Public Storage (PSA) 2016 Q2 法說會逐字稿

Good afternoon. My name is Jackie and I will be your conference operator today. At this time I would like to welcome everyone to the Public Storage second quarter 2016 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions)

Thank you. I would now like to turn the conference over to Clem Teng. Please go ahead.

Thank you, Jackie. Good morning and thank you for joining us for our second quarter earnings call. Here with me today are Ron Havner and John Reyes. Before we begin, I want to remind those on the call that all statements other than statements of historical facts included in this conference call are forward-looking statements subject to a number of risks and uncertainties that could cause actual results to differ materially from those projected in these statements.

These risks and other factors that could adversely affect our business and future results are described in today's earnings press release and in our reports filed with the SEC. All forward-looking statements speak only as of today, July 28, 2016, and we assume no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

A reconciliation to GAAP of the non-GAAP financial measures we are providing on this call is included in our earnings press release. You can find our press release, SEC reports and an audio webcast replay of this conference call on our website at www.publicstorage.com. Now I'll turn the call over to Ron.

Thanks, Clem. Welcome, everyone. We had another solid quarter here in Q2, so let's open it up for questions.

(Operator Instructions)

Our first question comes from the line of Ki Bin Kim with SunTrust.

Thank you. Ron, could you comment a little bit about same store revenue deceleration? I know it's not that much, it was only 50 basis points, off of a good number. I'm curious if you could provide some details of what caused it. And tied to that, from the years I've covered you, I've always known you guys to be a little bit more biased towards occupancy -- part of the equation -- so maybe you could comment on the decline you saw towards the quarter end?

That's a lot of questions, Ki, but I'll try to answer it. And then I'll have John chime in with some details. If you look at the same store portfolio and growth year-over-year in our top 20 markets, you see two markets that really stand out, Denver and Houston.

Denver's revenue growth year-over-year declined by 8.3% and Houston year-over-year by 6.6%. So those markets declined from nearly double-digit growth last year to about 2% this year and then you've got Washington, DC chugging along down there at about 2% growth as well. But the big declines were in Houston and Denver. And those are also markets where occupancy degradation was probably 150, 200 basis points. So challenging markets.

We have a fair amount -- there's a fair amount of new supply in the markets. We have a number of properties in fill-up. So there's some cannibalization of the product there. But I think Houston itself has some general economic slowdown there.

The other markets, our west coast markets, are doing phenomenal, from San Francisco to LA to Seattle, Sacramento, and they're full. So they're not able to grow enough in terms of occupancy to offset the decline in markets like Denver and Houston. That's kind of the big picture in terms of revenue growth.

Okay. Does that mean -- I can see those two markets being the supply -- controlled by supply markets.

Supply, and in Houston you've also got, I think, there's some impact there from the slowdown in the oil industry. Probably some out-migration of people in that marketplace right now.

Would I be stretching too far if I assumed for the other markets where, as you've talked about, more supply coming on, not just this year, but maybe next year as well, can this be -- can I draw a straight line and say there's other markets that might be seeing this weakness further down the road that might impact your overall results?

Well, there's certainly new supply and I've been saying for a year that -- two years, that new supply will definitely impact revenue growth. And certainly in markets, I think, like Denver, New York, it is impacting, to some degree, revenue growth. But if you look across the markets, you've got Denver down 8%, Houston down 6%, Chicago and West Palm Beach were down 2%, but everything else is plus or minus 1%. Kind of the standout on the upside were Seattle, 2% change in the growth rate year-over-year, and Sacramento up 3% year-over-year.

Sacramento had a phenomenal quarter, up 11.8% in terms of total revenue growth. Everything else is kind of bouncing around plus 1%, minus 1%, but then you've got these big anchors there in terms of Chicago, Houston and Denver.

Okay. Thanks, Ron.

Our next question comes from the line of Juan Sanabria with Bank of America.

Hello, I'm here with Jeff Spector. Just a question on rates. Any sense of what you're being able to push on a portfolio basis to start the third quarter and if you could help us maybe get a picture of how that trended throughout the second quarter, each month maybe throughout the second quarter versus July, and maybe what we're seeing in August to date.

Juan, this is John. Our rates I would say as we continue through the second quarter and into July, we've continued to -- overall, the overall portfolio, continued to ratchet rates downward so that now that our rates are below last year. We've also turned on more discounting, the dollar special discounting, as well as discounting on our website.

As Ron mentioned, much of that is coming from some of these weaker markets, so overall it's down. But there's markets that are up like the west coast that Ron mentioned. I would expect, until we see this weakness -- and the weakness is coming in on the demand side. Our existing tenant base is not turning over any faster than it had previously.

The move-ins that do come in are sticking around just as long as they always have. I think the difficulty that we are seeing in these markets is just lack of demand into our system and, therefore, we're having to reduce pricing and increase promotions.

Could you gives us a sense of what the year-over-year delta is in maybe July? Just to see how that compares?

I don't have that, but I can tell you in the quarter the year over year delta in the move-in rate. Last year the delta -- I'll say the year-over-year move-in rate delta is about -- we were up 3.9% on the move-in rate. But our move-in volume was about -- down about 3%. So overall in terms of, I would say, contract or projected rent, we were up slightly by about 0.5 percentage points. Great. And then just on the supply picture, could you give us a sense of what you're forecasting or thinking supply could be across your markets in the country.

You know what, do you mind getting back in the queue so other people can ask.

Sure. Sorry about that.

Our next question comes from the line of Steve Sakwa with Evercore ISI.

Thanks. Ron, you want to touch on supply?

Sure. I think it continues to expand. I don't have the second quarter numbers from all the public companies yet, but last year at the self storage association I gave a projection of 30 million square feet to be delivered this year, and using the same methodology, it's up to about 38 million square feet. So whether my methodology is correct or not, if you extrapolate that, there's been about a 20% uptick in the volume of new supply in the last 12 months.

Again, it varies, as I continue to say, it varies by market. Certainly the lower barrier entry markets such as Dallas, Houston, parts of Florida, people don't think of New York as a low barrier entry market, but there's a lot of supply coming into New York, those are markets that are getting, I would say, above average growth and supply, while markets like San Francisco, Seattle, and even most of LA have an absence of new supply. Or very little.

Okay. Thanks. And I guess second, it was striking this quarter that your expenses were up a little over 4%. I realize first half of the year, it's still low at 0.6%. I know you talked about expenses maybe finally picking up to a more normal rate and maybe people have doubted that, but maybe it's starting to come.

I guess can you just talk a little about some of the line items that are up? In particular, the on-site payroll was up 6.5%, and I'm just wondering if you're seeing on a sustained basis wage inflation and other things that may be putting you in a more normalized expense environment?

You said it correctly at the front, Steve. I've continued to say expect expenses 3% to 4%, and so we're kind of finally there. First quarter, Q1, we got a big benefit of the snow removal and obviously that's not going to recur. Property taxes continue to drive our expense growth, they're by far the largest item, and they're up to a 5% run rate.

On-site payroll, wage growth was about 1%, 1.5%. The change in payroll was really we had a workers comp credit last year, I think of $1 million, $1.5 million, and then we had an uptick in medical insurance. So that's really what's driving that line.

Going forward, though, obviously over the next couple of years here on the west coast we're going to see an uptick in base wages due to changes in minimum wage law. Does that address what you're thinking about?

Yes. I guess it sounds like maybe this, call it 3%-plus expense growth, which you've been able to keep it in kind of the 1% range, plus or minus, may be ending and we should be thinking about a more normalized expense environment from here forward.

I think that's a fair statement.

I think you should -- Steve, this is John. And also add that advertising expense is going to uptick as what we will be doing in some of these weaker performing markets is we will be increasing our advertising spend on the web, as well as we may increase our spend on television advertising sometime in the third quarter and into the fourth quarter.

Okay, guys, I'll yield the floor. Thanks.

Thanks, Steve.

Our next question comes from the line of George Hoglund with Jefferies.

Hi, guys. Yes, so stay on the development topic, your development pipeline is now about $630 million. Do you see that number as continuing to grow? And are you seeing any cannibalization from your new developments on your existing portfolio?

Well, last year I said the development pipeline was hitting about $500 million. I thought that was peak and Dave Doll and the team down there have moved it up to $600 million. Certainly some of those properties will fall out, but I'm very pleased with what we do have in the pipeline. We're going to have about $180 million of that deliver in the back -- in the second half of this year.

So it will come down. We'll see if the team can replace that $180 million. So we continue to develop. We see attractive yields in some markets just there is some cannibalization, although we're trying -- very focused in terms of developing where we don't have existing product right near our current product. That's not always the case.

There is some cannibalization. And certainly smaller markets like Austin, Texas where we put up a lot of product over the previous two years and we've seen a lot of other new product, there has been greater than average cannibalization, then say in a market like Dallas where we're building mainly in north Dallas where we don't have much product.

Okay. Thanks.

Our next question comes from the line of Vikram Malhotra with Morgan Stanley.

Thank you. Just looking forward into the back half and 1Q where things are just naturally a little slower and maybe you pull back on rate a bit, how are you strategically and tactically thinking given what you've experienced this past quarter. Obviously, the results are pretty strong, but I'm just looking forward and seeing at that time when things are weaker, what are you expecting in terms of (inaudible) and ability to push overall rate?

Well, this is John. We're still pushing rates -- the renewal rates to existing tenants, we're still marching down the same path we have. We're obviously watching that to see if it's triggering any ramp-up in move-out activities. So far it hasn't.

As I've mentioned, the real struggle on some of these markets is on the front end and getting more demand into our system. But if it continues, the weakness, we'll just continue to cut rates and we'll continue to discount until we finally can get to a point where we're comfortable that we've found an equilibrium that we're happy with. So we're not afraid to cut rates and we'll go right after market share.

And so just to clarify, the existing -- can you just give us an update, like how much is the existing rate -- the rate to existing customers, is that in line with recent trends and [Street rate] is still in that 6% range?

Yes, we're still sitting at increases to the existing tenant base, just like we did -- very consistent with what we've done over the past one or two years and the range is somewhere between 8% and 10% increases. Again, we're not seeing that our existing tenant base is any less stickier than they have been in the past. In fact, I think Ron is going to throw out a little stat here, and I'll let him throw that out. But the problem, again, in those weak markets are just trying to get the move-in volume coming in the door.

The percentage of customers greater than a year for the second quarter was up to 56.5%, which is an improvement from last year's 55.9%. Two years ago it was down at 54%. So we've moved that 2.5% over the last couple of years.

Okay. Thank you very much.

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

Hi. Thanks. Just first, a follow-up. John, I just was wondering if you could provide a little clarification. I think I heard you say that rates were lower year-over-year in July. Was that asking rates that you're referencing?

Yes, yes.

Can you just provide a little more detail there, or quantify what the year-over-year delta looks like?

The year-over-year delta, I think, the move-in -- I'm going to refer to what they're moving in at versus the Street rates, because Street rates, they're not -- to me they're not as important as the actual move-in rate that's coming in the door. Move-in rates were down about 2.5% month to date compared to the same time frame in July of last year.

Okay.

I would say, again, just keep in mind, that's the average for our entire system. Seattle's probably up 6% to 8% and Houston's probably down 5%. So this is -- I'm just throwing out averages here.

Okay. And over the last few years, is this the first time system-wide that you've had a reduction in asking rents year-over-year during a month?

I don't have that data in front of me, but I don't think so, but I don't know.

Okay. And then I'm just curious, -- Ron, you just mentioned that you're increasing rents to existing customers, the percentage of customers was higher year-over-year in the quarter. If you do start -- if you continue to reduce asking rents, system-wide, what does that do to the percent of the portfolio that gets a rent increase or is eligible for a rent increase?

Generally, as you reduce rates, customer duration gets longer. And so that, by definition then, or axiomatically would say, okay, if customer duration increases, percentage of customers greater than a year increases, therefore, the more customers eligible for an annual rate increase. I don't know if that's going to happen, but that's -- in theory, that's what would happen.

Okay. Thank you.

Our next question comes from the line of Gwen Clark with ever with Evercore ISI.

Hi, good afternoon. Just really quickly, can you give us an update on how Shurgard did during the quarter?

Sure. For the quarter, this is same store, Shurgard had a 7% NOI growth. Occupancy was up to 90.6%, averaged 90.6% versus 90.1% last year, and realized rents were up 3%. Overall revenue was up 3.5%, expenses were down 1.3%, that's how you got to the 7% NOI growth. Do you want by country?

No, I think that's good. So by and large it looks like those metrics look good. How are you guys thinking about your strategy post Brexit? If it has an impact at all?

It has no impact. We'll deal with whatever unfolds in Brexit. Keep in mind over in Europe over the next 12 to 18 months, you have a substantial number of elections which could change the political environment quite dramatically over in Europe, combined with the Brexit. So we'll see how it plays out.

Okay. That is helpful. Thank you.

Our next question comes in the line of Jeremy Metz with UBS.

Hey, guys. Ron, I just wanted to ask you, one, on succession planning and if you could talk about the decision to bring Joe Russell over to Public Storage from PSB.

Well, the decision was we had a great candidate, a person in Maria Hawthorne, who was capable of ascending to the CEO position at PS Business Parks, a 31 year employee, which then made Joe available. Joe has a phenomenal track record at PSB. We have not had a COO at Public Storage for about a year and-a-half, so he's a great addition to the management team.

Okay. So no intention to step down in the not too distant future then, I'm hearing?

I'll be here next quarter.

Okay. And then in terms of Oklahoma, your acquisitions there this quarter more than doubled your footprint in that market. I'm guessing maybe this was a portfolio deal. So I guess my question is if you did this to protect your current position in the market or is this a market on your radar to further grow into?

We haven't closed anything in Oklahoma.

Okay. I guess you have them under contract, right?

Yes. So if it's under contract and not closed I'm not going to comment on it. If we get it closed, that's a good question for next quarter.

All right. Thanks, guys.

Our next question comes from the line of Smedes Rose with Citigroup.

Hi, thanks. I just wanted to go back, you mentioned that move-in volumes are down. I'm just trying to think about -- and as much as you can tell -- do you think that's a factor of new supply overall or do you think there's an affordability issue where the industry has pushed rates high and long against very high occupancies for so long that people are just sort of turning away and you need to make it more affordable again, which is, it sounds like what you're doing.

Well, I'll start and let John finish. Go back to my earlier comments of a number of markets whether it's Sacramento, Seattle, even LA, Dallas, San Francisco, during the second quarter here, we were full last year at 96%, 97%. We were full again this year, 96%, 97%, so in terms of net pick-up, the move-in volume, there was no more space to sell this year than there was last year.

Where the markets are soft, whether it's Houston, Chicago, Denver, as John touched on, were cutting rates and it seems to be a demand issue. That's where you probably had the greater fall-off in move-in volume. So think of it as part of your portfolio, a good part of your portfolio, is just sold out year-over-year and so you're not going to have much of a change in move-in volume and the stuff that is soft is where you're going to have degradation and move-in volumes precipitating the change in rates that John touched about. Do you have any --

Hey, Ron, it's Michael Bilerman. Just going back to Joe Russell. Can you talk a little about the role and responsibility and, I think, when it was announced I was surprised it didn't have the COO in the press release. So talk a little about role responsibilities that you want him to accomplish and then talk about how it may be different. You have had a number of people through that role over the last five to 10 years and not much stuck. And so I'm curious how you expect Joe to make an impact and what his tasks are going to be to be successful in that seat.

Well, Michael, those are all good questions, but we're a little early in Joe's tenure up here at Public Storage to really answer all of that. As you know Joe, and the REIT community knows Joe, he's an established leader, and accomplished CEO. He brings much more to the table than the COOs that I have had. And, two, I've worked with Joe for 13 years at PS Business Parks. So I have a pretty good understanding of his capabilities.

Right now he's focused on learning our business and learning our markets. So right now he has no direct operational responsibility. He's out learning the business and learning the markets.

He had a pretty big move to make to come over, probably didn't need any storage.

That's good.

Have a good weekend.

That's good, Michael. Thank you.

Our next question comes from the line of Michael Mueller with JPMorgan.

Yes, hi. When you're looking at your developments that are in process right now, are you noticing any changes in the time to fill up? I guess going to that incoming demand question, is it impacting the development pipeline as well, the lease-up?

No, Mike. So far, knock on wood, the developments are filling up ahead of plan. Keep in mind, we've had somewhat of a strategy of being a little aggressive on pricing and promotion in some of them to accelerate that. So the real test will be in a year or two do we achieve the targeted revenue level as rates are stabilized. But for the most part, they're on average, ahead of plan.

Ahead of plan in terms of NOI, well ahead in terms of occupancy, and we're very happy with the developments, deliveries and what's been happening. Our San Fernando road property here in Glendale that we opened May -- end of May last year, is already 92%, 93% and is already at stabilized revenue level. So an absolute home run.

Got it. Okay. Thank you.

Our next question comes from the line of Todd Stender with Wells Fargo.

Hi. Thanks. You traditionally haven't been a big seller of assets, but I know you had a few markets you were testing the prospects of selling, ones in the midwest. Can you provide any updates there on your asset sales and maybe any other markets you're looking to test?

Yes, we pulled that package and have changed strategy in terms of what we're going to do in those markets. I can't comment on that now because we're in the middle of trying to do a couple of things, but I would just say we pulled that transaction. We don't have any properties on the market for sale right now. Maybe next quarter or the quarter after, I'll be able to tell you -- explain what happened.

Got it. Thank you.

(Operator Instructions)

Our next question comes from the line of Ryan Burke with Green Street Advisors.

Thank you. Ron, as he we talk about the potential for moderating top line growth, does changing consumer behavior or the impact of new supply worry you more over the next 12 to 24 months?

I'm not sure I understand that question. Change in consumer behavior?

Yes, so demand from either -- or decision patterns of either your in place customer or new customers, what rent increases they're able to digest, where you're going to be able to push rents?

Well, I think we've touched on the differences in some of the markets where the demand issue is more of a problem, maybe there's an uptick in supply there, certainly in markets like Austin. So that's having an impact on demand and rental rates. As I touched on earlier, we have not seen any degradation in the churn rate and actually have seen an improvement in length of stay this year versus last year, which would lead you to believe that customer stickiness and our ability to have pricing power with our existing tenant base is still quite good.

Okay. And then --

Does that answer your question?

I think that gets me far enough.

Okay.

In terms of the same store pool, you only rolled about 15 of the 120 assets that you acquired in 2013 into the pool this year, which makes the definition of your same store pool diverge from that of your peers even more so than it usually does. Occupancy on those assets is mid-90%, so I believe you could have rolled the rest of those in. Can you just talk to us about why you did not.

Ryan, this is John. The reason why we didn't is because stabilization isn't just about occupancy. I could fill up a property in a year by giving it away for free and then throw it into the same store the next year and revenues would then just go skyrocketing. We view stabilization as not only stabilized occupancy, but also the stabilization of the rental rates that the existing customers are paying.

So for those properties that we acquired in 2013 that we did not put in the same stores, even though the occupancies were mid-90%s, the rental rates that were being charged to the existing tenant base was still far below what we think a stabilized number should be. So those properties we didn't put in. They're still growing at a much more rapid year-over-year change than the same store properties that are operating in those same markets. So clearly they're not stabilized and so we didn't put them in.

Ryan, to add some color to that -- what John just said, on the 2013 acquisitions, our occupancies year-over-year were flat 94.6%, but the contract rents were up 7.4%. And NOI growth on those was up for the quarter about 12%. As John said, it would look -- make the numbers look nicer or stronger if we put them in, from an objective reality in terms of are they really stabilized or not, they're not. So we've kept them out.

Understood. Thank you.

Our final question comes from the line of Todd Thomas with KeyBanc Capital Markets.

Hi. Thanks. Ron, realizing that the development machine takes some time to get ramped up here, as you look at growth perhaps moderating a bit at this point in the cycle, do you feel as you look ahead over the next couple of years that you need to make any changes to how you're allocating capital as it pertains to development?

Todd, I'm not quite sure I understand. Are you implying or indicating that we should allocate more or less? I'm not quite following your question, I'm sorry.

I know in certain markets like Houston, for example, you've talked about a commitment to that market long term, plans to develop, say, 100 facilities or so. You're also seeing softness in that market today. Does that change at all your commitment to that market or how you think about the pace of development?

Well, a couple things. Houston's a great market. We think it's long-term. I view it as the oil capital of the world. It's a great dynamic market. There's a lot of submarkets within Houston where we have little to no product and some markets where we do have some product, but we could penetrate those submarkets more.

Same applies to Dallas. And there's a number of markets around the country, but those two markets in particular are very vibrant and this does not change our program going forward.

Now, what may impact our program is, as rates roll down, it may adjust our ability to develop because it may not make sense in terms of what we can get land for and construction costs and the returns that we want on development to build as much in Houston as I would otherwise like. But long term, we're committed to those markets.

Our development pipeline itself, I think we've delivered through June about $320 million or so, and so there's a fair amount of embedded growth on that. We're targeting stabilized yields, 8% to 10% on the development and I think in the second quarter we generated about $2 million on that $320 million of investment. So you can -- going forward as you kind of go out 2017, 2018, 2019, those development deals will provide a substantial source of growth for us.

Right now they're a bit of a headwind. Our 2016 deliveries for the first six months lost about $500,000. So, net-net, we think it's a great investment long term, as I touched on, they're filling up ahead of plan, but it's a bit of a headwind on earnings today, but a great source of future growth. Does that address your question?

Yes, that's helpful. Thank you.

We do have a question from the line of Steve Sakwa with Evercore ISI.

Thanks. Just a follow-up. On the non-same store pool, I guess if I look at the numbers, John, the occupancy is about 500 or so basis points below your same store pool, and I guess the realized rent per foot is about $1.50 lower. I guess, one, would you expect this pool to ultimately catch up to the same store pool? And if so, do you think that's a 12 month process or more like a 24 to 36 month process?

First off, Steve, it's a different market mix than the same store pool, so it's hard to compare the two. It's a little apples and oranges, but I would say that in terms of potential future growth in this, I think that we're probably another 12 months to 18 months away for another rate increase to existing tenants before we start getting to that level of them reaching that stabilization point.

Okay. So, I guess, you wouldn't expect the operating metrics of this pool of property, assuming it stayed static, to maybe get to the same level of occupancy or the same store, or you would?

All other things being equal, if they were in the same markets, they should get there. But my point is that they're in different markets, a different market mix and I'm not sure what they are. For example, if they were all in Houston, could they get to the same market mix -- same rate as our same stores, probably not because Los Angeles and San Francisco dominate our same store pool and they have much higher occupancies right now than Houston does.

And higher rental rates.

Correct. So you're asking me to compare apples and oranges. All I'm telling you is that they're not stabilized and I expect that their growth will continue to outpace the existing same store growth, not only the growth of the overall same store portfolio, but those properties that are in the same markets, they will continue to outpace them just because of still filling up or stabilizing on the rental rates.

Okay. Thank you.

Thanks, Steve.

That was our final question. I'd now like to turn the floor back over to Clem Teng for any additional or closing remarks.

Thank you for participating on our call this afternoon and we'll talk to you next quarter. Have a good afternoon. Thank you.

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