Welcome to the fourth quarter 2018 Extra Space Storage Inc. earnings conference call. At this time, all participants will be in a listen-only mode. Later, we will conduct a question- and- answer session, and instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero to reach an operator. As a reminder, this call is being recorded. I would now like to turn the call over to Jeff Norman. You may begin.
Thank you, Michelle. Welcome to Extra Space Storage's fourth quarter and year-end 2018 earnings call. In addition to our press release, we have furnished unaudited supplemental financial information on our website. Please remember that management's prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act. Actual results could differ materially from those stated or implied by our forward-looking statement due to risks and uncertainties associated with the company's business. These forward-looking statements are qualified by the cautionary statements combined in the company's latest filings with the SEC, which we encourage our listeners to review. Forward-looking statements represent management's estimates as of today, Thursday, February 21st, 2019. The company assumes no obligation to revise or update any forward-looking statements because of changing market conditions or other circumstances after the date of this conference call.
I would now like to turn the call over to Joe Margolis, Chief Executive Officer.
Thank you, Jeff. Hello, everyone. Thank you for joining us for our fourth quarter and year-end call. It was great to have so many of you here last month for our Investor Day, and we appreciate your interest in and support of Extra Space Storage. 2018 was another solid year. Same-store revenue was in line with expectations. Our diversified portfolio and best-in-class platform are maintaining very high occupancies while producing positive rate growth, despite a challenging environment with new supply in many markets. Expenses were also generally in line with expectations, with the exception of a couple of uncontrollable expenses which hit in the first half of the year. Our team stepped up and did a great job with controllable expenses, especially in the last two quarters, and found ways to offset some of the expense growth through savings and efficiencies.
Our same-store NOI grew 4% for the year, despite a challenging operating environment. Same-store NOI was enhanced by our strong external growth from third-party management and off-market acquisitions, resulting in core FFO growth of 6.6%, which was above the high end of our annual guidance. Looking forward to 2019, many of the themes are similar to 2018. We continue to see new supply delivered in many markets. The rate of deliveries has started to slow, and while we still believe new openings in 2019 will be lower than in 2018, we expect the impact of new supply to be greater due to the cumulative impact of several years of elevated development. These concerns are the same concerns we discussed on our call a year ago. However, there are also some encouraging themes from last year that will continue into 2019. First, the economy continues to be healthy.
Second, we are in a need-based industry with steady demand and solid fundamentals. Third, concerns about declining use of storage due to millennials, disruptive new businesses, or otherwise, are proving to be ill-founded. Fourth, large operators continue to have a significant technology advantage over most of the industry. As a result, occupancy remains very strong and we have positive rate growth in most markets. We have a geographically diverse portfolio and a platform built to drive traffic to our stores, our website, and our call center. In short, Extra Space is well prepared to navigate today's competitive landscape. The challenges presented by new supply also continue to bring us opportunities. In 2018, we added 153 stores to our third-party platform and continue to have a robust pipeline for 2019. We invested $580 million in acquisitions, $145 million of which was invested in certificate of occupancy or development deals.
We were successful at finding accretive acquisition opportunities through our partners and other relationships before they were exposed to the broader market. 84% of all 2018 acquisition volume was completed through off-market transactions. This off-market acquisition trend has continued into 2019, as we recently completed the buyout of one of our joint venture partners in 12 properties in Los Angeles and the Bay Area. These are well-located, purpose-built properties that we developed ourselves in the early 2000s in top-tier infill markets with true barriers to entry. Extra Space realized a $72.8 million promote in the joint venture through the transaction, which was applied to the purchase price. While 2019 will not be without its challenges, we are making the necessary investments to strengthen our platform and support our growth while maintaining operational excellence in the current environment. I would now like to turn the time over to Scott.
Thanks, Joe, and hello, everyone. Our core FFO for the quarter was $1.22 per share, and our core FFO for the year was $4.67 per share, ahead of our guidance. The beat was primarily due to property performance and G&A savings. Core FFO includes a $0.02 adjustment for the write-off of deferred financing costs related to the prepayment of notes payable to trust. We continue to evolve our balance sheet, which has never been stronger. During the quarter, we amended our credit facility, accessed our ATM, and increased our unencumbered pool, which now stands at $5.6 billion. These efforts are part of our goal to further diversify our capital structure, ladder our maturities, and minimize our average interest rate while extending the average term. This will ensure that we continue to have capacity to fund future growth through multiple sources of capital.
Last night, we provided guidance and annual assumptions for 2019. Our new same-store pool increased by 38 stores to a total of 821. Same-store revenue is expected to increase 2%-3% in 2019. As Joe mentioned, we believe the impact from new supply will be greater in 2019 than it was in 2018. The level of this impact will depend on the timing of deliveries and the speed of absorption in impacted markets, specifically the major Florida and Texas markets. Our guidance also assumes some revenue growth moderation in markets not heavily impacted by new supply. This is due to multiple years of outsized growth resulting in tough comps. Same-store expense growth is expected to increase 3.75%-4.75%. The increase in expenses is primarily driven by outsized growth in property taxes and marketing spend. Our revenue and expense guidance results in NOI growth of 1.25%-2.75%.
Our full-year core FFO is estimated to be $4.73-$4.83 per share. In 2019, we anticipate total dilution of $0.23 from value add and C of O acquisitions, up $0.03 from 2018. We recognize the short-term headwind this causes to our core FFO growth rate, but believe the investment in these lease-up stores continues to improve the quality of the portfolio and generates long-term value for our shareholders. With that, let's turn it over to Jeff to start our Q&A.
Thanks, Scott. In order to ensure we have adequate time to address everyone's questions, I would ask that everyone keep your initial questions brief. If time allows, we will address follow-on questions once everyone has had the opportunity to ask their initial questions. With that, let's turn it over to Michelle to start our Q&A.
Ladies and gentlemen, if you'd like to ask a question, please press star then one. If your question has been answered and you'd like to remove yourself from the queue, you may press the pound key. Once again, to ask a question, please press star then one. Our first question comes from Jeffrey Spector of Bank of America . Your line is open.
Good morning, guys. This is Shirley Wu with Jeffrey Spector. Thanks for the extra color on supply. I think in previous earnings calls, you've mentioned that the percentage of your portfolio being affected by the new supply would be around 60% in 2019. Has that changed? What do you think 2020 is going to look like?
Our view of 2019 has not changed. The only thing that's changed on the ground is a certain number of developments that we expected to be delivered in 2018 were in fact delayed, and now will be delivered in 2019. We expect the same thing to happen in 2019, that some of the properties that are scheduled to be delivered late in 2019 will in fact be delayed and not deliver into 2020. Our view continues to be that deliveries will be higher in 2018 than in 2019, although peak impact is in 2019 because of the cumulative effect. As to 2020 and our views, frankly, it's all subject to the trend continuing of decreasing new developments. If in fact, people start putting more shovels in the ground, then we could be wrong, and we just have to wait and see what happens.
Okay. Could you talk about achieved street rates in Q4 and maybe how that's going to look in Q1 of 2019 as well?
Yeah, Shirley. This is our achieved street rate. We achieved street rates that were in the low single digits, and it was about 2% in January.
Got it. Thanks, guys.
Thanks, Shirley.
Our next question comes from Jeremy Metz of BMO Capital Markets. Your line is open.
Hey, guys. Did you mention the drag from discounting at all? I know last quarter it was about an 80 basis points drag. It was supposed to abate a little bit here in the fourth quarter. What was it? Sorry.
In the fourth quarter, there was really no drag or no benefit from discounts. It was flat. Our guidance for 2019 assumes the same, no benefit or drag.
If we combine that with the 2% effective rate you had just mentioned here, it obviously takes a while to roll through same-store, but as we think where you're at today and where your guidance is, does that 2.5% midpoint for revenue assume you actually go negative on net effective rents? It sounds like January is holding, but are you seeing any sort of signs already, maybe in February, of some slowing that's making you more cautious?
February is not significantly different than January, and I think guidance all depends on where you are in that range.
Okay, just one last one. Joe, at the Investor Day, you touched on the new bridge lending program you started. Can you just give an update on where that stands today and what sort of activity you're seeing out there, and how much capital allocation are you putting in the budget here for 2019?
Sure, Jeremy. Be happy to. For those of you who weren't at Investor Day, we initiated a bridge lending program, the goal of which is to expand our management platform to form additional relationships across the industry, because we found through Management Plus and other activities we do, that those relationships frequently turn out to produce acquisitions or other benefits. To fill what we perceive as a capital void in the market and make some money by lending to non-stabilized stores. We will not be lending to development stores. We don't want to have to take over a half-finished development. We believe there is an opportunity to lend on stores that are not yet stabilized. We're just starting this program. We've made a couple loans. We have a few in the hopper. We're getting very good reception in the marketplace. We're just beginning.
We're going to walk before we run. We're going to see how the market reacts to this, and I would not expect it to be a significant capital allocation in 2019.
Thanks, guys.
Thanks, Jeremy.
Our next question comes from Ronald Kamdem of Morgan Stanley. Your line is open.
Hey, thanks, guys. Just following up on the same-store expenses. I think you mentioned outsized property taxes and marketing spend. Just curious if you can provide more details. How does the growth rate compare for those versus 2018, if there's any markets or any kind of a one-time thing that's really driving this outsized nature of these expenses?
Yeah. Our property tax budgets for 2019 assume about 4.5% increase year-over-year. We continue to see pressure across multiple markets. It's actually down slightly from 2018, but continues to be higher than inflation. 2019 marketing spend is about 11%, is what we budgeted, which is up from our annual run rate of 2018. That comes from a couple of things. One is just overall inflation from more people bidding on using the search engines, and that's driving the cost of the bids up, as well as we're in a supply cycle and wanting to make sure that we stay top of mind in people's buying decisions.
Great. Then just a quick one on development. AB, can you just comment versus three, six, nine months ago, have you seen any incremental sign from developers, whether it's yield compression, whether it's projects taking longer to lease up? Any incremental color on slowing of that supply pipeline?
I think we are seeing the factors you described. Yield compression, increased costs, and just an awareness that many markets are overbuilt or fully built, and some more caution. We are seeing a pullback in new supply in some areas, new developments in some areas. There still are people who have either more optimistic views or lower yield requirements that are still trying to go forward.
Great. The last one from me is just, I just noticed in the release that Miami was added to markets lagging and Philly was added to markets that are outperforming. Can you maybe a little bit more color on what's going on there? Is there anything to note there?
I think that's directly related to new supply. Miami has had a very large influx of new development that is impacting our performance, and we haven't seen the same thing in Philadelphia.
Helpful. Thank you.
Thank you.
You're welcome.
Our next question comes from Smedes Rose of Citi. Your line is open.
Hi. Thank you. I wanted to ask you the sequential decline in period-end occupancy from three Q to four Q was steeper than what we've seen in several years now. Did that surprise you at all, or can you maybe provide a little more color on the, I guess, vacates over the course of the quarter?
Smedes, first of all, I would tell you, I think sometimes people focus too much on rentals and vacates. I think if you look at our year-end occupancy, it was quite strong, maybe slightly stronger at the end of the third quarter. Again, the goal here obviously is to maximize revenue. You'll see it ±10, 15, 20, 30 basis points, depending on the month, depending on the quarter. I don't think the fourth quarter played out significantly different than what we were expecting, and we felt like we had a strong ending to the quarter and the year.
Okay. You were looking for that level of kind of sequential declines. That wasn't a surprise at all.
Not necessarily decline, on an annual basis, we were expecting no benefit from occupancy, and that's largely where we ended up. The same is true for 2019. Our budgets and our estimates are no benefit from occupancy. Again, we're not focused entirely on occupancy.
Mm-hmm. Okay. I just wanted to ask you mentioned that the third-party platform maybe has an opportunity as conditions are more challenging across the industry. Have you seen a pickup in inquiries or in just private operators looking to join a larger platform like yours?
We have. We've had a pretty robust pipeline for several years now. I think we are seeing more inquiries from folks who are having some problems at their stores, meeting the numbers that they would like to hit. I expect as things get tough, that will continue.
Okay. Thank you, guys.
Thanks, Smedes.
Sure. Thanks, Smedes.
Our next question comes from Todd Thomas of KeyBanc Capital Markets. Your line is open.
Hi. Thanks. In terms of the dilution from the lease-up stores, $0.23 versus $0.20 in 2018, you have more deliveries, both wholly owned and JV planned in 2019, but a little less than 2018. Would you expect that dilution to continue increasing throughout the year and into 2020, or do you anticipate that the dilution will level off and begin moderating during 2019?
I would tell you.
I'm sorry, Scott.
Go ahead.
Part of it depends on what we buy. A good deal of what we bought in 2018 were non-stabilized stores. I think there will be an opportunity, again, as operating conditions get tougher and some owners decide their best bet might be to sell. We may have an opportunity to buy stores that are not fully stabilized and may even be somewhat dilutive, depending on where they are in the first year. I think that's the biggest variable in which direction the dilution goes.
Currently, our budgets for C of Os, Todd, it's pretty even throughout the year. That could move depending on deliveries. We have seen deliveries continue to take longer, but right now it's pretty flat, specifically for the C of Os, not the lease-up stores Joe's talking about.
I think it's important to note that in a number of things we're talking about today, we're very focused on creating long-term value for our shareholders. If we have the opportunity to buy a good store at a good price that we know long term will produce value, will be accretive, then we're willing to accept a certain amount of short-term dilution to get there.
Okay. That's helpful. Then, can you provide an update or some color on the $300 million acquisition assumption that you have for operating stores in 2019?
Sure. We've closed $240 million worth of acquisitions already in 2019. We have under contract another $100 million worth of stores. We assume, like in the prior years, that it's going to be difficult for us to be competitive in the bid auction market and to be the high bidder and win a lot of stores that way. Our experience tells us that every year we are able to buy a certain number of stores out of our management platform from our joint venture partners or from our relationships in off-market transactions. While we can't identify those today, history tells us that we will have some success in that area.
Okay. Got it. Right. That includes the buyout of the JV partners interests that have closed to date. Okay. Then, just lastly, I was just curious if you could talk about the increase in G&A expense that you're forecasting and what that's attributable to specifically.
Yeah. The increase in 2019 in terms of our G&A, if you look at it in terms of a % increase, it's actually in line with the increase in the number of stores we've added over the last couple of years, and specifically what we're forecasting to add in 2019. That being said, about a third of the increase that we will incur in 2019 has to do with some outsized investments we are making in some technology opportunities and some technology initiatives that should provide a platform for us to grow in the future and to also achieve some economies of scale. I would tell you, we don't expect to grow one for one G&A with our property count, but this is a year we've chosen to invest more heavily in technology that will assist us in the future.
Okay. Thank you.
Thanks, Todd.
Our next question comes from Ki Bin Kim of SunTrust. Your line is open.
Hey, guys. This might be a hard question to answer, but from your perspective, what percent of development deals do you think are missing performance expectations?
I don't think we can answer that question, Ki Bin. I would tell you that on the deals that we do, our C of O deals or development deals, we've been very happy with our underwriting, and as a whole, we're meeting or exceeding expectations, but we have no way of knowing what other people are underwriting or how they're actually performing.
I asked that question just to see if there's any kind of trend in people missing their yields. That's probably the only reason why development will slow down, right? On your expense growth expectations of 4.25%, do you expect that to continue on to 2020, 2021? Or is this a kind of unusual year where you have some long-term resets that are happening and hitting in 2019?
In terms of our property expense growth being elevated, I think you saw it last year and this year largely as a result of property taxes. We hope that moderates. We're also seeing pressure on pay-per-click advertising, so that continues to increase. We hope in the future to be able to move back more towards inflationary expense growth.
One thing that's hurt us in the past few years is as values of self-storage properties has increased dramatically, excuse me, we've had property tax increases commensurate with that. As taxes catch up and get to property values, you would think outsized property tax growth would stop and would just be inflationary going forward.
Scott, just last one. When you quote street rates, how close is that to the actual move-in rate that you experience in any given quarter? Is that pretty close?
When I say achieved rates are up 2%, that is actually our move-in rate. Our street rates are going to be higher than that.
Got it. All right. Thank you guys.
Thanks, Ki Bin.
Thanks, Ki Bin.
Our next question comes from Jonathan Hughes of Raymond James. Your line is open.
Hey, good afternoon. What's the contribution from the new same-store assets on revenue growth guidance, and how should that trend throughout the year?
Jonathan, it's about 10-15 basis points of revenue contribution, and at the end of the year, it's basically zero. If you straight lined it, call it 30 at the start of the year and zero at the end for contribution between 10 and 15 basis points.
It's similar in 2018 and 2019, right?
Correct.
Okay. has there been any change to customer behavior and acceptance of renewal rate increases as competition has increased? Are there any knowledgeable customers out there using these new deliveries and kind of leveraging that and pushing back on, say, 9%-10% rate hikes?
No, we really haven't seen any change in customer behavior in that area.
Okay. That's just surprising. Fair enough. I realize this isn't a guidance, but any plans to look at maybe recycling capital from some of your weaker non-core markets, sell those, focus on better longer-term growth markets?
Well, we put one property under contract yesterday, so that's one event. We do have a list of properties that are always considered for either recap into a joint venture or outright sale. We periodically look at the portfolio and try to look at where those opportunities would make sense. To answer your question, we don't specifically have any portfolio on the market today, but it's always an option for us.
Okay. I'll jump off. Thanks for the time.
Thanks, Jonathan.
Thank you.
Our next question comes from Eric Frankel of Green Street Advisors. Your line is open.
Thank you. I just want to go back to the same-store calculations. Can you just confirm, so you say it's a 15 basis point drag. Can you just confirm the number of stores that are going to be added to the same-store pool?
Our current pool is 783 and the new pool goes to 821, so an add of 38.
All right. The average occupancy for the roughly, I guess, 440 or so stores, is that significantly lower or the same as what you currently have?
It's pretty much the same. They're very close to being right on top of each other.
Okay. Just trying to understand that better. I know in an earlier question just regarding your cap allocation guidance and the investments you have under contract and what you're hoping to close, but it seems like you're 70% of the way there essentially in terms of what you have under contract or have closed and what you've guided to. That seems somewhat conservative. Maybe you could provide a little more color on how you're thinking. I guess you have roughly $160 million of deals that you haven't gone under contract or closed on, but it's kind of based to your guidance. Any reason why that shouldn't be higher, just kind of given all the trends that you're referring to?
The only thing I could say is it's very difficult for us to predict when we're going to have opportunities to transact on an off-market basis. As I said earlier, that's really where we are able to be successful. We could talk to the brokers, and we can understand the pipeline and what we think is coming forward, but we know we're not going to be very successful there. Is it possible that we exceed our guidance and buy more? Absolutely. If accretive opportunities are available and good deals, we have a balance sheet and capital flexibility to execute on those transactions. I hope we do exceed our guidance in 2019 like we did in 2018, but we're not banking on it.
Okay. Thanks, everyone.
Thanks, Eric.
Once again, ladies and gentlemen, if you'd like to ask a question or if you have a follow-up, please press star then one. Our next question comes from Wes Golladay of RBC Capital Markets. Your line is open.
Hi, guys. When rent growth slows, is it driven more by changing distribution channels or lower street rates?
The street rates are really what's going to drive your rent growth. Your current street rates, your current achieved rate, at some point flows through and becomes your rental rate growth. street rates are going to probably be more influential than anything.
Okay. Going back to that three-year rolling supply, when do you see that peaking? Do you expect a gradual decline or a sharp decline, or how should we look at that going forward?
We believe that 2018 was the peak delivery year, and we expect a gradual decline. That's fully caveated by we don't know what people are going to do in terms of picking up development. We're looking at current trends and assuming that they continue. If for whatever reason, a bunch of people throw capital into development and start putting shovels in the ground where they shouldn't, then we could be wrong.
Okay. Maybe going back to Ki Bin's question about the developers not hitting the returns, are there certain markets where you see maybe in the next year or two you can have an opportunistic fund and take advantage of some of this?
I think that is likely. I think there are going to be opportunities to purchase projects that are not hitting pro forma or are not doing as well as a lender would like or an equity partner would like. Our acquisition guys are fully focused on that.
Okay. That's all for me. Thank you for taking the questions.
Thank you.
Thanks, Wes.
Our next question comes from Todd Stender of Wells Fargo. Your line is open.
Hi. Thanks. Just to go back to the $0.23 dilution expected from C of O and value add, have you guys separated those two, and how much do you ascribe to those two buckets each, if you have?
It's about $0.16 from C of Os and about $0.07 from lease-up properties.
Okay. Thank you, Scott. It could be a pretty good source of upside to earnings. You've got 12 of the 17 projected openings, I guess, opening in the first half of the year, but I also want to see potential offsetting that. Have you tapped the ATM already in January, February, just because you've acquired so much? Just seeing where your capital's coming from.
We used the ATM in the fourth quarter, and in the current quarter, we have not hit the ATM.
Third and fourth quarter.
Correct. Third and fourth quarter of last year, we used the ATM.
Okay. Thank you. just finally, excluding the 12 assets you described in California that you've already gotten, where are the other locations? I know you've got a couple C of O deals that are wholly owned, that you've acquired already in the first quarter. Where are those, what markets?
Plantation, Florida, Louisville, Kentucky, and Manayunk, Pennsylvania. Actually, we just closed one in Brooklyn, too, last week. Was that last week or next week?
Yeah, we have three that are closing. Well, two in Brooklyn, one in Queens. also Massachusetts, Maryland. they're kind of throughout the country.
Okay. Great. Thank you.
Thank you.
Our next question comes from Tayo Okusanya of Jefferies. Your line is open.
Yes, good afternoon. Couple of questions. The first one is the 2% increase in street rates that you guys discussed. Is that net of concessions or is that without concessions?
It is not net of concessions. That is just our achieved rate is the average someone is paying, no matter which channel they come from.
Okay. Do you have a discount year kind of-
I was going to say discounts year-over-year, there's no change.
That's the first thing. Going back to a question that was asked earlier on, not getting a lot of pushback from in-place tenants on rent increases. I was just curious, does guidance contemplate a slower rate of rent increases going forward because of supply or no?
No. We really don't believe supply impacts our ability to increase rents to tenants when appropriate.
That's helpful. Could you help us understand what the mark-to-market is in the portfolio? Like today, if a tenant moves out, average rents are X versus if a tenant moves in, they're probably moving in on average at this particular rent?
Yeah. If you look at our in-place rents and compare those to our achieved rents, so what people are renting at when they come in the door, on average for the year, it is mid-single digits, so call it 5%. That is considerably higher in the off-season, so right now it's, call it double digits, and then it goes to zero in the summer months. Depending on the time of the year, our rates are typically higher in the summer when more people are moving, and lower in the off-season when fewer people are moving. That roll-down is higher in the colder months. I would tell you to be careful to assume that's the roll-down on everybody, because you have many people that move in and move right back out, and so they're at very close to what the street rate is.
Gotcha. Okay. That's helpful. Thank you.
Thanks, Tayo.
There are no further questions. I'd like to turn the call back over to Joe Margolis, CEO, for any closing remarks.
Thank you, everyone, for joining us today. We expect another great year for Extra Space in 2019, despite the challenges we're all aware of and we've all discussed. We operate in a resilient sector. Our demand is need-based. We're able to achieve high occupancies and positive rate growth, and we have significant external growth opportunities. We continue to invest heavily in technology. Our digital marketing and revenue management systems continue to evolve and improve. None of this would be possible without our people. We have an incredible, deep team of dedicated, motivated, and engaged employees who live our values every day and are driving our performance. I want to recognize their contributions to our efforts and our success. Thank you all for your interest, and we'll talk to you soon.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.