Extra Space Storage (EXR): A Self-Storage REIT Offering High Yield and Fast Dividend Growth

Real Estate Investment Trusts, or REITs, are the best way for regular investors to gain exposure to high-quality real estate assets, including the fast growing storage space sector.

 

Extra Space Storage (EXR) is one of the best blue chip storage space REITs, with a great track record of growing investors’ income and wealth over the long term.

 

In fact, EXR’s stock has returned nearly 600% over the last decade, and the company’s dividend has increased by 680% during the previous five years.

 

However, while many value-focused dividend investors might worry that Extra Space Storage is now overvalued, this quality storage REIT still has plenty of growth potential ahead of it.

 

Let’s take a closer look at Extra Space Storage to see if this high-yield REIT could make sense for conservative retired investors living off dividends.

 

Business Description

Extra Space Storage is America’s second largest public storage REIT, owning or operating over 1,400 properties in 38 states, Washington DC, and Puerto Rico.

 

The company’s properties total 910,000 storage units containing 103 million square feet of rentable space.

 

 

The company is very well diversified geographically, helping to create a very consistent stream of cash flow from which to pay its fast growing and secure dividends.

 

California (19%), Texas (10%), and Florida (10%) are its biggest states. The Northeast (16%) is also meaningful, but no single region is large enough to bring the company down.

 

Business Analysis

Since inception in the early 1970’s, the storage industry has been the fastest growing segment of the commercial real estate industry, according to the Self-Storage Association.

 

According to the Self-Storage Almanac, in 2000 there were only 31,947 self-storage properties in the U.S. Today, there are more than 50,000 properties.

 

Increased population density and an aging population have helped drive the surge in storage properties, and Extra Space Storage has certainly benefited from these trends since its founding in 1977.

 

Extra Space Storage has been growing like a weed, with a blistering pace of revenue and earnings growth over time. In fact, the company’s revenue has nearly tripled over the last five years. This is due to two main factors.

 

First, management has been very aggressive in consolidating the highly fragmented public storage industry, of which Extra Space Storage, despite being the second largest player, holds only a 5% market share.

 

As seen below, Extra Space Storage spent more than $1 billion on acquisitions in each of the last two years.

 

 

This aggressive acquisition spree has led to some very impressive growth in the REIT’s store count, which has more than doubled since 2008.

 

 

According to the Self-Storage Almanac, the top 50 self-storage companies owned approximately 21.9% of the total U.S. stores in 2015, providing many opportunities for further acquisitive growth.

 

 

While some industries consolidate because their best growth days are behind them, the public storage industry is expected to continue growing over the long term, thanks to America’s aging demographics.

 

Between 2012 and 2060, America’s population of those over age 65 is expected to grow by nearly 50 million.

 

Many older Americans are expected to downsize out of large homes to much smaller homes and apartments, especially to help with retirement funding, which creates a secular growth catalyst for public storage facilities.

 

Another key aspect to Extra Space Storage’s business model is its third party management segment (the largest in the U.S. with a market share of 6%), in which the company runs storage properties it doesn’t own on behalf of the property owner.

 

This allows the REIT to leverage its expertise into a low cost, high-margin cash flow stream.

 

Better yet, thanks to this fast growing business, Extra Space Storage also grows its potential future property acquisition pipeline, ensuring strong growth into the future.

 

Similarly, the growth in joint ventures, which allows for cash flow growth with less capital investment, also helps Extra Space Storage maintain a strong growth pipeline without having to go through brokers and their commissions.

 

 

Equally important, management has proven very good at extracting increasing profitability from its existing properties.

 

In fact, Extra Space Storage is famous for consistently putting up some of the industry’s best same-store operating results, both from a revenue and net operating income (NOI) perspective.

 

 

The key to achieving such success is management’s talent for extracting increasing economies of scale in terms of administrative overhead, maintenance, and advertising, while also aggressively reinvesting into its properties to keep them up to date.

 

These actions help build brand equity and allow strong pricing power to increase annual rental fees from customers while still maintaining an impressive occupancy rate of 93.0%.

 

This is especially true in California, where strict zoning laws and expensive land prices make increasing storage supply time consuming and costly.

 

As a result, Extra Space Storage was able to squeeze 9.2% same-store revenue growth from its top five California markets in its most recent quarter.

 

Over 40% of Extra Space Storage’s customers have been using the company’s storage facilities for at least two years, highlighting the effectiveness of management’s reinvestments and the stickiness of the business.

 

The company’s strong growth in same-store cash flows and rising store count has resulted in truly sensational growth in adjusted funds from operations, or AFFO (the equivalent of REIT free cash flow and what funds the dividend).

 

 

Overall, Extra Space Storage appears to be a well-managed business in an industry that has enjoyed superb growth tailwinds since its inception more than 40 years ago.

 

Self-storage warehouses have many attractive economics. They require relatively few costs to operate (no furniture or carpet is needed to maintain their value), need few employees to run them, and generate great cash flow once they hit a high enough occupancy rate.

 

There will almost certainly always be demand for self-storage warehouses as well. While the industry has enjoyed strong growth, the fundamental need to have storage available for major life events (e.g. a move or divorce) makes for a slow pace of change.

 

 

Key Risks

While there are certainly many things to like about Extra Space Storage, there are also three main risk factors to keep in mind.

 

First, the last few years have been a golden age for storage REITs, thanks to new supply of storage facilities growing much slower than demand. This has allowed very strong rental increases that still allowed occupancy rates to hit record highs.

 

According to the Self-Storage Almanac, the industry’s occupancy rate has improved from 80.3% in 2008 to 90.2% in 2015.

 

However, the strong economics of this business are attracting new supply, especially in important markets such as Florida and New York, where zoning laws are not nearly as restrictive as the West Coast.

 

In fact, between 2016 and 2017, an extra 1,700 storage facilities are expected to open. In addition, management is starting to see rent increase fatigue, which indicates that future rental rates, and thus same store sales growth, aren’t likely to be as strong as in recent years.

 

That means that Extra Space Storage will have to focus more on acquisitions to continue growing strongly.

 

However, thanks to the blistering pace of recent acquisitions, the company’s debt load has grown significantly in recent years (more on this shortly).

 

Today, Extra Space Storage has a higher than average leveraged balance sheet, which may restrict how quickly the REIT can keep expanding without endangering its dividend.

 

We also can’t forget that, after nearly a decade of historically low interest rates, rates are finally expected to normalize in the coming years.

 

This means both higher interest costs for Extra Space (which has 24% of its debt at floating rates), as well as potentially lower share prices.

 

That matters because the way REITs are set up for tax reasons, they can only retain 10% of taxable earnings. As a result, growth must come from either new debt or selling new shares.

 

In a rising interest rate environment, where risk-free Treasury yields might rise to 4%, 5% or more, some of the demand for Extra Space’s stock, which has allowed it to raise cheap equity growth capital in recent years, could evaporate, slowing its growth capabilities.

 

Dividend Safety Analysis: Extra Space Storage

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Extra Space Storage has a Dividend Safety Score of 49, meaning that the company’s dividend is secure but also dependent on a healthy U.S. economy.

 

For example, during times of immense economic and credit market stress, such as 2008-2009, the REIT was forced to slash its payout.

 

Extra Space Storage’s dividend was 25 cents per share in the first quarter of 2009, and the company skipped its next two payments before ultimately reducing its quarterly dividend to just 10 cents per share in the first quarter of 2010 – a 60% cut.

 

It took until 2012 for the dividend to surpass its prior high, but storage REITs fared better than most other types during the last recession.

 

As you can see below, storage REIT stocks returned -25% in 2007 but gained in 2008 while most REITs were smoked.

 

 

Extra Space Storage’s occupancy rated dipped to 81.1% during the financial crisis (versus 93% today), and its high financial leverage made it too difficult to sustain the dividend.

 

Extra Space Storage is not for highly risk averse investors, especially those who require very consistent and safe payouts throughout a full economic cycle.

 

For such investors, dividend aristocrats and dividend kings are far more reliable choices.

 

However, despite the dividend cut in 2009, investors shouldn’t consider Extra Space Storage’s dividend unsafe today.

 

That’s thanks to very sustainable Q3 2016 and YTD 2016 AFFO per share payout ratios of 76.5% and 83.3%, respectively.

 

Anything under 85% is generally considered sustainable for REITs, and thanks to Extra Space Storage’s very strong AFFO per share growth rate (25.9% in the most recent quarter), the payout safety appears above average compared to the rest of the REIT industry.

 

However, there is the concerning issue of Extra Space Storage’s debt load. As you can see below, the company holds just $35 million in cash compared to total book debt of $3.99 billion.

 

 

While the REIT industry is highly capital intensive and the business model requires pretty high leverage ratios (Debt/EBITDA), Extra Space Storage has a relatively higher debt load than most of its peers.

 

REIT	Debt / EBITDA	EBITDA / Interest	Debt / Capital	Current Ratio
Extra Space Storage	7.1	4.22	58%	0.17
Industry Average	4.26	NA	48%	0.47

Source: Morningstar

 

In fairness to management, the current balance sheet is far from dangerous, with the interest coverage ratio (5.29) still being high enough to indicate that current cash flow easily covers debt service payments.

 

The company also has a $600 million revolving credit facility, which provides a nice cushion. In addition, over the past year management has made good progress on letting the growth in cash flow catch up to its debt load, thus strengthening the balance sheet.

 

Looking ahead, it appears that Extra Space Storage plans to slow its pace of future acquisitions a bit, though obviously things could change if management believes it can find some bargains that are highly accretive to AFFO per share.

 

A slow pace of capital spending should continue this positive de-leveraging trend and help to make the dividend increasingly secure in the coming quarters.

 

As long as the U.S. economy remains healthy and storage industry dynamics don’t drop off a cliff, Extra Space Storage’s dividend is in good shape today.

 

Dividend Growth Analysis

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Extra Space Storage has a Dividend Growth Score of 64, indicating that dividend investors can expect above average dividend growth going forward.

 

That’s thanks to the REIT’s continued strong growth in AFFO per share (for now), as well as management’s penchant for rewarding dividend lovers with very strong payout growth.

 

Extra Space Storage’s dividend has increased by a whopping 39.2% per year over the last five years. The last dividend increase was a 32% boost in early 2016.

 

 

However, due to the forming headwinds discussed earlier, income investors shouldn’t anything close to these kinds of dividend growth rates going forward, with 8% to 10% payout growth a far more reasonable expectation.

 

Valuation

Thanks to the recent REIT correction, a result of rising interest rates, Extra Space Storage is trading more than 20% off its all-time high.

 

That doesn’t make it necessarily cheap, given that it still trades about in line with its historical price/AFFO (one of the best valuation metrics for REITs).

 

On the other hand, Extra Space Storage is trading at a seemingly attractive level looking at its 4.3% dividend yield, which is above its long-term historic median yield.

 

Price/AFFO	Historic P/AFFO	Yield	Historic Median Yield
20.7	21.7	4.3%	3.1%

Source: FastGraphs, Gurufocus

 

While I like many aspects of self-storage companies, I can’t help but desire to pay a lower price given some of the headwinds potentially facing the industry in the form of increasing supply (i.e. peaking occupancy rates and pricing power) and higher interest rates.

 

Another 10% pullback into the low $60’s (versus $71 today) would make me more interested in Extra Space Storage. I think the company’s long-term growth opportunities are solid, but I would prefer to buy when industry conditions aren’t as strong – after all, most all things are cyclical.

 

Closing Thoughts on Extra Space Storage

Extra Space Storage is a potentially solid long-term dividend growth investment and arguably one of the best names in the public storage space.

 

That being said, investors need to realize that most of the growth catalysts that have helped it to achieve such amazing total returns in recent years could be starting to reverse themselves.

 

Combined with a higher than average debt load, Extra Space Storage isn’t exactly a “set it and forget it” dividend growth stock but one that needs to be monitored periodically.

 

The recent pullback in REITs has made Extra Space Storage start to look more attractive. However, the stock’s relatively high price/AFFO multiple and sensitivity to the storage industry’s unique fundamentals make me inclined to watch from the sidelines until a better deal appears.

 

Investors interested in learning about another well-known storage REIT should review our analysis on Public Storage (PSA). The company scores much higher marks for Dividend Safety and has rewarded shareholders with consistent double-digit dividend growth.