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  1. Home
  2. / Investing
  3. / Real Estate

This Self-Storage Stock Looks Set to Soar

Extra Space Storage is my favorite pick in the REIT sector.
By CHRIS LAUDANI Jul 02, 2015 | 10:32 AM EDT
Stocks quotes in this article: EXR, PSA

During the last year, the self-storage sector has been one of the strongest performing parts of the REIT sector. In the last five years, the 800-pound gorilla in the group, Public Storage (PSA), is up more than 400%.

There is a lot to like about the self-storage business. The industry is operating at full occupancy, rents are rising, there is pent-up demand and the sector is ripe for consolidation. With its recent acquisition of SmartStop, Extra Space Storage (EXR) is one of the most attractive stocks in the industry.

Extra Space Storage is the second largest self-storage REIT in the United States. The company operates 1,106 facilities in 35 states. The company bought SmartStop storage for $1.4 billion. SmartStop operates 169 locations in 21 states and Canada and is the seventh-largest self-storage operator.

Extra Space Storage operates over 81.8 million square feet of rentable space and 740,000 rental units. SmartStop will add 2.8 million square feet and 26,000 rental units.

According to the Self Storage Almanac, the top 10 operators own only 13% of the storage facilities, making the industry ripe for consolidation. The rest of the storage facilities are owned by mom-and-pop operators.

Many industry analysts believe there is serious pent-up demand for new self-storage facilities. Construction of storage facilities peaked during the housing crisis and construction has slowed to a crawl. Marcus & Millichap estimates only 75 new stores were built in 2014 and just 63 new facilities will be built in 2015. That works out to about 4.4 million square feet total, which is a 15% decline year over year. According to the EXR investor presentation, there could be pent-up demand for as many as 1,575 new stores in the United States. Population growth can support about 500 new stores annually. Supply has been constrained because of the lack of available land, difficulty in obtaining permits and tighter lending standards for construction loans.

Occupancy is at record highs. The housing crisis pushed many Americans from their homes into apartments. All their belongings got stuffed into self-storage. EXR, for example, has only six stores that operate at less than 79% occupancy. The rest of the stores operate between 80% and 95% occupancy.

Space is so tight the company has been able to steadily reduce discounts to new customers. In 2014, the company offered 88% of their new customers a discount (one month free storage). Today, only 55% of new customers were offered a discount or a teaser rate. 

Customers are staying longer, too. In 2013, 57.9% of customers stayed longer than 12 months. Today, almost 60% of customers stay longer than a year. In fact, 41% of customers stay longer than 24 months. The longer customers stay, the more rate increases they absorb.

The industry believes it has a huge advantage over mom-and-pop operators because the companies have built sophisticated websites that snatch up customers before mom and pop can sign them up. Most new customers search the Internet for the closest self-storage facility that offers the best deal. Fancy websites (as well as mobile sites and apps) can make all the difference in reeling in new customers.

Another advantage Extra Space Storage has over the small operators is its proactive site redevelopment. When EXR acquires a property, it has the funds to redevelop the site into a more modern, attractive facility. Many mom-and-pop operators let their storage facilities run down and become unattractive. Site redevelopment gives new customers the confidence their junk will be kept in a safe and clean environment run by a highly professional staff.

Historically, Extra Space Storage is very well run. In the first quarter of 2015, the company reported an 8.3% same-store sales figure with just 1.7% expense growth. Net operating income grew 11.4% with a 92.5% occupancy rate. The business is highly profitable. The company reported a 69.7% net operating margin. Holy cow!

While investors worry about buying REITs in a rising interest rate environment, Extra Space Storage is working hard to reduce its exposure to variable rate debt. Right now, the company has about $2.4 billion in debt with 30% of that debt subject to rate increases. The company believes it can whittle that figure down below 25%. If it's able to lock in low rates now, the company should be able to weather the storm of future rate hikes from the Fed just fine.

There is a lot to like about the self-storage REIT sector. Investors looking for a solid long-term story with a number of well-run companies should check in and stay awhile. Right now, my favorite pick in the sector is Extra Space Storage. It has plenty of growth ahead, is aggressively acquiring new properties and has been able to report a string of strong same-store sales figures.

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At the time of publication, Laudani had no positions in any of the securities mentioned.

TAGS: Investing | U.S. Equity | Real Estate | Stocks

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