Public Storage (PSA) 2016 Q4 法說會逐字稿

Welcome to the Public Storage fourth-quarter and full-year 2016 earnings conference call and webcast.

(Operator Instructions)

Today's call is being recorded. It is now my pleasure to turn the floor over to Mr. Clem Teng, please go ahead, sir.

Good morning, and thank you for joining us for our fourth-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, February 23, 2017, 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 report, 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.

Thank you, Clem. We had another solid quarter, so Operator, let's open it up for questions.

(Operator Instructions)

Ki Bin Kim, SunTrust Robinson Humphrey.

Good morning. If I think about your Company's history, you have always had a slight preference for keeping occupancy high. With that said, and the end of the quarter we saw a 50 bips decline in occupancy, while you maintained street rates at 4.7%. So, my question is, any type of change in the strategy and are you willing to let occupancies slide a little bit more for the sake of street rates? And is there an inherent pressure for you to keep street rates high in order to sustain the profitability of existing customer rate increase program.

Hi, Ki Bin, this is John. All great questions. No, we did not change our strategy to let occupancy fall, so that was not something that was intended. We certainly would like to see street rates maintain themselves and move higher because that is important when it comes time to raising rates to existing tenants or giving renewals.

But that certainly was not the intent -- what you saw during the fourth quarter. So nothing has changed. The occupancies obviously ebb and flow and what you saw in the fourth quarter was a little more move out activity than we had expected. But nothing more than that.

Ki, I would add our strategy is not principally focused on maintaining high occupancies. Our strategy is growing revenue per available foot. So, that is managing volume, rate, promotional discounts, all three together, to optimize the revenue per available foot that we have to lease.

Okay, and Ron if I think about some of that commentary you've made in the past about the supply picture in the industry. I'll say your estimates have been a little bit higher and maybe more correct on the overall supply coming in.

With that said and looking at the results in the fourth quarter and third quarter do you think it is possible when summertime comes around this year, that street rates or net effective rents can rebound? Or do you think that is probably difficult given what is happening with supply and demand out there?

Ki, it really is predicated on the market. If you look at the information released now that all the public self-storage guys have reported, if you take their C/O pipelines and what we are planning on delivering in 2017, our best guess is about -- for that group about 5.1 million, 5.2 million square feet. So that is up about 25% from the 2016 deliveries.

The current pipeline for 2018 is down but I don't believe the 2018 pipeline is completed yet. I think people will still be working on the 2018 pipeline here in the first half of 2017.

So were going to see, it looks like about a 25% increase in deliveries just from the public competitors, and my guess is that's whether the industry is 25%, 20% or 18%, there is a meaningful uptick in new deliveries, 2017 versus 2016. But those deliveries are not uniformly spread across the country. And I would have to say at least in terms of dollar value it appears most is coming into the New York market.

Just in terms of absolute dollar amounts, in terms of new deliveries, we don't have anything coming into the New York market. We just opened Jersey City but we don't have anything coming into the market going forward. But Cube and Xtra space appear to have a fair amount coming into the market.

So, obviously that market is going to be faced with a lot of supply here in the next couple of years. The other market that pops out is Portland, Oregon. We've seen that and we've seen a meaningful uptick and new supply there in Portland. We have already seen it in Austin, Denver, so it is not uniform across the country.

Okay, thank you.

Gaurav Mehta, Cantor Fitzgerald.

Any comment on what you saw on promotional and then discounts in the quarter?

Yes, Gaurav, this is John. Our discounts were up in terms of -- dollar amounts were up about 1.5%, we give away about $19.9 million of discounts versus $19.6 million for the same quarter last year. And this is for our same stores. Approximately 77% of our move-ins have some sort of discounts and that compares to about 72% for the same quarter last year.

Okay, great. And as a follow-up can you comment on how your assets in Olathe are doing especially in Texas?

For the most part they are leasing up but I would say it's too early to tell because normally in lease up we are little more aggressive on rental rates and promotional discounts. So while the occupancy maybe higher, it will be a year or two in terms of really understanding, are we achieving the rental rates that we underwrote. But so far they seem to be doing pretty good.

Okay thank you.

Smedes Rose, Citigroup.

I wanted to ask you on your pipeline, I think you said in your release you have about $430 million under development now being delivered. And what are your thoughts of continuing to develop at this juncture? And maybe also your view on acquisitions given a slightly higher cost of capital but also are you seeing any changes in cap rates on potential acquisitions?

So, your question is -- is your first question are we going to continue -- ?

Well, yes. Really -- yes, on your development you're appetite to continue to develop at the same pace that you have been. Is that -- would you expect to continue to do that over the next year?

It really depends on economics, Smedes. You're talking about a market like Houston where construction costs have not come down, land prices have not come down, but rental rates are coming down. I would say future development in the near term in terms of building our pipeline is probably limited.

Same probably goes for Denver. We stopped building in Austin about 12, 18 months ago for this very same reasons. But that does not mean other markets, such as Seattle, Miami, L.A., don't have deals to pencil and we will continue to build as long as the economics are there.

And then we have a wide variety of redevelopment opportunities at any one juncture. We've got 16 redevelopment opportunities in the pipeline and I would expect to see that grow into 2017.

Great, okay, thank you. And then just on the acquisitions outlook have you seen any changes, given slowing fundamentals it looks like across the industry, are seeing that show up in pricing or not really?

The pipeline, first quarter, is pretty thin but that's consistent with prior years. So, my guess is pricing will adjust but just if nothing else due to changes in expectations of growth rates going forward. But we haven't seen a lot of transactions clear here in the first quarter or even a lot of product on the market.

Great thank you

Todd Thomas, KeyBanc Capital Markets.

Thanks good morning out there. You mentioned that the move out activity was a little bit higher in the quarter than you expected and that drove the year-over-year decrease in occupancy at the end of the year. Do you anticipate being able to close the occupancy gap on a year-over-year basis or would you expect it to be lower throughout the year in 2017?

We could easily close the occupancy gap if we cut our rates and put it on TV and promoted more. So, it's -- as Ron said, it is not just about the occupancy. I have not focused on that gap per se, again we're trying to drive our revenues higher, create more cash flow per square foot, is what we're really trying to do.

Okay

(Inaudible) I don't know what's going to unfold in terms of what demand characteristics are going to look like or move out characteristics for that matter.

Okay and can you talk about where occupancy was maybe on a year-over-year basis, with that spread looked like at the end of January or maybe today just to get a sense for how business is trending so far on the occupancy side?

I would say it was very similar to how we ended the year. I think at the end of the year I believe about 50 basis points lower.

Okay. All right, thank you.

Thank you

Jeremy Metz, UBS.

Hey guys, I am on with Nick as well -- has a question here. First, I wanted to follow-up on a question from earlier. I was wondering if you could talk about your medium length of stay versus your average length of stay, which I believe is around 35/36 months and what exactly that means for revenue growth going forward from here in terms of the impacts from existing customer rate increases versus the need for overall market rent growth to drive revenue growth from here with occupancy basically full at this point?

That's an interesting question. It's very important. We've talked about the aging of our portfolio, those tenants that a been here longer than a year. And the reason why that is so important is because there's of it folks we generally give rate increases to.

And in the past have talked about our increases, the rate increase has generally been, for the past two to three years somewhere in the neighborhood of 8% to 10%. So to the extent that that tenant base that has been here longer than a year deteriorates, that gives us less opportunity to send those increases out. I can tell you for the full year, our overall increases to tenants resulted in roughly about $16.7 million to our contract rent and that compared to about $14.5 million last year.

So that was about 14% increase, which when you look -- when you think about the ins and outs, the move in and the move out side, that pretty much is a wash to a negative so we rolled down on the move in and move out activity. So, the bulk of the growth that we have experienced over the past couple of years has really come from the rental rate and renewals or the increases, as we call them, internally.

Does that answer your question, Jeremy?

Yes I appreciate it. And it sounds like you are also saying you're still getting those high single-digit existing rate increases. And assuming that is right, maybe could you just let us know where -- how street rates trended in January versus last year as well, just to frame this all of out?

Street rates were flat to up maybe 1% or 2%. We have not started sending out increases for 2017. We will begin that in a couple of months. But so far the tenant base that has been with us longer than a year hasn't deteriorated, so it's pretty much intact which is a good thing. So the degradation in our occupancy as we discussed earlier is really more from some of the tenants that have been with us or were only with us over the past six months.

Okay

Hi, it's Nick Yulico, Ron I wanted to ask you about that Trump in-house proposals to reduce the corporate tax rate to 15% or 20%. I'm wondering how you and the Board are thinking about the benefits of staying REIT if the corporate tax rate is lowered versus instead becoming a C Corporation, where you would have more flexibility in how much capital you can retain or even your ability to say fund a large buyback of the stock?

Well certainly if you take the extreme, if the corporate tech tax rates are 0% you'd say, why would you be a REIT? So, as the corporate rate tax goes up the incentive to become a REIT gets greater.

I think it is a little premature to comment on what we would do or not do since -- what the tax plan is, what is going to happen to interest expense, what's going to happen to deductibility of capital improvements, will have a big impact in terms of what is this -- it's the final taxable income. If we bought $700 million of developments and acquisitions last year and we got to deduct that in the first year that would certainly change our perspective in terms of what our dividend policy is. So it there is a variety of moving parts that would impact that final analysis in terms of what we would do.

Fair enough thanks

Juan Sanabria, BofA Merrill Lynch.

I was just hoping you could speak to how you think about street rates as we go into 2017 and your ability, or the ability for the market to see that improve into the peak leasing season given the 25% year-over-year increase in supply? And how you think it may play out. I know it's early and the street rate growth this year, versus, let's say, last year?

I will let John elaborate, but certainly a 25% increase in supply is a headwind to pricing power and certainly in the markets that I mentioned earlier where those deliveries are coming. I believe that will be a big headwind in terms of pricing power and may even -- most likely, like in New York where you've got 20%, 25% increase in supply over the next two years, probably rent roll down.

I would agree with Ron, it depends on the market. Houston, P&R rates are probably down about 10% year-over-year, whereas in Sacramento, California they are probably up 10%. So it really depends on the market where the supply is coming from and how it is affecting demand into our system. So we'll modulate our rental rates accordingly.

Okay great and just hoping you can speak on development return expectations what you're penciling in now and how maybe that's changed. And if the spread at all has compressed between development expectations for cash-on-cash return's versus stabilized acquisition yields to see if maybe the disincentive -- or there is less of an incentive for third-party developers to put capital to work to put your product in the ground?

Well, I think that third-party developers, as you've seen the expansion of the C/O pipelines from our public competitors, I think there's still a big development margin for incentive, economic return, for them to develop properties given what appears to me the price per foot that are being paid for these C/O deals versus our best guess of what we could develop product for those markets.

So as long as that big spread, in other words as long as people are willing to pay retail price, as if the property stabilize versus what it costs to build, I think there is a real economic incentive for them to continue. With respect to us we don't have a per se we're going to build 200 million or build 300 million this year it's really predicated on, what are the opportunities?

And they could be in LA, as I mentioned, or Seattle or redevelopment opportunities. We have our teams pretty well built out. We've got a good team, we've got some seasoning under their belts, so we can go in a variety of directions with respect to our development teams. And if deals don't make sense then we're not going to build in that market.

Okay, and what kind of returns are you targeting for your pipeline? Sorry if I missed it.

Generally 8% to 10% stabilized cash on cash, but that is going to be a couple of years out.

Okay, thank you very much.

George Hoagland, Jefferies.

Yes, I guess one question on the financing front, looking at the preferreds you have, I think it is two series that are currently callable. And just based on what you are seeing in the preferred markets, then also on potential for issuing unsecured debt, what are your capital plans for the year?

Capital plans, with respect to our preferreds specifically the redeemed -- the ones that will be become redeemable or are redeemable, and they go over the course of 2017 will have almost $1.7 billion of preferreds that become callable at our option. I think the average coupon is like 5.7%, I think today George, if we went out and tried to -- first off I don't think we can issue $1.7 billion of preferred.

Second I think the coupon -- that if we could go out and do a preferred today that it is probably higher than 5.7%. So it certainly doesn't make sense for us to call or refinance preferreds that are callable now with new preferreds because all we are doing is just swapping rate and not really gaining anything.

And I think probably what you're alluding to is would we issue unsecured debt to take out the preferreds? We might. We might do some of that, I would not say no to that.

We could probably issue 30 year debt, probably 100 basis points lower than that from what our preferreds are at, 10 year maybe another 100 below that. So, we're looking at it but we have not made any decisions yet on how we're going to do, or what we're going to do with those preferreds that are becoming callable.

Okay, thanks and then can you also just comment on the Shurgard performance in the fourth quarter.

Sure, Shurgard's same-store NOI was up 9.8% and that was due to 3% revenue growth and a 5.7% reduction in expenses mainly from various adjustments and lower marketing year-over-year. So 9.8%. Best performing market was Holland, up 22%, and the worst was the UK, down 5%.

Thank you

(Operator Instructions)

David Corak, FBR Capital Markets

John, I just wanted to follow up on a trend you pointed out to us in the last call and that was the idea that the end of quarter occupancy and the contract rent change were predictive of the rental income change in the following quarter? So if we look at it the 3Q numbers they were, once again, pretty accurate in predicting the [4%, 8%] rental income change this quarter.

But looking into Q1 the same math would imply rental growth decelerates to the low [4%] range which would imply deceleration is actually picking up a little bit. Could you give us some color and just how you see that playing out if there is anything different with the math that you guys are thinking about on that end.

The numbers that you just rattled off I mean that's those are factually correct. And I do think they are good indicators, so I think I would leave it at that without giving any of our -- we don't give forecasts, as you know.

But obviously the deceleration continues because you could see that in the numbers. I would say this, is that I think that the degree of the deceleration is slowing down but I still think deceleration is happening in many markets that we operate in.

Okay I guess the point was just the opposite of that is that those kind of numbers might entail that deceleration is actually -- could be more pronounced from 4Q to 1Q than 3Q to 4Q so I was just curious on that. But, I will leave it at that. All right, guys, thanks.

You're welcome

Gwen Clark, Evercore.

Good afternoon. Can you just run us through the revenue and NOI performance of your major markets in the fourth quarter please.

Gwen, this is John, I will give you the top 10 markets. So, I'm going to start with revenues. Los Angeles was up 6.5%. San Francisco, 4.9%. New York, 3%. Chicago, 2.5%. Seattle-Tacoma, market for us is 8%. Washington DC, 2.9%. Miami, 4.4%. Dallas Fort Worth area, 4.9%. Houston, minus or a negative 1.3%. Atlanta was up 6.5%. That was revenues.

I will give you NOI. NOI Los Angeles, 7.6%. San Francisco, 5.7%. New York, down 2%. Seattle up, 8.3%. Washington DC, up 1.2%. Chicago, up 12.5%. Miami, 0.8%. Dallas, up 8.6% Atlanta, 10.6%, and Houston, down 3.2%.

Okay thanks so it looks like LA and San Francisco are both slowing despite having not a ton of new the supply. Were the results in the quarter better or worse than what you expected going in?

I think they were pretty good but last year we in San Francisco and LA we had -- LA had 7.3% revenue growth, it is now down to 6.5%. And San Francisco had 6.6% and it's down to 4.9%. Still great growth numbers but there is no way we could continue with 7% or 8%.

Okay that is helpful. Thank you very much

Michael Mueller, JPMorgan

I know you touched on the different data points earlier as part of various questions. But from a bigger picture standpoint when you're thinking about your setup for heading into the spring and the summer high periods, how do you think it stacks up heading into 2017's high periods compared to last year?

I am not sure I understand your question, Mike, but I think that what we're going to experience, just like everyone, else is difficult comps going into Q2/Q3. Because at least for us we didn't really see the deceleration start until probably April/May of last year.

So, Q1/Q2 of this year, we are still comping against very tough comps. When we get around to Q3/Q4 we are already seeing deceleration so the comps, all things being equal, should be easier for us. I don't know if that answers your question Mike, but if it doesn't please rephrase your question.

It does to a degree. But also when you are taking a look at sending out the rental increases for this year compared to last year, is it expected to have the similar increases? Because I think you said that the pull of tenants who have been there over a year, it's about the same size as it was last year.

We don't know yet Mike. I mean the pull is the same but I'm not sure if at the end of the day those are going to be as sticky as they have in the past. I don't want to say they're not but I don't know. I don't know yet, I am hoping they are as sticky as they have in the past, but we don't know.

Got it, okay. That was it, thank you.

Vikram Malhotra, Morgan Stanley

Hello everyone this is Landon Park on for Vikram. I just wanted to touch base if you can give us any sense on the expense side for 2017, any one time line items we should be aware of or the cadence there?

Landon my guess is expenses will be somewhere in the 3% to 4% range. With the caveat that winter is not over so snow is always a variable. And the other variable is advertising expense. And my guess is we will be doing more advertising in 2017 than 2016.

But that is a month by month decision. So, I can't tell you what it is going to be for the year but my guess is it will be higher than it was last year. So core expense growth 3% to 4%, the biggest driver of which is property taxes which is going to be 4.5%, 5% again.

Okay that's helpful, thanks for that color. And then just one more, just from a philosophical standpoint on new supply coming online, how do you guys have your systems set up to react to that in any given market?

In terms of our operating system?

In terms of are -- do you guys generally just try to weather the storm or do you try to directly compete with new properties or how do you deal with that?

You know sometimes there is new supply added to one of our properties, a new development or whatever, but it's on a back street or it's not well-managed or not built properly. And it really does not impact us. So as long as we are seeing the move in volume and the rates are holding, we don't do anything.

And then other times a new competitor will come into the market and maybe cut off the street and so we have to be more aggressive in terms of our pricing and promotion's. So it's a property by property reaction to what is happening.

We do not sit back and say, okay Houston is going to have two million square feet delivered and therefore our rental rates -- we're going to cut our rental rates by 10%. That is not the way we manage the revenue. It is property by property, space by space.

Okay and have you seen any changes in trade areas? Or how do you think about the average trade area for your properties?

Well, generally our customer base is in 3 to 5 mile radius. So that's what we focus on. So when we do a development or even do acquisitions we look at the level of competition within the trade area, the household income's, the densities, what's the population growth, and especially on developments, what do we know is in the hopper in terms of other people developing product and what is our guess in terms of what that is going to do in terms of competition per person in that marketplace.

Great thank you very much

Jason Belcher, Wells Fargo.

Just first, just as a follow-up to the preferred and debt issuance question earlier. Can you talk a little bit about your thoughts around tapping the debt markets in Europe versus the US?

We have not, even though we had issued euro denominated debt, but we did not actually go to Europe or with European investors for that matter. We issued that debt to two US insurance companies. I don't think that we would probably issue -- go to Europe and issue euro denominated bonds. I think our next, if we do issue unsecured debt it would be here and the US -- it would be US dollar loans.

Okay thanks. Then I did not quite get what you said earlier. Would you mind please repeating those levels where you said you thought you could issue 10 year and 30 year debt currently?

I think 30 year we're probably down in the 4.5%, 4.6% and maybe10 year is probably like 3.6% range, but to be honest with you I don't have exact numbers because we have not really talked to any bankers about that.

Okay thanks a lot

Think you

Smedes Rose (sic - Michael Bilerman), Citigroup

Ron, can you remind us when you were talking about the 8% to 10% stabilized cash-on-cash, yields on development, when you are modeling that out now, a few years out, how much street rate growth are you effectively embedding into getting to that 8% to 10%.

Zero

So, it is based on current rate going forward.

Yes, the development group goes to the pricing group and gets the pricing by space size for that particular submarket. So there is a independence check and balance, right? The pricing group versus the development group. And that is what they use.

And then we underwrite to a 90% occupancy even though we tend to operate higher than that, we underwrite to a 90% occupancy and we do not include tenant insurance or merchandise in that number.

Okay and then I don't have anything on the move in or move out activity in terms of space size. Has there been any up sizing or downsizing of existing customers that still find that they have a need for storage as a need based product, but they need a larger space or feel that rate has gotten too high, so have figured out a way to get their stuff into a smaller box? I just didn't know if there are any of those trends that you are seeing at all.

The relationship between square foot occupancy and unit occupancy is pretty consistent year-over-year. And so that would tell me that there's been no shift. If you have -- sometimes you'll see in a property a big difference between the unit occupancy and the square foot occupancy so you're selling out of your big units right away and so there is a big difference between the two. But the relationship, over time, those ratios really haven't changed in the last -- I have not seen them change in quite a while.

Michael, this is John. So we do have -- a lot of time tenants who are occupying a larger space will downsize, or transfer as we call them, internally into smaller sizes. So, this past year about 70,000 folks basically downsized. That compares to 70,000 last year too, so it was almost exactly the same.

And once -- we're last, maybe I could ask one more, is that okay?

Sure.

If you think about larger facilities, so thinking development, there currently has been a trend where some of these larger facilities have gotten built adding more units, adding more supply. I think about what you have done here in New York a number of years ago in that project. As you look forward in your development pipeline, how do you see that shift changing in terms of overall aggregate size of a self storage facility?

Overall if you look at our development pipeline, it's certainly is larger than the properties we built 10 or 15 years ago. But we do not -- in the real estate group, we do not sit down and say, okay we want to target 100,000 square feet or 150,000 square feet. It's really predicated on the opportunity. So like the Jersey City building, we said, okay can we do 250,000 square foot in that particular location? Can we build it out? Does it make economic sense?

If the building had been half that size and something else had been [joined] it we would do the same underwriting analysis and so we would have a 125,000 square foot property, instead of a 250,000 square foot property.

And the same thing goes for the land lots in terms of being in particular sub markets. How big is the lot? What is the zoning? Can we go -- do we have to stay single-story ? Can we get three-story or four-story in that particular jurisdiction? So there is a lot of things that influence the particular size of the property other than just absolute can we go as big as we can. Does that make sense?

Yes. Thank you

A lot of jurisdictions will not let us go above three stories and we'd like to build five stores because the zoning is very restrictive about we can't get more than three stories.

Right, okay thank you

Thank you.

At this time there are no further questions in queue. I will not turn the conference back to Mr. Teng for any closing remarks

I appreciate everybody's attendance at our conference call today and we will talk to you next quarter. Have a good afternoon.

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