Good morning, ladies and gentlemen, and welcome to the Third Quarter 2017 Extra Space Storage Inc. Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host, Jeff Norman, Vice President, Investor Relations.
Thank you, Andrew. Welcome to Extra Space Storage's Q3 2017 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 statements due to risks and uncertainties associated with the company's business.
These forward looking statements are qualified by the cautionary statements contained 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, November 2, 2017. 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. Good morning, everyone. Before I begin my remarks, I just want to say how impressed and humbled I am by the sacrifices our teammates made in Florida and Houston and Puerto Rico. They went to extra effort to take care of our customers, to take care of our stores and most importantly maybe to take care of each other as family. I am very proud to be associated with a company that has teammates like this.
I want to say that all of our employees are safe and we didn't have any injuries in any of our stores and I'm very grateful for that. So thank you for giving me the opportunity to say that and I'll start my remarks. Throughout the Q3, we had strong execution and posted another solid result. Same store revenue growth was 4.8%, NOI growth was 5.5% and FFO as adjusted growth was 10.8%. If we exclude our properties in Houston and Florida from same store totals, revenue growth for the 6 40 stores not impacted by hurricanes actually improved 20 basis points to 5.0 percent and NOI increased 40 basis points to 5.9%.
So our outperformance this quarter was driven by strong operating results produced by our diversified portfolio, not by one time events. Houston did grow occupancy and is well positioned for growth going forward, but there was no benefit to revenue and NOI in the 3rd quarter. Florida received some benefit to occupancy and revenue growth in the quarter, but we don't expect the long term benefit to be significant. We have provided additional details related to the performance of these markets in our supplemental financial information posted on the website. On our last call, we announced that Strategic Storage Trust, formerly known as SmartStop, decided to internalize management.
And as planned its 94 stores left Extra Spaces system effective October 1. As of today, we've added 121 properties to our managed mid platform this year and we expect to add approximately 30 more between now year end for a projected 2017 total of 151 stores. From a store count perspective, this offsets the loss of the Strategic Storage Trust properties. Further, our 2018 pipeline is the largest we have had in our history with over 100 stores approved to be added to the platform already. 3rd party management will continue to be a growth driver for Extra Space.
Finally, I would like to provide an update on the 36 store portfolio that we have marketed for a joint venture recapitalization. The transaction is now under contract, debt financing has been arranged and we plan to close by December 1, 2017. Proceeds will be reinvested in other properties through 1031 exchanges, which we have under contract. We will be prepared to discuss additional details after this transaction closes. I would now like to turn the time over to Scott.
Thank you, Joe. Last night, we reported FFO as adjusted of $1.13 per share, exceeding the high end of our guidance by $0.02 The beat was primarily due to stronger than expected property and tenant insurance results. We recorded a net loss of $2,100,000 related to property damage and cleanup from the hurricanes. We recorded an additional $2,300,000 for tenant insurance claims for a total of $4,400,000 related to the hurricane. These losses have been added back to FFO as adjusted to more accurately reflect our run rate.
Occupancy for the same store pool ended the quarter at 93.9%, a 140 basis point increase. The growth in occupancy wasn't just the result of the hurricanes. Same store occupancy growth in non hurricane markets was up 130 basis points. Throughout the quarter, we were able to increase rates to new customers in the low single digits and we continue our existing customer rate increase program without changes. During the Q3 and subsequent to the end of the quarter, a number of our acquisitions closed or went under contract.
As of today, we have closed $140,000,000 in wholly owned acquisitions and invested another $15,000,000 in stores held in joint ventures. We also bought out our joint venture partner's interest in several other properties, adding another $20,000,000 in investment for a year to date total investment of approximately $175,000,000 We have another $240,000,000 under contract and scheduled to close by year end. We remain focused on only acquiring properties that create long term value for our shareholders. We funded our acquisitions and loan maturities with draws on our credit facility and the closing of our 10 year $300,000,000 private placement that we announced last quarter. The funding is part of the funding of this private placement is part of our strategy to lengthen our average debt term, increase our fixed rate debt ratio, and expand the size of our unsecured pool.
Based on performance year to date, we raised the bottom end of our same store revenue guidance by 25 basis points to a range of 4.5% to 5%. Year to date expenses have been below budget, and we have lowered our annual expense guidance to 1.25% to 1.75%, increasing our annual NOI guidance to 5.75% to 6.5%. As a result of the Q3 beat, we are increasing our full year FFO as adjusted guidance to $4.32 to $4.35 per share. Our guidance also includes $0.07 of dilution from our C of O stores and an additional $0.08 from value add acquisitions for a total of $0.15 We are accepting some short term dilution in exchange for outsized long term value creation. I'll now turn the call back to Joe.
Thank you, Scott. With most of the year behind us, 2017 has shaped up well and we are pleased that our sector leading performance has allowed us to increase guidance each quarter. The fundamentals in storage are healthy. Demand has been steady resulting in growth in occupancy and rental rates. As expected, the rate of our revenue growth has moderated since the beginning of the year, but the rate of the moderation is flattening.
We are confident that our systems are well equipped to maximize revenue in the current environment and our team has demonstrated a track record of consistent execution. We also have some headwinds, which are unchanged from the previous two quarters. High seller expectations continue in this competitive acquisitions environment and several submarkets have felt the impact of new development. However, these challenges present opportunities. The competitive acquisition market allowed us to put our 36 property portfolio under contract at attractive pricing.
And the new development has led to the acquisition of purpose built assets that will create significant long term value for our shareholders, while enhancing the overall quality of our portfolio. New supply has also resulted in significant growth in our managed portfolio, which generates an income stream for us today, increases our footprint and provides a meaningful acquisition pipeline for the future. Our 3 pronged ownership structure positions us to continue to grow efficiently in the current or any other economic climate. This external growth platform together with our sector leading same store performance and our efficient balance sheet all contribute to meaningful and consistent FFO growth and to our ultimate goal of maximizing the long term return on our investors' capital. Let's now turn the time over to Jeff to start the Q and A session.
Thank you, Joe. 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 an opportunity to ask their initial questions. And with that, we'll turn it over to Andrew to start the Q and A session.
Our first question comes from the line of Gaurav Mehta with Cantor Fitzgerald. Your line is open.
Thanks. Good morning. A couple of questions. So I guess, you mentioned 3rd Q was ahead of your expectations and you raised your same store revenue guidance for 2017. I was wondering in terms of markets, which market outperformed your expectation in the quarter?
The West Coast markets in general continue to perform very, very well for us. Orlando and Las Vegas and West Palm have also been strong markets for us.
And I guess on the expense side, what's driving the expense guidance, Kurt, for 2017?
Yes. So the Q4 looks like it's elevated expenses, but it really relates more to a tough comp. Last year in the Q4, we had negative expense growth right around negative 2%. So year over year is really the difference.
Okay. Thank you. That's all for me.
Thanks, Gaurav. Thank you.
Our next question comes from the line of Gwen Clark with Evercore ISI. Your line is open.
Hey, sorry if
you can
hear me.
We hear you now, Gwen.
Hey, sorry about that. My phone is getting off the headset. Can you guys talk about where street rent trends are today and then where move in rates are and I guess what you guys call your effective rate?
Yes. So throughout the Q3, our street rates were about 5% ahead of where they were in the prior year and our achieved rate was about 3%. And moving into October, those are continued strong.
Okay.
And then I guess on that piece, I know promotions as a percentage of revenue seems to have been trending up as of early September. Can you talk about where that is today and how that fared relative to your expectations?
Yes. So discounts as a percentage of revenue were just under 4%, and we continue to discount rentals. About 55% of our rentals received some type of discount in the Q3. Most of those the most popular discount continues to be 1st month free. And we continue to use discounting as a way to move occupancy.
You can move rate, you can move discounting or you can move your marketing spend. And right now, we're probably a little more focused on the discounting side.
Okay. That's helpful. And sorry again about the headset.
Thanks, Gwen.
Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets.
First, can you provide an October occupancy for us and where that is year over year?
So our occupancy year over year at the
end of the quarter was 140 basis points. We've actually seen it come down a little bit closer to the 1% delta at the end of October. That's primarily a result of some of the move outs we've seen in Florida as the elevated occupancy around the hurricanes has kind of gone away.
Okay. And then, the increase in rental activity in the quarter, rentals were up 7% a little over 7%. Is that more inbound hits? Or is it driven by a higher conversion rate? What's the mix like there?
It's a little of everything. And as Scott pointed out earlier, we're constantly playing with the various tools we have to maximize revenue and we were able to increase occupancy by using those tools this quarter.
You also saw more activity with the hurricanes, Todd.
Okay. How do you measure your conversion rate? Or how would you quantify that? Is there something that you can share with us around what your conversion rate looks like?
We don't share that information, Todd, sorry.
All right. Thank you.
Thanks, Todd.
Our next question comes from the line of Juan Sanabriya with Bank of America.
Just on the same store revenues, you commented that you thought that the pace of growth was decelerating, but the Q4 implies kind of at the midpoint of your guidance 3.4%. Is that where you see things? I know you've kind of had a history of beating and raising or is that is there some conservative business built in there? That will be my first question. Yes.
Juan, so the Q4 does imply some deceleration. The number you give is kind of your number, I would tell you, just kind of depending on where you pick in the range. But I think if you look sequentially from the second to the third, the average 4.8 after starting ending the 2nd quarter at 5.2, somewhere in that quarter you were below 4.8. So I think you see some deceleration in the 4th quarter, but it has moderated significantly.
And when will and can you just talk a little bit about SmartStop and where the occupancy is there versus the rest of the portfolio? Because I think it still contributed a fair amount of the relative performance this past quarter when you thought that that'd be kind of flat in the second half of the year?
Yes. So it's within 50 basis points in terms of occupancy compared to the rest of the portfolio. So it's really right on top of the rest of the portfolio. We started the year thinking that it would add on average for the year about 50 basis points benefit, the change in same store pool. Now we're probably closer to 75 basis points on average.
Our thinking was it would start the year at 100 basis points and be 0 by the end and it's probably on the higher end of the 50 basis points to 75 basis point range. And
so sorry, just to clarify, the occupancy is 50 basis points below the rest of the portfolio? Is there anything
It's actually so it's very close and it's going to be market by market. What I'm saying is it's within 50 basis points, but it's a combination of rates as well as occupancy that have provided the benefit from the change in pool.
Okay. Thank you.
Thanks, Warren.
Our next question comes from the line of George Hoglund with Jefferies. Your line is open.
Hey, good morning guys. Just one question on the acquisition environment. Just what are you guys seeing out there in terms of portfolios in the market? And then also, are you seeing any change in the competitive landscape for acquisitions in terms of how's the appetite from private equity? Has there been any noticeable change there?
Sure. So transaction volumes are down significantly. The last statistics I saw was 63% between 2016 and today through the end of the third quarter. So the volume overall is down significantly. We believe the quality of most of what we see on the market in terms of product quality or markets is lesser than what we would like to chase.
So it's just a very difficult environment. And as you suggest, there is significant interest in private equity in self storage. I think that even with our reduced numbers from years, we still look a lot better than other real estate asset classes and people are looking to get exposure to self storage and we're seeing new private equity money compete in this space.
Okay. And then just following up on that. Given the amount of private equity money looking to get into the space and given where some of the stocks have gone over the past 12 to 24 months. What do you think is the likelihood of large scale M and A in the sector?
Yes. I'm not sure I could really predict large scale M and A.
Okay. Thanks.
Thanks, George.
Our next question comes from the line of Neil Milken with RBC Capital Markets. Your line is open.
Hey, guys. Good morning. Good morning. In some of the other sectors we're seeing just the lending per environment tightening giveaway to the ability for the REITs who have better access to capital to provide that mezz part of the capital stack. Have you seen more people come to you looking for mezz financing?
And are you considering that just given sort of kind of elevated supply and the less dilutive impact of that versus a SCIO lease up?
It's a really good question. And we thought there was going to be an opportunity in mezz. And Frank, we thought there would be a void in the capital markets there. There would be a way we could attractively place capital given the current acquisition environment. For us, we would be unwilling to do it on a development property.
I don't want to be in a position where I have to take over some broken development property. But we thought maybe for people who had under leveraged assets with long term debt on it that might be an opportunity. We made some increase in the market and we were wrong. We just we haven't found that to be an opportunity. But we will continue to try to be creative and find ways to invest investors' capital at good risk adjusted returns.
Okay. And last one
for me. Just given the sentiment and nature of the environment for stabilized assets and pricing, are you kind of alluding to you getting more comfortable with your Cboe pipeline? Do you see that increasing? And if so, what size relative to the enterprise are you comfortable with this part of the cycle?
It's a good question. So first of all, we have an internal governor on the amount of dilution, our C of O pipeline and our value add stores will that we're willing to accept. And we monitor that every quarter and we do our best to stay within it. One way, if we see attractive deals that we can continue to participate, but stay within that dilution governor is to execute deals in joint ventures. And I think if you look at our C of O pipeline, there's a good number of the deals are executed in joint ventures.
We still believe there are opportunities in CFO in development, although they're fewer and far between. We approved in 2016, 38 CFO transactions and we've approved so far this year 15, 7 of which are in joint ventures. So we're about half of the pace that we were a year prior. But we're never out of the market. And to the extent someone has a submarket, a location that makes sense and a cost that makes sense, we'll continue to participate.
Thank you. Thanks, Neil.
Our next question comes from the line of Vikram Malhotra with Morgan Stanley. Your line is open.
Thanks, guys. Thanks for taking the question. Just want to dig into sort of the West Coast markets a bit more, maybe if you could compare and contrast LA and San Francisco a bit. LA did seem to decelerate quite a bit, where San Francisco sort of was more stable. Just wondering what are your expectations over the next, call it, 6 to 12 months for those West Coast markets and if
you could just compare the 2? So, the acceleration is relative and we're still growing rents in Los Angeles at over 8%. So that's a pretty good clip and it's real hard to think you can sustain over a long period of time higher rent growth. I think those markets are going to continue to be very strong because we just don't see very much new development. It's very difficult to get things built in those markets.
There's some exceptions, Irvine, San Jose. But overall, we expect those to continue to be very strong markets.
Okay. And then just on supply sort of now coming towards the end of 2017 into 2018, any updated thoughts on sort of the pipeline and deliveries? It seems to be there's a couple of different figures out there now. I'm just wondering what your thoughts are and when you expect to see the peak impact from this in the markets where you are seeing supply?
So earlier this year, we were asked the question on overall number and we said 600 to 800. If we had to give an update now, we would say we're probably towards the lower end of that range. But I want to caution as I think I have in the past, the overall number and the focus on markets, I think can be misplaced because the most important thing is where these stores are being built. So, example, Dallas is kind of the poster child of a lot of development, possibly over development. But Dallas is several markets.
Our stores in South Dallas are growing revenue at 10%, where North and East Dallas are slightly negative. So it's real hard to say how many stores are being delivered in the country, what's the overall number or even how many stores are being delivered in a market because it depends where those stores are being built.
Okay, great. Thanks guys. Thanks Vikram.
Our next question comes from the line of Kevin Kim with SunTrust. Your line is open.
This is Ki Bin. I'm sure you figured that out. So it seems like the results are just trending a little bit better than guidance, obviously. If you had to look at all the variables that you're always managing to drive occupancy, drive revenue, what is the surprising factor that came in better than expected?
I would tell you occupancy has been better than expected as well as we've been able to have a little bit more pricing power than I think we expected early on in the year.
So when you say occupancy, if you can dig in a little bit deeper, is that because different ways of advertising? Is the private market getting a similar uplift in your MSAs? Or are you taking share? Just wondering if you could provide more color on that.
It's hard for us to get really good statistics on the private market. But I will tell you, systems that we can stick the most people into the funnel and convert the most people out of there. And we're never happy with where we are. We're always going to try to improve it. But right now, the system is working pretty well.
And when you say the system, how much of it is truly your algorithms and your pricing systems outputting something and you guys do it versus something more subjective that you might do during the quarter?
So our machines, our algorithms work in conjunction with our people. We don't turn the machine on and just let it run. There are situations that a machine doesn't know the road in front closed or whatever. And so it's a combination of our people on the ground and in our data science and revenue management teams and our algorithms.
Okay. Thank you.
Thanks, Kevin.
Thanks, Jeremy.
Our next question comes from the line of Todd Spender with Wells Fargo. Your line is open.
Hi, thanks guys. Can we hear details on the properties you acquired in the quarter, specifically locations and maybe stabilization occupancies that kind of stuff?
The combination of a few things. We did a certificate of occupancy in Georgia. We bought 1 in Virginia. We bought 1 in North Carolina, one in Florida and then one joint venture in Massachusetts. Majority of those are lease up or certificate of occupancy deals.
And Scott, can you go through your underwriting assumptions? I guess, if you're willing to take 1 on balance sheet versus 1 in a joint venture, maybe go through maybe the growth annual growth rates and maybe going in yields?
So we underwrite all stores the same regardless of whether we're going to offer it to a joint venture partner or not. And the question to us would be sometimes it's Exposure to a market, different factors. Exposure to a market, different factors such as that.
And then sometimes just managing the dilution, quite frankly.
And do you guys have an updated dilutive number or dilution number, maybe an annualized number?
Yes. So in terms of certificate of occupancy, we've got $0.07 in our current number and then $0.08 related to stores that will stabilize at a number higher than our in our current earnings. So $0.15 total of additional earnings from those C of O or from those lease up properties.
Okay. Thank
you. The other factor, frankly, to give a complete answer is sometimes developers bring us stores that they will only do on a joint venture basis, where we don't have access to the transaction unless we're willing to do a joint venture.
Got it. Thanks for the color.
Sure. Thanks, Todd.
Our next question comes from the line of Ki Bin Kim with SunTrust. Your line is open.
Right this time. That was quick. So just a quick one. When you guys said CFO deals that you're doing this year is probably half the pace, are other players picking up that slack? Or is it just less getting done?
I would say there's less getting done.
Okay. That was it for me. Thank you.
Sure. Thank you.
There are no further questions at this time. I would now like to turn the call back over to Joe Margarles.
Thank you everyone for your interest today in Extra Space and look forward to seeing you shortly. Have a good day.