Description

EXR (extra space storage)

We are short the self-storage REITs.  These are generally good businesses (higher quality than the average REIT), but they are facing a fundamental outlook that may be the worst they have ever faced.  After the recent bounce, they are trading around their historical average multiples; after one adjusts for interest rates, they are trading at/near the high end of their historical range.

I will focus on EXR in this writeup, but this thesis applies to all of the US storage REITs.  Consider the following:

Valuation: I see EXR trading at a ~5% implied cap rate; this compares to a twelve-year average of ~5% (range: 3.5% - 6.5%).  The 10-year yield is currently 175bps higher than it was during those twelve years; the real 10-year yield is currently 150bps higher than it was during those twelve years.  Adjusting for real rates, EXR is the most expensive that it has ever been.

Long term fundamentals: the next 20 years for the industry will be less good than the last 20 years.  This is because the niche has institutionalized – it used to be that EXR/PSA could use their institutional scale and sophisticated pricing & marketing to drive 20-50%+ more revenue out of a given facility versus a mom-n-pop.  Combine this with the REITs’ lower costs of capital, and there was a massive runway of accretive rollups and developments.  The REITs still have an edge, but much of it has eroded versus 20 years ago: there is plenty of PE/institutional money in the space; debt is more widely available; and the REITs themselves rent out their platforms to smaller operators.  This was a huge value driver/tailwind that is greatly diminished.  There are several other (albeit less significant) ways in which the future will be less good than the past: fourth/fifth generation facilities have a higher CapEx burden; rate hike & auction moratoriums are becoming more common; the industry is pushing closer to likely saturation limits (now 12sqft per capita).

Near term fundamentals: storage was a massive COVID beneficiary, as Americans cleared space for home offices by putting their junk into storage.  Occupancy levels spiked from the low-90%s into the high-90%s, and move-in rents doubled (in some geographies, more).  The industry is now dealing with the hangover, as new supply is absorbed and demand retrenches as behavior normalizes.  Industry occupancy has fallen back into the low-90%s, and move-in rates have fallen 25-50%+.

In the face of easing occupancy and plummeting move-in rates, the REITs have kept the same store figures from falling into the red by aggressively hiking rents on in-place tenants (historically, they have generally pushed in-place rents ~10% p.a.; more recently, this has been 20% and even 30%).  As a result, the gap between in-place rents and move-in rents is currently the widest it has ever been: a whopping 71%!  I think this setup makes it very hard for the REITs to avoid posting negative same store in 2024, yet consensus is still holding out hope.  The hope – as I understand from the REITs and the bulls – is that churn remains low, and in-place customers continue to accept elevated rent hikes, while lower interest rates stimulate summer homebuying, causing storage demand to jump into Q2/Q3.  Even in the bull-case scenario, same store growth in 2024 is still worse than all but one year in the past decade (2020) and has little prospect for rising much from there.

Storage REIT prices could continue to rise if the 10-year yield were to continue its fall of the past couple of months, but I am long plenty of other REITs that I think should outperform in this scenario.  Moreover, a continued rapid fall in interest rates would probably be paired with consumer distress and rising churn.  In other words, with respect to the macro, the storage REITs are priced for a goldilocks scenario so narrow, I don’t believe it can exist.

Convexity: On the flip side, if churn starts moving up to more normal level (or even higher than normal levels, given the weak consumer that I keep reading about), then same store could turn sharply negative – likely worse than anyone thinks possible, given the unprecedented gap between street rates & in place rates.  I think this event would be a thesis-buster for many bulls and the stock would blow through recent lows.

Risks:

Demand spike: A  spike in demand could lead to a return of pricing power, and the negative same store scenario would be off the table.  Of course, this would likely correspond to a stronger consumer/economy, which would come with higher interest rate expectations.

Interest rates fall: If the 10-year were to fall to under 250bps, then EXR would no longer look expensive.  But that's proabaly a scenario where churn has increased.

Catalyst

Street rates stay down

churn increases

same store turns negative