From his perch as head of the country’s largest self-storage REIT, Ron Havner thinks 2013 is “a great year to sell” if you own a self-storage facility.
“There’s a lot of money (out there), interest rates are low, banks are hungry to lend and so, in my mind, it’s a seller’s market,” Havner, chairman, president and CEO of Public Storage Inc., said at the recent NAREIT’s Investor Forum in Chicago.
That being said, Havner isn’t too keen on buying properties right now.
“We’re looking at every deal,” Havner said, “but the pricing, the financing that we’re seeing out there makes it very challenging to deploy capital and earn a reasonable rate of return, at least today.”
What does Havner look for when considering a purchase? Public Storage rarely purchases healthy, stable properties. It prefers to buy financially distressed facilities.
Properties coming out of bankruptcy or struggling to maintain a 40 percent to 50 percent occupancy rate historically have been Public Storage’s bread and butter, as the REIT usually can acquire these properties at 70 percent of replacement cost. In fact, Public Storage hasn’t purchased a single stabilized property since 2010.
Here are some of the other issues that Havner touched on during the NAREIT forum.
Customer Acquisition Costs
With occupancy rates exceeding 92 percent, Public Storage is spending less money than ever on TV and Internet advertising. Additionally, it is giving fewer promotional discounts, and it has stopped using the Yellow Pages altogether.
“Our customers are more valuable this year than they were last year. And why is that? Well, it’s because it’s costing us less to get them,” Havner said. “Our customer acquisition costs are down to $2 per customer, versus 25 to 30 bucks last year.”
Unlike Extra Space Self Storage Inc., which isn’t constructing any new properties at all, Public Storage is ramping up its development pipeline. It plans to spend about $100 million on development in 2013.
“I’m not sure the brain damage is worth it to go build the acquisition pipeline.”
As opposed to Sovran Self Storage Inc. CEO David Rogers, whose REIT uses third-party management to gain insight into various markets and build an acquisition pipeline, Havner isn’t a big fan of third-party management.
Although Havner concedes that third-party management drives Internet search activity and helps boost brand recognition, at the end of the day “it’s a lot of work for a 6 percent management fee.”
Public Storage occasionally offers third-party management in regions where it doesn’t already have a presence.
One of the reasons Havner doesn’t place much stock in third-party management is that Public Storage already has an immensely strong brand name in self-storage.
In fact, he said, “Public Storage, the brand name itself, is one of the top five keywords that’s typically searched for on Google or Yahoo, so it’s a huge benefit for us to have that name.”
Public Storage’s chief financial officer, John Reyes, said roughly 70 percent of the REIT’s customers use the web to search for self-storage. “Public Storage pretty much names (the storage) category, not unlike Kleenex or Band-Aid,” Reyes said.
Although Havner initially was skeptical about Public Storage’s European expansion (the REIT sold half of its European portfolio in 2008), the overseas market is doing quite well.
Public Storage took a 20 percent tax hit on all of its U.K. rental income, and Havner acknowledged that “consumer awareness of the product is not what it is in the U.S.” Nevertheless, at 90 percent occupancy, Public Storage is performing well in Europe, he said.
Focus on Cash Flow
“If you focus on the cash flow, you’re pretty hard pressed to find a better business than self-storage.”
Havner thinks there’s entirely too much emphasis on net asset value (NAV) among Wall Street analysts. He doesn’t think too highly of NAV-based pricing models.
“On an NAV basis, applying cap rates, you can make any company look any way you want,” he said. “Start with an 8 percent cap, and everything looks overvalued. Start with a 2 percent cap and you get a completely different result.”
Conversely, if you look at a self-storage business’ adjusted funds from operations, you can get closer to the actual cash flow.
Funds from operations (FFO) = Net Income after adding back depreciation
Adjusted funds from operations (AFFO) = FFO minus capital expenditures
Havner said: “If you look at the AFFO multiples and you get down to cash flow, self-storage is actually pretty cheap.”
To further support Havner’s claim that self-storage is one of the best real estate asset classes, it’s important to remember that self-storage requires few brokers, maintenance expenses and tenant improvements. Moreover, storage customers are extremely “sticky.” After doing statistical tests in different regions, Public Storage has found rent hikes of 3 percent, 5 percent and 8.5 percent have little bearing on customer retention.
From top to bottom, images courtesy of radarla.com, insidermonkey.com, greenboxselfstorage.com, shurgardeurope.com