Storage REITs are finding that “good” may not be good enough to entice investors.
The publicly traded storage REITs continue to outperform their REIT industry peers, but investor interest shows signs of cooling along with expectations of slower growth ahead.
“Overall, the self-storage industry looks healthy,” said Brad Schwer, an equity analyst at Morningstar in Chicago.
The four biggest storage REITs reported solid third quarter financial results with same-store net operating income (NOI) growth coming in at between 5% and 8%. Fundamentals remain strong across the board with occupancies at 90% or better and annual rental growth ranging between 3.7 percent to 6.6 percent.
The storage REITs have been the best performing REIT sector over the past decade, and last year they outperformed the rest of the REITs by almost 40 percent.
“The reason behind that is because they have the best top line growth and same-store NOI growth,” said David Corak, a vice president and REIT research analyst at FBR & Co. in Arlington, VA.
Storage REITs have benefited from what has been very limited new supply, steady demand and fairly aggressive strategies to fill space and raise rents. Customers typically rent for between one and two years and the top operators have successfully been able to bump rents 8 percent to 10 percent halfway through their stay.
Yet there are clear signs that growth has been decelerating, which is not sitting well with some investors.
“For the first time in about six years you now have a good amount of new supply coming online, which hampers fundamental growth for existing storage facilities,” said Corak.
In addition, some markets are reporting a little softening of demand in some markets. The shifting balance between supply and demand is resulting in a pullback from the high single-digit growth rate that the sector has been enjoying for the past five or six years.
Part of the story is that REITs are having to work harder to maintain occupancy. REITs are finding they need to spend more on advertising, increase discounts and promotions and offer aggressive rates to maintain occupancies. That is hurting top line growth, says Corak.
For example, Life Storage Inc. (formerly Sovran Self Storage Inc.) posted solid third quarter results with same store NOI growth of 5.8% and occupancies that rose 50 basis points to hit 91.9% at the end of September. However, Lift Storage CFO Andy Gregoire noted in the company’s third quarter earnings call that the increased occupancy “came at a price” with free rent increasing significantly for the first time in many years.
Life Storage also is projecting that fourth quarter will be “down on a few fronts”. For example, Houston has decelerated faster than expected and Life Storage is forecasting negative same-store growth in that market as the company pushes incentives to maintain occupancy. The company also expects higher property tax assessments to impact performance with property taxes in some metros increasing 11.5% to 12.5% compared to 2015.
The increased competition on the supply side has broader implications for the self-storage industry.
“I think the whole sector is going to see a slowdown in revenue growth and NOI growth,” said Corak.
The REITs are likely to hold up better as compared to the mom-and-pop operators, because they have stronger operating platforms, more sophisticated technology and greater scale, he adds. In the past down cycle, REITs only lost 3 percent to 5 percent of occupancy whereas mom and pops typically lost 10 percent to 20 percent, he says.
“So, as we gear up in this development cycle and there are more deliveries coming online, I think REITs are going to get hit, but they are not going to get hit nearly as hard as the mom-and-pops,” Corak said.
Overall, REITs have had a great run and are still posting some very good financial results. But investors are a bit wary of buying into storage REITs that may be headed into a period of less robust growth ahead.
REIT stock prices also have taken a hit in the past several months and may drop further. For example, Public Storage has seen its stock price drop more than 20 percent since April’s peak of more than $276 a share.
“I think there is going to be a little bit more pain in the sector over the next couple quarters as you see the continued fundamental deceleration,” said Corak. “But if we reach a point where fundamentals are steady, then I think you will start seeing more demand for the stocks.”
The flip side of the story is that some investors may jump at the opportunity to buy at discounted prices.
“We continue to view our self-storage companies as undervalued,” said Schwer. “These stocks have had a meteoric rise in the last several years and the market has presented investors with a buying opportunity—just in time for the holidays.”