for our company. And so we're very happy, even though we're managing 640 properties and we only own 219. We're happy with the fact that we have the larger footprint.

As you can see by our results, 2006 was an excellent operational year for Extra Space. And 2007 is frankly starting up very well. I think our performance is the proof of our successful integration of Storage USA. In the future, we won't be talking about that integration anymore because it's essentially done.

Karl noted that we spent quite a bit on capital expense this year. In fact, we spent $40.9 million on CapEx. And that's on all the properties that we own or have a joint venture interest in. Approximately $6.8 million was spent on our wholly-owned properties. During the coming year, we're going to be doing an additional $12 million of CapEx on the properties as a whole.

A lot of this is carryover work that didn't get completed in 2006. And approximately $3.5 million of our $6.8 million worth of CapEx expected of our own properties is really carryover CapEx, much of it to do with the Storage USA properties that we acquired. Once this is all completed, we are going to be happy with the condition of our properties.

So if you look at what's going to happen in 2007, the reality is 2007 is the year that we will capitalize on the operational efficiencies and the rebranding and the better looking properties for better operational performance of all of these properties that we've acquired.

Our goal this year for acquisitions is 250 to $350 million. Last year, we had a less aggressive goal. Part of that was because our total focus last year was on operations and integration. This year, we're going to have a bigger focus toward growth. The market remains competitive. And cap rates for acquisitions are still quite low. We're targeting between 6.5 and 7 cap for most of our acquisitions and quality markets.

Our internal growth goal is to be in the 4 to 6% range in same-store growth. Our January numbers are in line with the top end of that range. We will also continue to grow through development. Development will add three wholly-owned properties in 2007 but another 15 or so in 2008.

Of course, with the opening of new development properties, there is a drag to our FFO. And in the earnings guidance, we mentioned our guidance about $0.025 of drag is considered in that earnings guidance. So if you look at the earnings before drag from development properties, the guidance would be more like $1.08 to $1.14 or a little higher, $1.085 to $1.145, because we're going to have that drag.

Now some people have asked are you going to sell any development properties. The fact is that we may. Right now, we do not have a specific--any of them identified to sell. We've had discussions about this in the past. But right now, we like all of our development properties. So we do not have a specific plan to sell any of the development properties.

So development is diluted. But we think in the long run, it is extremely a good rate of return. If you look at the numbers going back a number of years of acquisition properties versus development properties, it's clear that the development activity is a higher IRR activity for the rate. So even though in the short run it's diluted, in the long run, it will be accreted.

The environment for self storage business remains positive. And Extra Space is well positioned I think for a good next year. As I've said for many quarters, storage is a great business. It's a great business because people in our country are addicted to their stuff. They love it. And as a result, they get too much of it. And we provide them the means to store it and to take care of it. I think our industry is progressing. We've seen lots of upgrades in the industry as people look at storage and they think about it in a more positive light because they value their goods.

Our economy is strong. And that's been excellent for our business. The economy's particularly strong, frankly, in the East Coast and West Coast markets where our properties are targeted. We believe our strategic position is improving now. It really--only in the last three months have all the properties been rebranded Extra Space. Our new website is operating. So we think now we can take advantage of our brand.

And with that, I think I'll end the call and thank all of the Extra Space management people and everybody, our team in the field, for a great year and for the opportunity this coming year to show the world what we have with one united brand. Thank you very much.

From this -- I think this part we're going to ask the questions.

[OPERATOR INSTRUCTIONS] And we'll take our first question from Christine McElroy of Banc of America Securities. Please proceed.

Good morning, guys. I'm here with Ross Nussbaum as well. Ken, just to follow up on your comment on the integration, what percentage of the Storage USA assets have permanent signage at this point as opposed to temporary banners?

Probably about 98.

This is Karl. It's slightly less than that. We've got about I think 38 properties that haven't been. And you're seeing a lot of them in New York City because we've had some issues there. But yeah, I think it's out of the 434, I think at this point we have 36 that have not had permanent sign changes. And that's a result of a lot of cases.

There are some that -- where there are partners that are and some other things going on with them. And in a few -- in a lot of the cases, it's zoning issues. And we're -- when we went in to get the permit for the sign, other complications came in. And we're working through that.

Well, actually as related to that, I was thinking of the percentage of the wholly-owned properties as opposed to the larger portfolio. There were originally 459 Storage USA properties. So it would be 38 our of 459.

36, yeah.

36 that haven't been resigned yet.

Okay. Great. And then what's the cap rate on the Rent-A-Space acquisition?

We'd rather not comment on that.

Okay. And then just to follow up on acquisitions, with over 220 -- or with about $220 million of acquisitions already completed or under contract, it seems like you've already identified the bulk of your projected acquisitions for the year. Does this mean that you're slowing your acquisition sourcing efforts? Or are you just tending toward being conservative?

We're tending to be conservative. We're certainly not slowing our acquisition efforts. It's just a matter of you can't guarantee how many acquisitions you're going to do. We're actually going to be aggressive. We'll do more than $350 million if we find good acquisitions to do. It's really a matter of looking at every deal that comes along, seeing if it meets our criteria.

This year, we're going to be trying harder to get acquisitions that are accretive. What I mean is buying less lease-up properties just because we'd like to sew some accretion. Last year, we didn't get any accretion from acquisitions. We got a lot of value. And we'll see the accretion this year. But last year, we didn't get any. So this year, we're kind of -- our goal is to make the $350 million accretive.

Okay. Great. And then I believe Ross has a follow up.

Hi, guys. Just one quick question, can you talk a little bit about the pilot program you have with that eBay I guess test program going on? What's the success of it? Any plans to roll it out?

Program's called Zippy. And at this point, there is not a lot going on with it. We have ten properties where we will be rolling it out. And we haven't seen a lot from it yet.

Okay. So at this point, your plan is just keep testing it and make a decision at some point later this year?

Yes. For us, it's a very low-risk proposition. We have some units rented. And if it works, we get some additional commissions from it. And the other side benefit is if it works that you'd have customers coming to the site that maybe wouldn't have come there otherwise. But we don't really -- we're not projecting any significant impact from that.

We'll take that next question from Christopher Pike of Merrill Lynch.

I'm sorry about that. I had it on speaker. Can you guys hear me?

Yes, we can.

How you doing? Good morning. Maybe question for Ken or Karl in terms of typical seasonal patterns, I think if you look at the occupancy numbers at the end of the quarter and the average for the quarter, you see a little bit of a downtick.

Are you starting to see typical seasonal patterns emerge in storage because I know, Ken, you and I had a discussion awhile back talking about how over the last couple years if you will, we've kind of just leapfrogged the typical seasonal patterns you see in the latter part of the year and the first part of every new year?

Well, I think that there is this past year, like we did in 2005, it seemed like the business did not drop off as much as it had in previous years. I think part of that may have been from the warm East Coast winter that was --the late winter in the East Coast.

But the patterns are still there. The low of our business is last week. I think it's around the 20th of February if you look at it where the exact low point is. And then it starts picking up in March, April, and May.

We have, however, seen some deceleration of and some actual decreases in certain markets that have been very strong. Florida, for example, except for Miami, has been weak. And we've seen decreases in occupancies. One of the factors that helps us even out these occupancy changes is being very proactive with our revenue management activities. And so we're hoping and we believe that our revenue management skills will keep us in the weaker markets from having occupancy declines like we've had in previous times.

The other markets that have been weak, Detroit continues to be weak, Philly, Las Vegas interestingly enough. One of the struggles we've had -- not struggles, but we have a big preponderance of properties in D.C., Boston, and New York/New Jersey.

All three of those markets are running on a revenue basis, year-end revenue basis, growth wise at below the average for our country. It's sort of 4.4% for Baltimore, 3.7% for Boston, and only 3.6% for New York/New Jersey. It's a big amount of properties.

Have you guys started to see -- I'm sorry -- have you -- just along the same lines, have you started to see a higher correlation with respect to, let's say, overall housing costs in those markets because, Ken, some of the markets that you mentioned are clearly starting to see the crescendo, whether it be multifamily, single family? Are you starting to see a more higher or more robust correlation between housing formations or rent levels and storage demand emerging?

Well, there's still a correlation there. There's no question about it. The deceleration of the housing markets in San Diego, some places in Florida, and in Phoenix, we are seeing in the fourth quarter. Even though Phoenix was our top market, we saw a real deceleration of rental activity in the fourth quarter. So we've got to watch that.

We also saw deceleration in San Diego and in certain areas in Florida. And we think that may be partly correlated with sort of the housing slowdown. And clearly, the Northeast has never been a housing boom place. And it's not a boom place for us right now. And Detroit certainly is not a housing boom place. And it's a negative place for us right now.

In terms of, Ken, you mentioned the $0.01 drag on the developments that came up out of the ground in '06 that impacted the numbers. Was that an impact to Q4? In other words, that one penny is going to roll over four times into '07?

No, that was really --

I was a little confused about that.

It depends on when the properties open. So it was actually over the whole --

So it's a full year impact.

It was really the last three quarters of the year. We decided to start reporting that so that -- in our estimate for the coming year right now is $0.025 internally.

Okay.

And we started -- we decided now we'll report this on a quarter-by-quarter basis, so that you can understand clearly what the sort of before development activity FFO was and what the actual drag is from the development activities.

Okay. Just a couple more questions here, so bare with me. In terms of the CapEx increase that Karl had mentioned, is it portfolio specific? What I mean is as you divide it up, this use of portfolio into separate portfolios and approved stuff in the separate portfolios, is it specific to one group of properties that you see a significant increase in the CapEx? Or maybe is it attributable to some geographic market or something other than, okay, we're just spending $0.50 a square foot, including $0.25 on maintenance CapEx portfolio wide?

Well, let me sort of characterize that. Most of the CapEx that was done the past year was done on the former Storage USA properties. The CapEx done on the former Extra Space properties planned for this current year is primarily resigning things to bring them up to our current signage level.

So the bulk of this, the extraordinary CapEx, was because of deferred maintenance and also rebranding and repainting and resigning and putting new offices in the former Storage USA properties.

So with respect to Extra Space, which owned 61 of those storage properties wholly-owned, the bulk of the $12.6 million of CapEx was for those properties. But it was all over the country. It wasn't in a specific geographic region.

It tended to be more on the older properties than the newer Storage USA properties because Storage USA had quite a mix of older properties. The average age of the Storage USA properties I think when we took it over was in excess of 15 years, whereas the average age of the Extra Space properties at the time of the merger was only eight years. And so that sort of characterizes it.

Okay. I guess, then just on a leverage, I guess if I pick through the numbers here, it seems like you have a bit more capacity for acquisitions than $300 million. Just a back of the envelope, assuming a 40 to 50% leverage ratio, it sounds to me like you've got about $450 million capacity. Is that directionally accurate if you were to really use all the dry powder, including encumbering -- your current asset base?

That's correct. This is Kent. We would -- if we were to use all the leverage we could get, we could get up to a much higher number, close to the number that you're talking about. The numbers I stated were ones that you could quickly add up and get to a number that says we have $300 million available today to go out and buy -- using cash to buy property.

That's just cash in line. You can pretty much lever up 50% to get that $300 million, right?

That's correct.

Okay. And I guess, Ken, how do you juggle or manage if you're going to continue to develop, which is something that we applaud at least from a value perspective, and leverage, where do you guys target your coverage and your leverage overall if you're going to go down the road of developing on balance sheet for your own account?

Well, I would say right now we're on the lower end of the leverage and that we would go between that -- today's market value is somewhere around 40% up to the mid-50s at the high end. So we're going to leave that range quite broad because we want to leave ourselves flexibility. It sort of depends on the equity markets and how they react to our stock, et cetera as to whether we use debt or equity.

With respect to coverage ratios, I think our goal is to -- we're back -- we're up to 2.27. That's the best that we've been since we went public. We'd like to keep it up near there, over 2.

Okay. And I guess just one last question here, I guess for Karl because in your prepared comments you were talking about this initiative if you will to try to determine what you guys are doing different from your peers.

I realize you're going to still roll that out shortly. But what would you say is the biggest difference in terms of how you guys operate as a company compared to some of your peers, whether they be public or private?

Well, and I mentioned it there, our Clean and Green Program, which we put a lot of emphasis during our visits to the properties and the training of our people to -- people rent Empty Space. And what we're focused on is getting our managers to -- we put a lot of feedback, a lot of push on our managers to keep our facilities looking cleaner, looking fresher.

We feel like we're putting the CapEx dollars we're putting in. And we're biting off. We are saying we're not just going to spend $0.25 and that's it no matter what. We're spending what it takes to make our properties look better than anybody else's properties.

And then we're going to keep them looking better, having the managers, whether it's the restroom, the office tour, whatever, when they walk in, a customer's going to see a difference at our site. And we want our managers to sell that as well. We don't want to just do it. We also want them to be selling that.

And when you consider that coupled with your, I guess, employee satisfaction surveys, have you seen an increase in manager retention out on the field?

Yes, we actually have seen improvement, especially on our primary store managers. We've seen it dip down to levels that are more acceptable to us. And that pleases us. But turnover is going to happy. And we're probably at about a level where we expect it to be at this point.

But it's just for us having that survey of the employees and telling us that we're continuing to move in the right direction of the employees feeling better about -- it's really two questions. How satisfied are you with your job? And the second question is, is Extra Space a great place to work? The third question is does my supervisor treat me fairly? And we had a high rating on that. But the first two questions weren't as high. And it's gotten a lot better.

Okay. Thanks a lot, folks.

We'll take the next question from Michael Knott of Green Street Advisors.

Hi, guys. Hey, Ken, you said that you're now more focused on external growth going forward now that the integration is more complete. When you think about really significant external growth opportunities, should we be more expecting you to maybe try to double down on your existing portfolio, maybe by eventually trying to negotiate a buyout of Prudential or maybe using your stock to buy other publicly traded portfolios that already use your center shift system?

Let me remark first on the financial issue. We've had some conversations with Prudential about our desire to increase our interest in the Prudential joint ventures. We have not come to any agreement, not that we have a disagreement. We just haven't come to an agreement.

So the first thing is with respect to Prudential, we would be very interested in eventually acquiring all of the Prudential properties. That may be some years in the future because Prudential has indicated to us that they are reasonably happy with the portfolios that they have and with the income performance of the portfolios. We don't have any deal there. But long run, we'd like to see--we'd like to own those properties.

With respect to other acquisitions, we really aren't in a position to comment at this time.

Okay. And then speaking of the Prudential portfolio, any thoughts on the NOI growth differential between the wholly-owned portfolio and your own Storage USA portfolio and the Prudential segment?

First of all, the Prudential segment is now accelerating and getting better. In previous quarters, it was not doing as well as the Extra Space portfolio. I would attribute that partly to all the rebranding and CapEx and the fact that we made the properties look a lot better.

But I think you have to -- the real truth is that the Extra Space core-owned properties are newer. By and large, they are in the stronger markets. And many of them were built by Extra Space. And we would expect over time that core 219 properties to perform a little better than the broader group of properties because of the locations, the quality, and the newer properties nature of them.

Okay. And then just moving on to development, you commented that your targeted acquisition yields are, call it, 6.5 to 7. But I noticed the $57 million of development cost from 2002 vintage looked like its yield in '06 was about 7.6%.

Is that enough of a development premium in your eyes? Or are those properties a little below your expectations? Can you just comment on how that sort of influences your decision to allocate more capital to development?

I would say that over the years we've done better than that 6.6% after four years or 7.6% after four years and that there are a number of properties in that group where we stubbed our toe. And we made some mistakes on development that I know what the mistakes were. And we're not proud of them.

Right now, the development yields that we're targeting are really between 8.5 and 9 in the markets where we're working at. And we believe that they are realistic and that they will do that number. Clearly, 7.6% is not acceptable. But we can't lie about the numbers about what we've done.

Okay. And then my last question is for Karl. Karl, if I remember correctly, I think at the Investor Day about a year ago, you guys were targeting, call it, $0.20 to $0.25 for CapEx reserve. Can you just comment on if my memory is right and then any changes and why the reserve is--?

Well, it just comes back to what I said earlier. And normal ongoing CapEx--the normal stuff does run--and the other thing that I think has been a mistake in the past is that we pick a number per square foot. And we say it's $0.25. Well, the reality is over time, that also should increase just by inflation. And it was $0.20 to $0.25 five years ago. And it's still $0.20 to $0.25.

But that's more kind of the normal maintenance. But what we find is every year there are office renovations, apartment renovations, property upgrades, security upgrades, and things like that that we end up doing and need to do to keep competitive that really are above -- that really come in above that $0.25 and need to be factored in. So that's why we broke it out and said $0.25 is the normal ongoing.

And the additional amounts are more for -- it's not -- it needs to be differentiated because it's not -- they're really subjective and not stuff that absolutely has to be done. But they're stuff that help keep us competitive. And we're committed to keeping our products and our properties out there competitive.

Thank you.

[OPERATOR INSTRUCTIONS] We'll take our next question from Paul Adornato of BMO Capital Markets.

Hi. Good morning. As branding becomes more of a priority, I was wondering if you could tell us what you've done in terms of TV advertising experiments and what we might expect in terms of TV advertising going forward.

We, last summer, we tried some TV advertising in selected markets. Boston was one of those markets. We were not able to try it in enough markets because we had not yet had all of the properties branded Extra Space. They were--more of them were Storage USA than Extra Space. So we didn't have a common brand to theme last summer. We had some good success with that TV advertising.

And we will be doing more testing of that this year in selected markets. I would guess that before we did a all-nation type program like one of our competitors does, we would need to do more testing and be certain of the effects of it. So I would not expect to see a big TV program in 2007. It may be something we'd be targeting more in 2008.

But just commenting on this brand thing, one of the things that is a huge benefit to us in having the one-brand platform now is the internet because we are number two in the country in size. And the internet's very important. And it is becoming more important today than it was five years ago.

And if you consider the fact that people get on and look at Google or Yahoo! or some other search engine, and they're looking for storage in their town, we can much -- because of our size, we're much more likely to be near the top one or two in those search engines, which gives us a natural advantage being a bigger company that we didn't used to have because it all used to be based on Yellow Pages and who had the best placement.

And a lot of the local, smaller guys could get the best placement. And so as the internet is developing, the importance of a national brand is becoming greater in our business.

And to follow up, you mentioned -- Karl, I think mentioned that your conversion success on web inquiries improved 50%. I was wondering if you could put some numbers around that. Is that going from 2% to 3% or 10% to 15% closure?

I'm not going to give you the specific data, the exact specific data, but I will say this. Right now, approximately 15% of all of our renters first contacted Extra Space through the internet.

Okay. And so they may --

That was before the 50% increase now that we've gotten. Okay. In other words, that was previous data. And so -- but the trouble is it's very hard to track it. We can have -- we can get that data. But the data of actual people renting through the internet is lower than that.

Right.

Because a lot of what the internet does is it acts a little like the Yellow Pages. The people learn about it, and then they call or they come in. They don't actually rent on the internet.

Right. And finally, I was wondering if you could just talk about perhaps any long-term trends that you're noticing in terms of tenant turnover. Are you able to discern that out of all the promotions and other integration issues that you've gone through over the last two years?

Well, if you look at long-term trends on tenant turnover, I would say that it's slowing. There's sort of two ways to look at it. If you look at our whole portfolio today of 330,000 customers, the average tenant has been there 28 months. And that average is increasing over time. That means that there's a lot of people who are staying permanently in their self storage unit.

If you look at a typical property over a five year period and you ask every tenant that moved in and then moved out how long did they stay on average, the ones that moved in and moved out, it's like nine months. But that seems to be quite stable. So you have sort of stability of the turn.

But you have a lot of people who are just also staying a long time. So you have this group of tenants who just don't move out that increases the length of the average stay at the property. But that's a slow change. That's nothing that's dramatic. It's not a big trend.

Okay. Thank you.

We'll take our next question from Jeff Donnelly of Wachovia Securities.

Good morning, guys. Ken, I was wondering if we could step back for a moment and talk about the metrics that you utilize to measure value creation at least as it relates to your development activity.

If I heard you clearly earlier, [EXR] mainly focuses on, or [inaudible] is maybe focused on FFO accretion rather than net asset value growth from developments. Is that correct? And I guess, can you just clarify for me your rationale as it pertains to development?

I don't think that's correct. We're looking at a balance between the two. First of all, as a -- if we were not a public company and were just a private company, I would spend all of our capital on development because development creates -- is a higher yield, higher yielding activity, value creating activity. But there's some problems with that.

Number one, it's very difficult to put together the infrastructure and get the kind of volume you want to have in development for a company our size. So it has to be coupled with building the business with regard to acquisitions.

The good thing about acquisitions is that they provide immediate cash flow. They provide efficiencies in certain geographical areas to give us certain strength in markets. And so there's sort of benefits to both.

Okay. I thought I misheard you. And then I'm just curious, if you are looking for stabilized yields on developments in the range of I guess 8 to 9%, what does that technically imply for first year or initial year returns on development? Because I'm curious how that compares to the yields you're seeing on acquisitions of around I think you said 6.5?

Okay. The first year after property is opened is likely to have an NOI of barely positive. And it's almost like 1% or 0.5% yield. And the typical or average lease-up period is around three years. So what that means is you don't get to the 9% number until you're four years down the pike, the fourth year, because you're still leasing up in the third years. Now that's one of the negative business aspects of the self storage business.

It is -- of all the different major property types, it is probably the slowest to lease up. Now we have had lease ups in six and eight months. But they're very few and far between. We generally have found that lease ups in California and the West are faster than the East. But once they're leased up, the performance is not too much different.

But one of the reasons you'd rather have newer properties in your portfolio is that once a property's, say, four years old and it's fully leased, it is our experience that the next four or five years you're able to get faster rent increases on average than you are in a completely mature property. And there's two reasons for that. Number one, because it's a better physical property, it's more competitive in the marketplace than an older property. And you can sort of kind of build on that.

And the number two, in the older property -- in the newer property, you have a higher turnover initially because you don't have as many sort of permanent, long-term tenants. And as time goes by, that turnover of tenants slows which means that instead of needing to -- initially when you get the full lease up, the new property may have to rent and rerent 60 units a month, whereas the older property 30 units a month.

And as that need to rent 60 units a month declines from 60 to 30, you can push rent because you don't need to be quite as price competitive in the market. And so that's why you'd rather own -- if you were buying things, the thing you want to buy is something that's four years old and it's fully leased, not something that's 25 years old and out of date.

I just want to follow up. I guess I'm curious then. You mentioned TV advertising earlier as a way of sort of heightening visibility to drive revenues. And some of your competitors talk about I guess elimination of discounting as a means of driving cash flow but effectively is a means of increasing their net [runs].

If it takes effectively, I guess, call it, three to four years to if you will disrupt consumer shopping patterns to eventually get a property to stabilize, I guess how realistic is it then that whether it's changing discounting or changing [inaudible] strategy, how realistic is it that those same consumer patterns will changes just as quickly or more quickly I should say than it would take to stabilize a new development property?

I don't think consumer patterns are changing. I think that they're changing very slowly. I mean the internet is one factor in making the change. This issue of discounting versus not discounting, discounting has been around in this business for 25, 30 years.

In fact, as long as I've been in it, over 30 years, we've been doing discounting. And the reason for it is as follows--people like to have a deal. They like to feel like when they're renting something that they get a deal.

And also, and this is the factor that is important, our largest competitor, Public Storage, often offers the first month's rent for $1. That's their common deal. Well, why wouldn't you just rent the first month's rent for the full price and get that extra income? The reason that they do that and the reason that we often do the same type of deal is that the tenant when he rents believes that he is going to stay less time than he actually stays.

So in his mind, that discount is more important than a lower price because you'd argue that it's really -- you can either discount it, which one month free is going to cost you 8 or 9% on the top line. That's what it is if it was a nine-month average tenant turn. But since they stay longer, the reality is the business operates better with higher prices and more discounting than it does with lower prices and no discounting.

So we've tested this. And we've found that if you eliminate the discounting, you do diminish dramatically the velocity of new tenants coming in, particularly in a market where there's lots of competition.

Okay. Thanks.

And we'll take our next question from [inaudible]

How you doing, guys? Couple of questions, first of all, in the guidance, were there any promote income or merchant development gain income?

No.

Okay. And the 4% revenue guidance, $0.06 NOI guidance kind of implies a flat expense guidance. Is that how it's penciling out to you guys?

No. I think that we said that the revenues were going to be between 4 and 6%.

Oh, okay. Okay. Sorry about that. And last question, what was the rental rate increase in the fourth quarter year over year?

Rental rate increase.

Right.

I think it was about 6%.

Okay. Because it looked you gave the absolute numbers for the fourth quarters but didn't talk about what it was year over year.

Yeah, I think it's 6%.

Okay.

6.0%.

And I guess final question, the tenant insurance revenue number you had this quarter, is that kind of a run rate going forward?

We believe that the tenant insurance is likely to increase during the year. We have a major initiative right now going on to try and help our tenants protect their goods by offering them the insurance. Our tenant insurance penetration overall was about 19% in the whole portfolio.

We're right now running closer to 45 to 50% of new tenants right now. So we expect that tenant insurance rate and our internal goals are to increase the amount of revenues from tenant insurance a good deal this year. We haven't budgeted huge amounts in our guidance. But we certainly have a goal to do it.

Let me give you an example. Unfortunately, we had a fire at a facility in Birmingham, Alabama, here about four weeks ago where a tenant was a newspaper distributor and was in the unit with a kerosene heater. And the kerosene heater somehow didn't mix with the newspaper. And it caught on fire. And it burned up a building and 36 units. And out of those 36 units, only five of them had insurance.

And this is unfortunate for all those tenants who didn't choose to take the insurance. And it's a negative thing obviously when these kinds of things happen. They don't happen often. But that's why we're offering it.

Okay. Thank you very much for your time.

And we'll take our final question from Michael Knott of Green Street Advisors.

Hey, guys, just want to follow up on a couple things that you had said earlier and then also tie that in with an earlier question. It looks like the occupancy, the average occupancy -- and I'm focusing on your legacy same-store pool here just for simplicity -- looks like the average occupancy in the quarter was, call it, 100 basis points.

But the occupancy at the end of the quarter was essentially flat year over year. Is that what you were saying earlier, the occupancies have declined? So I just want to get clarification on that and then also how that ties in with your earlier comments that your running in January or so far this year at the top end of your 4 to 6% same-store guidance for '07. Just curious how those are working. Does that imply rental rates are growing faster than in '06 or expense reductions are continuing?

Okay. What we saw is a deceleration of rental activity in our same-store portfolio--not our same-store but our whole, our owned property portfolio in the latter part of the fourth quarter. And we looked at that really carefully. And we're making--because I think we were pushing street rates a little bit too high too fast. So we sort of backed up on that.

Meanwhile, January was -- we're starting out the year pretty good. And that's more due to existing tenant increasing than it is to street rate. Our occupancy has not decelerated in January. But we did see a deceleration in that time frame which would be sort of November and December.

So that's why the average for the quarter was higher than the ending. Also, last year, we saw a relative acceleration last year which was a little better. Part of that we think was due to the hurricanes in Florida which had an effect.

It's also important to remember that we're talking about the delta in year over year occupancy. So when we're saying in 2006 we had excellent growth over 2005, what we saw was the gap between the '06 and the '05 occupancy closed as we got further along in 2006.

All right. Okay. Thanks.

I'm showing no questions at this time. I'll turn the call back over to [inaudible] for closing remarks.

Thank you, everybody for listening in on this call. We hope it was informative. And we thank you for the support of all of our shareholders and the analysts. And we expect a good year to come. And we look forward to reporting to you in the, I guess, the end of April. Thank you very much.

Ladies and gentlemen, thank you for joining us on the call. You may now disconnect.