Extra Space Storage Inc (EXR) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, thank you for standing by and welcome to the 2007 First Quarter Extra Space Storage Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's call, Mr. James Overturf, with Extra Space Storage. Please proceed, sir.

Good morning to everyone, and welcome to Extra Space Storage's first quarter 2007 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 to you before management gets started this early morning. In addition to our press release, we have also furnished unaudited financial information on our website. Click on the investor info section, and then on Financial Reports, and the document titled Q1 2007 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 which 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 acquisition programs, revenues, net operating 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.

These forward-looking statements represent management's estimates as of today, April 25th, 2007. Extra Space Storage assumes no obligation to update these forward-looking statements in the future because of changing market conditions or other circumstances.

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

Good morning. We are happy to have you join us in our conference call today and I hope those of you on the call have had a chance to look at our press release. We've started the year 2007 with a solid first quarter. Our fully diluted FFO for the quarter was $0.24 per share. That's 20% higher than a year ago at the same quarter and is within our guidance, which is between $0.23 and $0.25 a share.

This amount includes approximately six-tenths of 1% of drag from our development activity and our new projects that have come online from our development program. Year-on-year same-store performance at our 181 same stores was excellent. Revenues were up 5.8% and then operating income was up 8.4%. I'd like you to note that our same-store pool has increased from 102 stores last year to 181 stores this year.

The biggest part of that increase is the inclusion of 61 stores that we acquired through the Storage USA acquisition. And now the 181 same stores is a much larger potion of the wholly owned part of our company, where we have about 220 wholly owned stores. For the first quarter, we closed on acquisitions of four properties for a total price of $29 million. These properties were located in Arizona, Florida, Maryland and Tennessee. All four of these properties came from our strategic partners program.

In the second quarter, we've closed one acquisition so far in Maryland for $12.5 million, and are about ready to close a second one from the same seller at $15 million. These did not come from our strategic partners' program. We currently have under contract $216 million worth of properties which we expect to close in the second quarter. This includes the $150 million 5A portfolio. That portfolio we now expect to close in late June or possibly early July.

The market does remain very competitive for acquisition deals, and we have missed out on quite a few opportunities because we were not willing to pay the low cap rate that the market is demanding. On the development front, we've completed the development of two joint venture properties in California and New Jersey for $16.3 million, and we expect to complete three more wholly owned development projects for a total cost of $28 million during the year 2007.

During 2008, we will be developing 17 properties will be completed. Many of these are already under construction or just about ready to start construction. One of these will be joint ventured. All the rest will be wholly owned, and the total development cost of these is about $137 million.

Also during the quarter, we completed an exchangeable note offering, otherwise referred to as a convertible debt offering, with a very good interest rate of 3.625% on the interest rate and the conversion feature kicks in at $23.48 a share, which is a 20% premium over our stock price the day that the deal was done. The deal was upsized from $200 million. We expected to raise $200 million and were given the opportunity for an additional $50 million. This puts us in an excellent position to grow externally while maintaining a reasonable debt ratio.

Now I'm going to turn the time over to Karl, to let us talk a little more about that operations and more specifics about our company.

Thanks, Ken. Good very early morning here in Salt Lake City to all. Our same-store properties continued their strong operational performance from last year during the first quarter. These 181 facilities had year-over-year growth of 5.8% in revenue and 8.4% in net operating income. Once gain, these are excellent numbers, especially when compared against great numbers in 2006.

Waited average RevPAF, or revenue per available foot for our same-store pool was about $11.75, which represents a 5.9% increase year-over-year. The increase was nearly all from higher rates, as year-over-year average occupancy was flat. Our stabilized group of 581 properties operated by Extra Space had revenue and net operating increases of 5% and 6.3% respectively for the quarter. These are also very good numbers.

Now, our expenses are lower than we budgeted due to light snow removal expense in the early winter and lower advertising and utility costs. Even though I'd like to see these expenses hold at the current level, we fully expected our expenses to come more in line with our budgeted levels of 3% to 4% as the year progresses.

We have higher advertising expenses as a result of some national -- I'm sorry, we will have higher advertising expenses as a result of some national advertising that we're going to be doing in the second quarter, and we'll give you more on that a little bit later. Northern California, the central and Texas regions were the strongest performers, with year-on-year growth above 7.5%. Florida, after a couple of years extraordinary growth is our softest market when compared to last year.

Occupancy there is down about 4% and revenue increases are negligible. At a more detailed level, our top-performing MSAs, where we have ten-plus properties and high rent square foot are Chicago, Dallas and San Francisco. Phoenix, though growth has slowed a bit from 2006, is also continuing to do very well. Boston, LA, the Baltimore-DC area are all in the 5% range of revenue growth. Las Vegas and New York City markets are up slightly but below the portfolio average.

Though Florida as a whole is soft, it's really a market by market phenomenon. For instance, Miami has revenue growth in the high 3% and Boca and West Palm have negative growth. Orlando is flat, while West Florida is more in line with Boca. The supplemental package of information on our website is performance broken down by region and MSA, if you need to look at it for more information.

Overall, rental activity was flat this year compared to 2006. Weather seemed to affect rental activity in the mid-Atlantic and Northeast regions, especially in the last few weeks of the quarter. The weather in early April, as those of you in the Northeast can certainly attest, has continued in this trend. Our property operating performance over the next few months is going to be key for Extra Space's year as a whole. With that in mind, we're going to be rolling out our first-ever national television advertising campaign, running on cable channels.

After a promising limited test last summer, we're looking forward to the impact that this program will have on site traffic and just as importantly the awareness of the Extra Space brand name that we have rebranded all of our properties. The program just started this week and will consist of 60 and 120-second spots on networks such as Bravo, TLC, Spike, DYF, [DIY], which is Do it Yourself Network and MSNBC.

Though it's early, in the first couple of days of the program, we've seen a significant increase in call center volume and Web traffic and reservations. The program is scheduled to run through the end of June. We'll be monitoring the results closely and possibly make some adjustments based on network and airtime performance.

The approximate costs of programming will be about $1 million and we'll spread it across the 640 operated properties. In other marketing and promotional news, we are currently running a sales program that is tied in with Extra Space's 30th year anniversary. This program consists of pricing and discount specials at about 320 selected properties.

The most prevalent discount is one month free and unit pricing has been lowered an average of 6%, using our real-time pricing triggers through our revenue management system. This has increased our discounting when compared to last year. However, the properties in the sales program have responded positively and have shown increased rental activity.

Now I'd like to wake up Kent Christensen, our Chief Financial Officer, who will comment on our financial results in more detail.

Thanks, Karl. There's a little more information about our first quarter numbers. Total revenues for the three months ended March 31, 2007, were $53.8 million compared to $45.4 million for the same period of 2006. Net income was $6.5 million, compared to $738,000 last year.

Contributing to the increase in revenue and net income as a marked increase in the number of wholly owned properties due to acquisitions and development, continued lease-up of our pre-stabilized properties and our operational and revenue management team's ability to maintain occupancy and increase rental rates at all our stabilized properties.

On the debt side, the news for the quarter was the issuance of our $250 million in exchangeable notes. The proceeds place our balance sheet in a very strong position for growth while keeping our debt ratios in a comfortable range. We feel confident that we'll be able to use this money for acquisitions in the next year. We have paid off $30 million of variable rate loans. In the meantime, the rest of the money is earning over 5% in short-term investments.

Including the proceeds from the offering and our untapped line of credit and unleveraged properties, we have access to over $500 million for growth opportunities at this time. Total outstanding debt as of March 31st was approximately $1.24 billion, including the $120 million in notes payable to trust, and the $250 million in exchangeable notes. Approximately 93% of our total debt is long-term and fixed rate, with an interest rate of 5% and an average maturity of nearly six years. The total weighted average interest rate of all debt is 5.1%.

Our total debt as a percentage of our total market cap, including OP units, was 49.1% at the end of the quarter. And our current fixed charge coverage ratio as of March 31st was 2.15, and that compares with our 2006 number of 1.85. G&A for the first quarter was $9.3 million. We are on a pace to be within our 36 to $37 million target in G&A cost net of development. Our G&A number also includes our acquisitions department, which is not outsourced.

For the three months ended March 31, 2007, the CCS/CCU calculation as outlined in our IPO prospectus allowed for the conversion of approximately 471,000 shares and units. Those shares will be issued on May 4th. Total shares and units converted to date are approximately 526,000. At the current rate of NOI growth, we anticipate converting approximately a total of 1.5 million shares and units in 2007.

FFO for the quarter was $0.24, and as Ken already stated, included in that $0.24 was six-tenths of $0.01 from our development drag on three wholly owned properties and two joint venture properties that opened in 2006, and two joint venture properties that have opened so far in the first quarter of this year.

At this time, we estimate our fully diluted FFO for the second quarter to be between $0.26 and $0.28 per share. For the year, we estimate FFO per share to be between $1.07 and $1.12. For the second quarter, the delay in the 5A acquisition was offset by the accretive nature of the exchangeable offering.

With that, I would like to turn the call back over to Ken Woolley.

Thanks, Kent. As you heard during the call, we've had a positive 2007, at least the beginning. We've had excellent revenue and NOI growth in our same-store pool and in our company overall and our operating performance is doing very well. Some of you may have heard that we have entered the international arena by forming a joint venture with a company in Mexico.

The company is called U Storage, and we are now a 49% owner of that company, and we are working forward to working with our partners in Mexico to exploit a market which is very small and underdeveloped at this point, but we believe has excellent potential.

Mexico City, for example, has nearly 30 million people and has less than ten self-storage facilities. So we're looking forward to that opportunity and we will be keeping you more up to date. That investment right now is only a $5 million investment, so in the overall of our company it's quite small, but in the years to come it could become larger.

Also, we've looked at other acquisition opportunities in Europe and we've not yet had an opportunity to get into that market in a way that we'd like to. If we do get into that market, our intention would be to do it on a fairly large scale, and the opportunity to do so has not really presented itself.

We do however believe that our operational capabilities and our knowledge of how to run this business is such that we could take on an international opportunity and if it presents itself we will go after it. We are making growth our kind of key goal of this year. In the past, last year, we were really focusing on operations and getting Storage USA and Extra Space put together. That's pretty well done, so we're really focusing on trying to increase the acquisitions.

It's true that we've been very successful in working with our strategic partners to purchase properties and probably a little less successful in the open market because of the low cap rates, but we are working hard to make deals and to buy properties in the best markets in the United States. About half of the -- 30 acquisitions we've completed since the beginning of 2006 have actually come from that strategic partners program.

Now, the key from our income growth this year is going to be really the performance in the second quarter. It's our biggest rental quarter. We're very optimistic for our prospects for excellent rentals because of our many new marketing initiatives, such as television and our new enhanced website and better Internet marketing and our 30th anniversary sales.

However, we are also cautious, because there has been weaker rental activity -- not same-store income growth, but rental activity, in Southern California, Florida, New York-New Jersey and the Washington, DC-Baltimore markets. These trends are a little concerning, as they've shown up here in the first quarter, and if they extend into the second quarter, it is something that we are going to have to take very dramatic action on, we believe ,through market and price initiatives.

The self-storage business continues to be a great business. It grows when the economy doesn't grow. It appears to grow, and it has in our experience grown, over quite a long period of time, at a rate faster than the population growth and the economic growth, and that's because of the tremendous consumerism of the American society, and the fact that we Americans like to keep our stuff and we don't like to give it up, and we don't see that trend changing.

And so, we're very happy that we're in this business. We think we're positioned well to perform well. Our properties lead the industry in market location and in demographics. Our centralized operational and revenue management systems do have the ability the respond quickly to changing market conditions, and we believe that we are an industry leader in this area, and our management continues to be committed to the goal of increasing shareholder value for all of us.

In closing, I'd like to thank everyone for being here at this early hour, and appreciate your support. With that, Kent, Karl and I will take questions.

[OPERATOR INSTRUCTIONS]

And your first question will come from the line of Christine McElroy of Banc of America.

Good morning, guys. I'm here with Ross, as well. As you're ramping up your development pipeline, can you talk a little bit about lease-up timing? On average, how long should it take these developments to lease up to a stabilized level? Are you finding that these lease-up periods vary by geographic area, and what do the stabilized yields look like?

Yes, they do vary by area of the country. We have consistently found that the west coast developments, including Phoenix and California, have leased up sort of on average between 18 and 24 months, and that the east coast is taking 36 to 48 months to lease up properties. The interesting thing about that is once they're leased up, the characteristics of income growth are not that different, but it just is a slower lease-up time for properties on the east coast.

We don't see that time changing. It really hasn't changed in the last three or four or five years. In other words, it's about the same today as it was five years ago in those regions of the country. We haven't done too much in Florida, but Florida seems to be a little more like California in its lease-up characteristics.

With respect to yield on cost, the pro forma yield on cost and the numbers we're looking at and the deals we're doing right now are between 8.5 on the low end, and I'd say just under 10 on the high end. We tend to demand a higher yield on cost for properties in the east than we do in the west, just because of the slower lease-up time and the fact that there's a little more riskiness of the lease-up activity.

Just going back to the lease-up timing, I thought I saw in a presentation that you guys put on your website a little bit ago that you were looking in some areas at four to five years. Can you expand on that?

Our historical time? Yes. The average I said in the east coast has been three to four years, but when you have an average, you have a bell curve and you have some that take longer, and so we have had some on the east coast that have taken us as long as five and a half years.

And also properties that we brought into the portfolio that Storage USA developed in the east coast had the same characteristics. So in the bell curve, you do have some as long as five years. And that's when you don't hit the market just right or when you are a little early in getting in the market and you're sort of first in it takes a little longer.

Okay, so on the margin they're not getting longer.

No, I don't think they're getting longer. I wouldn't say that's our experience.

Okay, and then can you just update us on your plans to possibly institute a merchant development program? What your thought process is there?

We're not doing that.

You're not doing that. Okay, great. And then just a follow-up, the $1 million of costs associated with the national ad campaign. Is that just through the end June? Do you he any more cost base in there through the rest of the year?

No, we don't. That's just through the end of June.

Okay, great. Thanks, guys.

And your next question will come form the line of Chris Pike of Merrill Lynch.

Good morning.

Good morning, Chris.

A couple questions here, folks. Ken, in terms of your national advertising campaign, how do you envision your call center changing to support that? I know you've contemplated an internalized structure, maybe even beta tested that, but as you move full force here, how does your call center change?

In the short term, there really is no change, although the TV advertising will direct more of our traffic to the call center because we're using a unique 1800 number or 1-888 number so that we can measure the impact. I think we have mentioned in the past we are testing at about 60 sites, having all calls roll over, but we're pretty early into that testing at this point, so no other changes are contemplated.

Okay, Karl, back to you then, I guess. In terms of your second quarter occupancy, I'm not looking for specific guidance, per se, but typically what type of sequential increase have you seen historically moving from Q1 to Q2, removing some of the weather-related issues or some of the other concerns or cautions that you've alluded to on the call?

Well, normally, looking at the past and what we would expect, we'll gain about two to three points from the first quarter to the second quarter, and we're expecting that same thing to happen in 2007.

Okay, in terms of acquisitions, just a couple of questions. The cap on -- or the average cap rate on the 29 million in Q1, what was that?

Chris, this is Kent. The number was over 8%.

Okay, and I guess just from a big-picture perspective, I guess if you weigh in the 155 A and the 50 million that you probably got year-to-date, of the remaining 150 million that you've alluded to in your guidance, what percentage of that should we assume comes from strategic partners, versus marketed deals, or just outside of the Extra Space world, if you will?

We would expect that -- obviously, we don't have anything under contract in the number that you just brought up, but we would expect it would be like 50/50, half and half.

And I guess, touching on your international comments, Ken, I understand the Mexican is relatively small. It's an equity position at this point. But expanding internationally would a multi-country platform like the PSA Shurgard, would that be something that would be of interest to you folks?

Or, do you think it's probably better to enter international markets one country at a time, not having to deal with several different accounting or legal constraints as, let's say perhaps the PSA folks are dealing with right now?

Well, first of all, we believe that PSA is in an enviable position because Shurgard really did all of the heavy lifting. They plowed the ground and did a tremendous amount of work in those European countries. And, yes, I mean, if we had had the opportunity to acquisition a portfolio like PSA did in those European countries, we would love that.

But if we're going to be entering on a scale smaller than 150 properties, it would be much more efficient and better for us to do it country by country, not two properties here and two properties there. We wouldn't want to do that. Looking at what Public Storage did, though, they have enough volume in the countries that they're in that it's great.

Okay, I guess just one, I guess, fundamental question. You guys expect any pickup from, I guess, the college recess, especially in the Southern markets, where there's a heavy college concentration, like Florida and the Southeast? I mean, do you guys typically see that through the summer months maybe you're able either to push rate a little more than typically observed?

Yes. This has always been true, since the founding of our business, basically, that if a property is near a university or college, the months of May and June are just dynamite months for leasing, and the month of September they all move out, and it's usually the smaller units, and we hate it.

We like it, but we hate it. And the reason we hate it is that here you have a property that might be sitting at 80% occupancy through most of the year, and then it goes to almost 98% during the summer and then it goes back to 80%. So we tend to, A) get rid of all the specials at those properties, so that we're not giving one month free to all the college students that are only going to be there for three months. And, B) we tend to try and get the properties mostly leased up so that the college demand doesn't affect us too much.

On the net, we view it as a negative, not a positive, because they never become long-term tenants. But we don't see it in markets generally. We see it in very specific properties that are close to colleges.

Okay, thanks a lot.

And your next question will come from the line of Jeff Donnelly of Wachovia Securities. Please proceed.

Good morning, guys. A few questions. First off, actually, it just pertains to your annual guidance. I guess effectively it's unchanged, despite the issuance of exchangeable senior notes. I would have expected that would have had a beneficial impact on your guidance. Any thoughts there?

Well, first of all, we increased the low end of the guidance by $0.01. Second of all, our guidance included the acquisition of 5A, which we expected to close in the first quarter and it didn't close, because it will be accretive. Right now, it's slated to close the last week of June, and so we sort of lost out from that. And so, we didn't increase the upside of the range because of those sort of offsetting factors.

Also, there's a negative number that we didn't really talk about so far. We sort of missed our internal number on our accretion of overhead costs into the development program. Some of our development projects have slipped in terms of their timeframe and we are unable to either collect the development fees or to accrue the costs of overhead.

And, in fact, in the first quarter, that amounted to $0.01 a share. If we had hit our own internal budget, we would have had $0.25 a share instead of $0.24 a share. Other things came in better, so it didn't really hurt us.

There's always risks. As I did mention, we're a little cautious, because we've seen some slowing of rental activity and a little bit higher vacates in markets, specifically, the year-on-year net rentals are down -- and this is for the first quarter, are down 18% in South Florida, 8.5% in San Diego, 5% in Washington-Baltimore, 4.9% in New Jersey, 3.8% in Chicago and 12% in Memphis.

These are negative trends. Now, these are net rentals. These are on the margin. We're increasing tenants. We've actually in many of those cases had positive income growth, but other markets have had positive net rentals, so it's not all a gloomy story. But I'm just being a little more cautious here because year-on-year we've seen a little bit higher vacates, and so therefore we haven't changed the upper range of the guidance.

If things go well and we do a good job in operations, we could see our company hit the upper end of that guidance. If things kind of moderate a little bit in the economic environment and we don't get as many new acquisitions, we could see it at the lower end of the guidance.

You dovetailed nicely. Now my next question, is what's your gut at what's going on behind that weakening, if you had to make a guess? And to the extent that does continue, are you seeing that in April? What steps do you actually take?

First of all, what do I think is behind it? It appears to me in Florida it is the unwinding of all of the demand caused by the hurricanes. When I look at net rentals, the actual new rentals coming in in Florida are not that different than last year. It's the vacates that are higher.

So in that case, it seems to be we had a lot of excess demand from people who had their houses hurt and things like that and they've now fixed their homes and they've moved back out and they are not using the storage as much.

In Southern California and San Diego and in Las Vegas and even to a little bit extent, Phoenix, it's probably the slowdown in the housing market that's affecting it. I can't really answer the reason, and maybe the trend isn't that strong -- Washington, Baltimore, New York, New Jersey, could be what was more emphasized in March and early April could be just the weather and it may not be a trend at all.

I just want to circle back quickly on a comment you made earlier about I guess accretions coming from development fees and just slipping behind on timing. From an earnings standpoint, is that just a timing issue? In effect, that penny, you might be able to pick up in future quarters or is that effectively --?

No, when I said the accretion, that isn't really accretion. What that is is we are able to capitalize certain of our overhead costs into the developments, but we have to do that on a very rigorous way when we've in fact acquired a property to develop or it's been approved or it's under construction, and we can't capitalize an expense if the activity didn't occur, it's related to what happens and how fast our development program happens. So if it doesn't happen, then it just becomes overhead.

Okay, and then just a question or two on the international side, regarding Mexico, how would you compare what you think the opportunity is in Mexico versus that in Europe in terms of investment returns or unit growth potential? Real estate historically has been a little cheaper than what you see in Europe. Do you think longer term it's a better place to go?

Yes. The three properties that the U Storage company has already have been excellent in performance and the cap rates, cost on cost, are way higher than Europe. And if you look at the density of population in certain cities in Mexico, and also the tourist cities of Mexico, there's a lot of money.

I mean, yes, there's a lot of poverty in Mexico, but there's also a lot of money there, and there are certain markets there that w believe will be excellent for self storage. It appears to me a little when I see the lease-ups that are much faster than in the U.S. that they in fact are a little more like it was in the U.S. in the '70s, whereas Europe has always been a slow lease-up market. And I'm talking about whether it's England or France or Germany or Belgium.

And the cash on cost, the yields have not been that great in Europe. If you look at the development yields that Shurgard actually achieved, they weren't very good. They weren't any better than the U.S. In fact, they were really not as good as the U.S., and so the argument to go build in France is not that strong, really. I'd rather do it in New York.

Do you think the consumerism that I guess you need in those markets to have the demand for people to go out and get self storage exists in Mexico like maybe you see in the United States or Europe?

Well, it doesn't exist in the population at large, but you have a growing middle class and you have a pretty good size upper class where there is a lot of consumerism. One of the things you'll be interested in is that the self-storage industry is exploding right now in Hong Kong. The number of properties just since we looked at it a year and a half ago has almost tripled, and there's a lot of consumerism in China, of example. We haven't jumped into Hong Kong, but we've looked at it.

Just one last question. I mean, I guess return opportunities aside, at some level, I guess are you concerned, or how prudent is it for a company of your size to be exploring international expansion, just given the cost and the effort that it can soak up from management time? And I guess to the extent you do pursue it, are you going to look mainly by acquisition as opposed to development?

I think the latter. The acquisition is to post the development. In the case of Mexico, we have a strategic partner. We're taking it cautiously, we're going to look at it and we aren't spending a lot of management time on it. We are not in fact -- it's something we've looked at and we did make a bid on a company in England and that company eventually went public instead of selling to us and that's fine.

But what we wanted to say on this call, if a significant opportunity presents itself, we will look at it, but right now we're not spending a lot of management time on it. Our management time is being spent on acquisitions and development here in the U.S.

Great, that's helpful. Thanks.

And your next question will come from the line of Michael Salinsky of RBC Capital Markets.

Good morning, guys. Quick question on the insurance business. It seemed like it continued its strong ramp up there in the first quarter. Just in terms of scale, how much do you see this business contributing to the bottom line in 2007 versus 2006?

We see it continuing to grow. Gross, we're going to generate about $8.5 million in 2007 and about $4 million of net overall.

This is Kent. That's about double what it was a year ago.

Okay, makes sense there. I know you talked a great deal about your development pipeline for 2007 and 2008, but can you kind of give us a sense of the cash outlays you expect to spend both in 2007 and 2008?

On the development?

Yes, the actual cash outlays, not the total costs themselves.

Well, right now, the total expected budget for those projects is $137 million and with the cash we have we would be using our cash to do a lot of that, but as soon as we find acquisitions that we want to acquire then we would be leveraging up those properties and end up with 80% loans on those development deals. So we would only have 20% of our cash in the development deal.

So you'd put in place mortgages there, you wouldn't --

Yes, we would use debt to finance the development.

Okay, makes sense there. I noticed during the quarter also that the amortization of intangibles dropped fairly steep from the fourth quarter. Was there any major driving factor behind that?

Yes, the amortization of intangibles is a calculation where on an acquisition opportunity you have to allocate some percentage of the purchase price to the customer rent rolls that you acquire. The accounting rules require that you amortize that over a very short period of time, 18 months, so with the acquisition of the Storage USA assets, you have hit the 18-month period, and therefore the amortization is going to dramatically drop.

Okay, so the 900,000 is a fairly consistent run rate going forward, or do you expect additional drop-offs?

We'd still expect it to drop even some more as we go forward, but for FFO it's an add back, so it's not affecting our FFO number, it's only affecting our net income.

Fair enough, and, finally, just looking at Mexico and I know you guys had talked about Europe and Hong Kong. How are the regulations different in self storage and some of these countries you mentioned versus the U.S.?

The regulations of Mexico are really undeveloped. There's not enough properties. I think there's like 25 properties in the whole country, and there aren't regulations. It's really very early days, and so I guess my answer would be there are no regulations. You just run it as a business.

But it's also a less litigious environment than the United States.

So there is a possibility, then, you guys could go in without a joint venture partner in a call it international opportunity?

Well, right now, in this particular case, we are very committed to our joint venture partner, so we'll have the opportunity as development deals come along in Mexico, and we can't really do it by acquisition, because there's no properties in Mexico to acquire to participate at a larger level than 49% as capital is required if we think the deals are good.

Great, thanks, guys.

And your next question will come from Michael Knott of Green Street Advisors.

Good morning, guys. I was just wondering if you could comment on if you were to strip out the legacy same-store properties from the now-larger same-store pool, how did those fare?

I don't know if I even know. Do we know? Do we have the data? We have the data some place, but I don't think we kept track of it.

We're really operating -- trying to move away from the legacy ESS to the legacy Storage USA. In general, the legacy ESS stores are newer and in better markets and are performing better than the legacy storage USA properties, but we're moving away from really trying to compare the two and really looking at it as a unified portfolio.

Right.

We don't even have the data prepared, Mike. We could obviously get the data, but we don't have it on the spread sheet. We do have it?

No problem. I was also curious how the wholly owned Storage USA stores compared to the 254 joint venture Storage USA properties, which seemed to be a little below the wholly owned same-store pool yet again. Just curious if you guys have any more insight as to why those continue to trail?

I'll take this one. Because, in general, the legacy ESS properties are newer and nicer properties than the legacy Storage USA properties. They just compete better. The customers are -- as they drive by, they look newer and better and as they rent, they appreciate. It's the reason you spend more money for a newer, better property.

Okay. And then, Ken, can you elaborate on some of your initial comments on the sales market being competitive and EXR passing on some deals due to very low cap rates in the market? Can you just maybe put some parameters around that and maybe what you think different buyers are willing to accept in terms of unleveraged IRRs?

I think where we've seen the biggest competition is in properties in lease-up. We would love to acquire new properties that have just finished their -- they've just gotten to full occupancy. And what's happening is many of those properties that are coming on the market are selling when they're at 20%, 30%, 40%, 50% occupied and the buyers are willing to pay a price that is nearly the same as if it was fully leased.

And because we're a REIT, and because we're judged on our FFO, it becomes very difficult for us to compete in purchasing a lot of properties that are in lease-up that would be dilutive to our FFO. And so, those really nice properties are often getting snatched up before we get the opportunity to want to buy them when they're 70% or 80% occupied, so that's one issue we're dealing with.

And it's because so many private buyers don't care about FFO. They care about long-term -- and maybe to me what happens also is that new entrants to the business, people who have not been in the business very long before often underestimate the difficulty and the actual lease-up timeframe and the ultimate cash flow from a property.

So we see what's happening is, we'll look at a portfolio where we will bid on it, it is a lease-up property, we'd like to have it, and we look at the ultimate cash flows and we see a cap rat of really, in our view, it's a 6% cap rate on ultimate cash flow. But from the view of the seller who's promoting it, it's a 7.5.

And to the buyer who thinks he's going to get a 7.5, he's buying it thinking he's going to get a 7.5. And we look at it and say well, we've had a lot of experience in these markets and we don't think it's every going to get there, and we think you've overestimated what's going to happen when it's going from 40% to 85%.

So we see a lot of that going on, and it's usually people who have sort of recently jumped into the market because it's a great market to be in. There's a lot of institutional money chasing self storage and that's where it seems to be going.

Okay, and then I guess just lastly, is the U Storage deal, is that included in the under contract number you quoted earlier?

No, it closed, and it's really individual properties, because we own a minority position in a corporation, a Mexican corporation. And I think our investment was 4.5 million or something, or 4.7 million, just under five.

Okay, and then my last question is for Kent. Kent, how did you guys look at the convertible note deal and measure the tradeoff of low interest rate versus the equity that you're possibly giving up on the upside?

Well, obviously, the equity that's being given up was sold at 23.48. So if our stock gets to 23.48, then that means that all of us and all of our investors have done very well, and in between now and then we've had a very low interest rate bond that we've been able to see a lot of accretion from.

Okay, thanks.

And your next question is from the line of Paul Adornato from [BMO] Capital Markets.

Hi, good morning. Just a couple of questions. Was wondering if you could tell us what the message will be in the national TV ads. Will you be offering a blanket discount?

We'll be offering basically the same special that we're offering at most sites, anyway -- well, it'll be a little bit better than that, but the basic offer is one month free, but it is based on availability, so it is impacted by occupancy. Now, the incremental giveaway is that we're also in the ad going to promote a free box package that's retail value $50. So that is an additional from our cost standpoint about $25, so from -- but we wanted to have a strong offer.

So there's really one month free, based on availability. We also promote two months free for a 12-month lease, which all properties offer also anyway, and then what is new or unique to the TV offering is the free box starter package, which runs about a $50 value.

Okay, will all that information be contained in the ad?

Yes.

Okay, and I think in the last quarter we talked a little bit about you positioning the product as a premium product, that is, not competing on price. How will that kind of mesh with the TV ads?

I'm not sure. We compete on price. Now, we feel that we should be able to get in relation to our competitors at or above competitors' prices, where a property is superior to the competitor's, but we certainly try and compete on price.

I think what we had talked about in the prior quarter is we had a program called [Sizzle] that is a training program for our salespeople that tries to get our managers to focus on things other than price. That doesn't mean that we're not competitive, but we also believe that we have what we believe are the best managers in the business, the best products.

We promote a program called clean and green, where our product is going to be cleaner and look better to the customers when they come in, and so we're putting that all together, but we're not only focused on price. But we realize you can't be non-competitive on price and special.

Right, right. Okay, thank you.

You're welcome.

And your next question is from Paul Puryear of Raymond James.

Hey, good morning. A couple of questions. Ken, do you track your renters by use, residential versus commercial? And I just wondered, if you did, if there was any insight into some of these weaker markets where in Florida, I suspect, contractor use would be way down?

We track them whether they're business or not, or whether they're residential, or whether they're business and residential. We don't track them by type of business, do we? I don't think we do, so I don't think we'd know that.

Yes, we do, but we don't have that data available right at this moment. And it's really more a trailing. We have a new renter survey that customers fill out and we accumulate that information.

Do you track it month to month? I mean, is it something you would look at as you saw markets star to weaken?

Yes, we would.

And is there any insight from that?

No, we don't right now -- well, I guess the answer is, we haven't really seen a significant change in trends.

Okay. Another question. The occupancy at 84% I think it is for the same-store portfolio, how do you think about occupancy versus rate, versus overall performance? 84 just feels like it's low. Obviously, you're expecting to ramp up here as you get into the better season, but just curious how you think about that.

I'll say something, and then I'll let Ken jump in. We'll peak out -- last year, at the end of April, we were about 84% comparable to where we are right now, and we peaked on all mature at about 80 -- actually in July, at about 87%. The owned stores only, that's for the 580, for the same-store 180 stores, we peaked out actually I use once again in July at about 88.6%, close to 90%.

Ninety percent is about where we'd like to peak out. It is a seasonal business. Would we like to be at 95% all year long? Sure, but it's also a balancing of getting the maximum rate with getting the right level of occupancy. Ken, do you have anything to add?

No, I was going to say the same thing. You have to really look at the seasonality. And the data we provide is the average occupancy for the quarter. And since the low of occupancy occurs sometime in February, the average occupancy for the first quarter will be the lowest occupancy of the year, and the highest occupancy of the year occurs in July. So there is a sort of four points variance.

And that factor, coupled with in that whole scheme of occupancy, we have certain markets which are weaker by nature either because of the competitive situation or because of some growth factor right now. So we have a lot of markets that in July they're up in the mid 90s, and we'd love to have, for example, the Boston area, in the high 80s, but it's not. And we'd love to have Detroit in the high 80s, but it's not, and we haven't been able to get it there.

And right now we're having declining occupancy in Florida by four or five points when it had been in the mid 90s, and now it's slipping. So when you look at a national portfolio, It's hard to run the thing really higher than about 90% at the peak.

Good enough, thank you.

And your last question will come from the line of Chris Pike of Merrill Lynch. Please proceed.

Hey, folks, I just wanted to follow up on the international commentary. I think an answer kind of got lost in the conversation, but just to be clear, going into international markets, you guys want to hold them on balance sheet 100%. You don't want to be a joint venture partner. Is that correct?

No, it isn't correct. We don't have any international deals right now and we have to look at as to what's good for the investors. And the only deal we have is with Mexico and it's a joint venture because, frankly, we have a great joint venture partner there and we don't really feel that w have the expertise to be developing by ourselves in Mexico. If a large portfolio came available in Europe, which is the other big market --

Yes, that's kind of what I'm pointing at.

If it became available, then we would try and buy it on balance sheet, yes. But it would have to be an accretive, good thing for our investors and something that was big enough for us to spend management time on it.

And then from just an infrastructure perspective, because I know the PSA folks, when they digested Shurgard, there were some issues with overhead, too many folks, work in there perhaps, not enough results from a personal perspective.

When you guys were looking at the [Safestore] acquisition, how would you have brought that into operations? Would you have kept the existing personnel, the property managers? Or would you have changed things? Would someone from Salt Lake have gone out and managed that out of an office out in the UK? How would that have come down? '

We would have left it intact with its current management.

Okay, and there would have just been oversight from Salt Lake.

Right.

Okay, thank you.

And, sir, you have no further questions at this time. I would like to turn the call over to management for closing comments.

Okay, first of all, I'd like to answer Mike Knott's information with regard to -- or his question with regard to the original same-store portfolio. It turns out that if you looked at the original same-store portfolio of last year, of 102 properties, the revenue increase would have been 6.7% and the NOI incase would have been 10.4% for the quarter, if we'd been using [the same for]. And for the SUSA properties we brought into that portfolio, 61, the revenue increase was 4.13% and the NOI increase was 4.9%.

So what Karl said is true. We aren't keeping that data. We had it here, and our analyst had to do a little work. We're not going to be tracking it and reporting it, but it is true that the Extra Space properties -- the original Extra Space properties were a little nicer, in a little better markets and doing a little better than the overall portfolio as a whole. And that's the way it is.

We're very excited about 2007. We have a great operating team right now and things are working well. Our operations is working well. Our training is going well. Our website is really picking up tremendously. We have a new website that was introduced in January and it's having some very marked increases in our rental activity, and we look forward to a great year in the coming year. Thank you for listening on the conference call, and we look forward to talking to you all in the future. Goodbye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a wonderful day.