Public Storage (PSA) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Public Storage Second Quarter 2017 Earnings Call. (Operator Instructions)

I would now like to turn the conference over to Mr. Clem Teng. Please go ahead, sir.

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 27, 2017, and we assume no obligation to update or revise any forward-looking statement, 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, and good morning, everyone. We had a pretty good quarter, Q2.

So operator, let's open it up for questions.

(Operator Instructions) Your first question comes from David Corak of FBR.

Looking at your rental income growth for the quarter. The occupancy and the contract rent formula that's historically been a pretty strong predictor of rent growth was off materially to the downside by about 60 bps, and it's the first time it's been off for a while. Can you just help us understand why you think that was off so much, John, and how we should think about that going forward? And it looks like the math would imply another 50 bps or so of deceleration, 3Q.

Yes. There was nothing really specific that caused that difference. So I think it was just really the way the quarter had accelerated quicker than what it normally did, so the -- excuse me, the deceleration happened faster than what those numbers would normally indicate on how that quarter would predict to be at using those metrics. So there's nothing unusual other than the deceleration and how quickly that happened.

And going forward?

Well, going forward, we still have those same indicators in there. So right now, if you net the 2 numbers, they're at about a 2.9%. I don't know what the third quarter is going to be, but it's probably going to be somewhere in the 2% to 3% range.

Okay. And then maybe a bigger-picture question for you, Ron. I think, overall, we're kind of struggling to really put our finger on what's having the most impact on fundamentals right now in the industry, whether it's the supply side, the demand side or maybe some combination therein. So maybe just very simplistically, if you had to fill out kind of like a pie chart, allocating the impact, some percentage of supply and some percentage of demand, what do you think that looks like today? And then maybe what do you think that chart looks like a year from now?

Well, I think I'd step back. And certainly, new supply is having an impact, but I think a bigger impact on the numbers is the comps that everyone's coming off of from 2015 and 2016. If you recall, first quarter '16 and even second quarter, most operators were pretty full, peak occupancies. Promotional discounts had been dialed down. Advertising expense was nominal. We -- like for us, we did no advertising in Q2 of 2016. And so your growth in terms of rental growth today is, for the most part, what your rental rate increases are to your existing customers. And that's in -- offset in part by rental rate roll-down because new take rates are lower than in-place rents, which peaked probably in Q1 or Q2 of '16. So you've got the headwind of roll-down. Occupancies are still robust, but promotional discounts are certainly not going down, maybe going up modestly, and then for us, we're increasing advertising. So it's just incredibly tough comps. I'll give you an example. Atlanta certainly has new supply, but Atlanta in Q2 of 2016 had a 9.2% same-store revenue growth, and it came in this year at 3.3%. So that's a pretty good degradation in revenue growth. But I would tell you, last year, Atlanta at 9.2%, it was clearly not sustainable, peak occupancies, lower discounts and, clearly, not a sustainable number. So bigger picture, it's just really tough comps, peak occupancy, lower discounts. And then you probably got some headwind with respect to -- well, no doubt you have a headwind with respect to new supply.

Your next question comes from Steve Sakwa of Evercore.

I was just wondering if you and John could maybe talk a little bit about street rate growth and maybe how that street rate growth has trended in some of the markets that have had more supply like New York and some of the major Texas markets like Houston, Dallas and Austin.

Steve, this is John. Right now, I'd tell you that our street rates are up about 2%, but that's going to change probably pretty -- today, it'll change. We are going to start reducing rates significantly in some of our major markets. During the -- for example -- Houston, for example, is a market that we're down -- we were down during the quarter about 15% in rates. We'll probably take those down a lot more. Overall, our same stores on the move-in rates, the take rates that are coming in were down about 4% during the quarter, and we had about flat move-in volume. With respect to our other major markets, I would say most of them are down to flat with few exceptions, such as like Los Angeles and Seattle, but I would say most of them are fairly flat.

So John, is it fair to say that Houston is kind of the market where things are the worst in terms of decline?

Well, I mean, if that's in terms of decline, it's our worst performing market in terms of year-over-year growth, but it's not necessarily our worst performing market in terms of the deceleration. There's other markets like Ron pointed out. Atlanta, that is decelerating, I think, worse than Houston is.

Right. And could you just maybe speak specifically to New York and kind of the metro area?

Well, New York last quarter -- last year had, for us, 3.8% revenue growth and this year had 2.25% revenue growth, so it's off about, what, 150 basis points in terms of Q2 '16 growth versus Q2 '17 growth. I think with New York, your question is probably related to new supply. And while there is new supply in New York, I don't think most of the anticipated new supply has hit the market yet.

Well, I guess that leads me into my next question. Broadly speaking, Ron, as you sort of look at the landscape, and you've been through several cycles, what is your expectation about when new supply peaks? When would that have sort of the maximum impact or negative impact on your business? And I guess when do you sort of see things kind of stabilizing or turning? I mean, is this still another 6, 12, 18 months from now?

Well, Steve, it's similar to my answer from last quarter, and that is we have higher deliveries this year than last year. And based on my unscientific analysis of looking at pipelines and I only have -- I don't have the other 3 public guys' C/O pipelines yet because they haven't reported. But going back from last quarter, supply -- using that methodology, new deliveries will be up about 20% next year. So I'm guessing 35 million square feet gets delivered this year, 43 million square feet or about 700 or 800 properties next year. So if we're hitting a peak in terms of deliveries, it's probably '18, and then you're going to have a year or 2 of absorption from that.

Okay. And I guess, just sort of last question. As you sort of put all this together and you look at sort of slowing revenue, rising expenses, more advertising, I mean, do you or would you expect NOI growth to turn negative in this cycle and possibly happen in 2018?

I can't say that, Steve, because we'll increase marketing spend as necessary to drive volume, and we're coming off a low base of '16. I would be surprised if we went negative, but I can't say that, that's out of the question.

Your next question comes from George Hoglund of Jefferies.

I was wondering if you can comment on the expense growth. I mean, I know you said a good portion of the increase is due to the tough comps, but can you just talk about some of the others, increase in advertising, and sort of how much is that due to, I guess, not an easy comp, just other factors?

Yes. Well, in the -- at the end of Q1, we said we'd spend more on advertising and marketing expense, and we did. That was up about $1.7 million in Q2 versus last year -- I'm sorry, about $2.7 million. $1 million of that was Internet marketing, so we went from $3.4 million to $4.4 million. And TV went from 0 to $1.7 million. So our total spend on those 2 items was up $2.7 million. The other big driver is, which has been a constant for the last couple of years, property tax is up again, $4.5 million -- or $2.5 million.

Okay. And then, just the -- I think it was 5 properties that were excluded from the same-store pool. Can you just comment on those?

There was plenty, plenty.

Okay. In which market?

Houston and Carolinas, I believe, some in the South Carolinas.

Your next question comes from Gaurav Mehta of Cantor Fitzgerald.

A quick question on revenue management, and you touched upon that a little. But I was wondering, if you were thinking about occupancy, and I think you mentioned that you would start cutting rates significantly and going forward, is that an effort to maintain occupancy at current levels? And would you say that you have hit the floor, below which you don't want your occupancy to go?

No, I think it's either we advertise a lot more or we start cutting rates. We do both, and we're just -- we're going to experiment with more rate reductions and see what that gets us. It's not about occupancy per se. We're trying to maintain a revenue growth, and so that's really our goal. And so we're going to start playing with the rental rates a little bit more.

Okay. And as a follow-up on the expense, you talked about spending more money on TV and Internet. Have you seen impact of that on getting new customers?

I'd have to say, in Q2, the increased marketing spend, Internet spend wasn't as effective as we would have liked. Everyone's -- I could tell you everyone is paying a lot more on the Internet. There's a few more competitors and the bids are higher, but it's not really changing the positioning. It's just costing more but not really driving much more volume. And TV, we got some lift in it, but it wasn't as effective as we would have liked.

Your next question comes from Todd Thomas of KeyBanc Capital Markets.

John, just I wanted to follow up to your comments also about starting to reduce rents in some markets. I think you said significantly and also said that you would begin today. Can you just elaborate on that a little bit, maybe in terms of the magnitude of some of the rent reductions and also maybe speak to some of the markets?

Well, I can't speak as to the magnitude, Todd. But the markets, I mean, you can imagine they're the usual suspects that we've been struggling with, such as Houston and Denver as well as others where revenue growth or occupancies or move-in volumes are under pressure. Those would be the markets that we would target and the degree or the significance could be anywhere from a 5% or whatever to 15%, 20% reduction in rates. So don't really know -- I don't know those numbers just yet, but our folks are working on them.

Okay. And then just in terms of occupancy, in the context of maximizing revenue growth, do you expect to see that year-over-year occupancy gap stabilize or potentially narrow a little bit? Or is it a little too soon to tell?

Todd, it's a little hard to tell. As I've mentioned in prior quarters, the occupancy gaps are really in places like Houston and Denver, whereas we're chockful in San Francisco and Los Angeles. And so you can't really move customers. As John mentioned, in Houston, we were down 15%, 20% of rates in the quarter, and we really didn't -- actually, we saw a negative movement of volume in Houston in the quarter despite increased marketing and lower rates. So some markets, it's just hard to get the velocity -- the move-in velocity going.

Okay. And just lastly, if I could, real quick, Ron, circling back to some comments you made last quarter, I think, about macro factors and the consumer a little bit. Anything new on that front, either as it pertains to the consumer or just demand in general, whether you're seeing any changes to demand from the phones, web hits, reservations, anything like that related to inbound inquiries to the system?

Well, I would just say that the trends that were prevalent last quarter I don't think have changed much. You've got -- the provisioning of the banks for consumer credit continue to tick up. Delinquencies continue to tick up. Overall leverage of the consumer is still high. So those macro factors that I touched on last quarter haven't changed. If you look at our portfolio, all top 20 markets had lower revenue growth year-over-year, same as Q1. So we're down across the board to different degrees. The markets are somewhat changing in terms of the degradation or rate of degradation. Houston and Denver have been leading the charge. Our big decelerators this quarter were Charlotte, Portland and Atlanta. So there's a change, but -- in terms of which markets are decelerating a little faster, but overall, all the top 20 markets are down in terms of rates of growth.

Your next question comes from Smedes Rose of Citigroup.

I was just wondering if you could talk a little bit about if there's any change in behavior from your in-place customers versus the incoming customers, which I think you've said there's some difficulty and you've had to up the promotion to get them in. But are you -- it seems in the past you've had fairly consistent rate increases for your in-place customers, but did you see any change there this quarter?

Smedes, this is John. We have continued to send out the rental rate increases or the renewals just like we did last year. We haven't changed. We're still monitoring it very closely to see if there's an uptick in move-out activity. We haven't noticed anything. So the in-place -- the long-term tenant still is very sticky. The length of stay still appears to be very similar even on new incomings tenant. The issue really is trying to get more demand into our system, and we have lack of pricing power, which is what we were talking about in Q1. So those issues continue to be with us.

Okay. And then switching for -- gears for a second. Are you seeing any change, Ron, in the availability of capital to the space given that fundamentals continue to decelerate and I think probably ahead of expectations clearly? Do you -- have you heard anything in terms of construction lending or equity checks required to get new construction going?

We've heard of tightening of construction lending. Mind you, we don't -- we're not people that use construction lending, but we've heard of tightening of that. We've gotten a couple of calls from people asking us if we would like to make construction loans, which would tell me, obviously, the banks are not making them because they're calling us. And we're seeing a few more deals -- inquiries on deals where people have projects in the ground or just out of the ground that they'd like to monetize sooner rather than later. And you've seen there's a couple of packages on the market today where someone has developed 4 to 6 portfolio -- 4 to 6 property portfolios, and rather than waiting for them to get stabilized, they're putting them on the market. So I would say some of the quicker-thinking developers are bringing stuff to market and then seeing the slowdown that's happening overall.

(Operator Instructions) Your next question comes from Juan Sanabria of Bank of America Merrill Lynch.

Just hoping you could give us a sense of how street rates moved throughout the second quarter and into July. And just conceptually speaking, all else being equal, if street rates, let' say, go flat, how long would -- do you think it would take for same-store revenues to get to that flat level that street rates would be suggesting, over time, it should get to?

Well, again, our street rates during Q2, not going to speak to that, what the move-ins were doing. The move-ins came in at rates that were below last year by about -- I think it was about 5 -- 3.7%, and we had about flat move-in volume. So that would suggest that our street rates throughout the quarter were pretty much down. Currently, our street rates are up about 2% for the month of July, but as I mentioned, we'll be probably cutting many markets by varying degrees. In terms of your question about if street rates stayed flat, I think you were asking if we would -- what would that do to revenue growth.

How long would it take to get same-store revenue to match that street rate growth?

I don't know. I have no idea. Right now, we are rent rolling down. I think, Ron, might have touched on that. People are moving in at about $135 a month, and they're -- excuse me, they're moving in at about $130 a month, and they're vacating at about $138 a month. And that compares to last year where it's about flat, where they were moving in at $136 and vacating at about $136. So we're rent rolling down. And that particular metric, we're actually accelerating so the rent roll-down spread has widened.

And the up 2% -- you said street rates were up 2% now versus July. Is that an improvement from what you saw in May and June? Or is that kind of fairly stable?

I don't recall what that was in May and June. I can't answer that.

And then just last question for me. On the development that you guys are -- have in place, any change in terms of expected yield given kind of a softer market and/or maybe longer lease-up times? Can you remind us what you're targeting on dollars being spent today?

I'm sorry, remind you of what we -- our expected yields are or lease-up times?

Yes. Both actually.

Well, when a project comes out of the ground, it leases up -- so far, the properties coming out of the ground are leasing up faster than we projected, albeit at lower rental rates than we projected. So we're getting some benefit of lower rental rates versus greater volume, and net-net that's a positive. In terms of the projects that we've so far gotten out of the ground, they look to be on track. But as I've said before, it'll be 2 to 3 years before we really have a good grasp of are we hitting the numbers or not. Q2, we're going to deliver about 16 properties, 1.6 million square feet across 5 different markets, the largest being Houston, where we'll deliver 770,000 square feet.

And just what stabilized yields do you think you'll get based on kind of the markets today -- market rents today?

Well, the market rents change every day, so I don't mark to market the portfolio every day in terms of what the yield is. But I -- so far, we're on track to get somewhere between an 8% and 10% cash-on-cash return on cost.

Your next question comes from Ki Bin Kim of SunTrust.

How much is existing customer rate increase program contributing to that 3.2% same-store revenue growth this quarter?

Ki, I mean, for the quarter, the rate -- rental rate increases added about $400,000 of monthly contract rent, which did not offset the rent roll-down we experienced, which was about $1.9 million.

So -- okay. So is that the first time in a while where the existing customer rate increase program, which is -- I guess there's a lot of debate about it, but doesn't really contribute a whole lot but actually going negative?

It didn't go negative. It was positive $400,000.

Well, I thought it was $400,000 plus, minus the $1-point-something million negative.

So the move-in/move-out equation took away -- because we're rent rolling down, took away about $1.9 million of monthly rent, whereas the rental rate increases added about $400,000.

Okay. And is that -- that contribution pace, is that -- do you think that would be fairly consistent even if, like you said, move-in rates are down 4%? If that's the case, does the existing customer rate increase program still have the same impact going forward? Or do you see some risk with that?

Well, it still has -- I mean, year-over-year, it still has the same impact with -- relative to itself. My point is, is that, that impact is not enough to offset the rent roll-down on the move-in/move-out volumes, whereas, in the past, the move-in/move-out volumes pretty much were slightly negative to flat. And so the rate increases had a much more impactful year-over-year growth, that growth that we're experiencing than it does now, even -- not withstanding the fact that the volume is basically the same. I don't know if that makes sense, but it's not as impactful because the rent roll-down is just trumping it right now.

Okay. And just are you noticing any changes in the closing rates off your call center or your website? Or are maybe the days to release a unit increasing at all?

Well, I'll tell you that -- we call it production rate. Our production rate, which measures basically the move-ins that we get versus the inquiries that we're getting, are better. So we're getting a lot less inquiries, about 3% to 4% less inquiries into the various channels we have, whether it be call center, the website, either the mobile or the desktop. But notwithstanding the fact that we're getting less, we have flat move-ins for the most part. So we're making up for it by getting better reservation rates and getting better show-up rates.

Your next question comes from Vikram Malhotra of Morgan Stanley.

Could you just maybe give us any update or any more color specifically on San Francisco and L.A. and then just the revenue growth in the top 5 markets -- same-store revenue growth?

Same-store revenue growth, top 5 markets. Los Angeles is 5.7%. San Francisco was 3.6%. New York was 2.2%. Chicago was 1.1%. D.C. was 2.0%, and Miami was 2.2%.

Okay. And just specifically on L.A. and San Francisco, anything different you're seeing this quarter in terms of street rates or just behavior from customers?

Not necessarily behavior from customers. John can comment on the street rates. San Francisco Q2 2016 had 7.2% same-store growth, and it came in at 3.6%. So -- and Los Angeles was 7.9% last year, and it's at 5.74% this year. So actually, those 2 markets were the biggest contributors to our slowdown in revenue growth, not because they're doing bad, 3.6% and 5.7% is very good. It's just coming off very tough comps from 2016 of 7-plus-percent revenue growth. So those 2 markets were almost 60 bps of our 2.7% revenue decline year-over-year. 95%-plus occupied, promotional discounts are good, so overall demand is very good in those markets. It's just that they're coming off very tough comps.

Okay. And then just going back to the question on just revenue growth. I remember maybe 2, 3 quarters ago, you'd mentioned that your view was that revenue growth sort of stabilizes of long-term average. Just maybe any updated thoughts around that? It seems like we've dipped a little bit below long-term average. I'm just wondering where you see stabilization.

Well, I believe I said the long-term growth rate over 20 years is something like 3.4%, 3.6%. We were above trend line for about 3 years, so we could be below trend line for some period of time to get to an overall average of that. And again, the overall long-term average may change from 3.4% higher or lower, but it's not surprising to me that we're below trend line given how far above trend line we went.

Your next question comes from George Hoglund of Jefferies.

Just a question on the financing. I mean, since you guys just redeemed some preferreds and you've done one of the preferred issuance, I was wondering how you're thinking about preferreds versus unsecured bonds going forward and kind of where do you think you could price a 10-year and a 30-year bond and then preferreds today.

Well, we're thinking about both, George. We're thinking about issuing unsecured as well as maybe continuing to tap into the preferred market. Both of them are open for Public Storage. It would really be what's the use of proceeds really. In terms of the amount we may issue -- I'm sorry, your question was what we can issue 10-year, I think is what you asked.

Yes, 10-year and 30-year debt.

So 10-year, we think, it's maybe around 3.30%-ish area, and the 30-year maybe about 4.20%, 4.25%. And that's an off-the-cuff guess, I mean, but I think it's roughly in that neighborhood.

Okay. And then, I guess, would you think preferreds today would be similar to where your last issuance is?

I think preferred is still around the same place we did the last issuance, which is the end of May, early June, which was the 5.15%.

Your next question comes from Michael Mueller of JPMorgan.

A couple of questions. I guess, Ron and John, on the development pipeline, the new development, you have about 470 in process, expansions of about 190. And I guess just given the backdrop and if you're looking out to next year, would you imagine that your pipeline is up similar size? Or do you think you'll pull back on it a little bit?

At this time, I think it'll be about similar size, probably a mix difference in terms of more shift -- continued shift towards redevelopments versus ground-up developments. But if I look out to '18 in terms of deliveries and what we've got in our -- I'll call it, our second shadow pipeline, stuff we have in the works, I think we'll be close to where we are today.

Got it. And I apologize, I missed the intro comments if there were any, but for the effective rate increases that went to existing customers this year, can -- did you say what those were at this point?

We didn't say that in our comments at the beginning of the call, but it was -- the rate increases are similar to last year, Mike, roughly in the 8% to 10% range to existing tenets that qualified.

At this time, there are no further questions. I will now turn the floor back over to Mr. Clem Teng for any closing remarks.

Thank you for attending our conference call, and we'll talk to you next quarter. Thank you.

This concludes your conference. You may now disconnect.