Public Storage (PSA) Q4 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Jackie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Public Storage Fourth Quarter 2012 Earnings Call. [Operator Instructions] I would now like to turn the call over to Clem Teng. Mr. Teng, please go ahead.

Thank you, Jackie. Good morning, and thank you for joining us this morning for our fourth quarter earnings call. Here with me today are Ron Havner and John Reyes. All statements other than statements of historical facts included in this conference call are forward-looking statements, subject to a number of risks and uncertainties that could cause actual results to differ materially from those projected in these statements. These risks and other factors that could adversely affect our business and future results are described in today's earnings press release and in our reports filed with the SEC. All forward-looking statements speak only as of today, February 22, 2013, and we assume no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. A reconciliation to GAAP or the non-GAAP financial measures we are providing on this call is included in our earnings press release. You can find them, our press release, SEC reports and audio webcast replay of this conference call on our website at www.publicstorage.com. I'll turn the call over to John Reyes.

Thank you, Clem. Our core FFO per share was $1.86 compared to $1.66 last year, a 12% increase. This increase was driven by a 9% growth in our same-store NOI, growth of our non-same-store properties and lower preferred stock dividends. With respect to our capital activity for 2012, we issued a total of $1.7 billion of new preferred securities, with an average coupon rate of 5.7%, and redeemed $2 billion with an average rate of 6.6%. Last month, we issued $500 million of preferred stock at 5.2%, the lowest rate ever. A portion of the net proceeds from this issuance was used to pay off the outstanding debt under our revolving credit facility. We increased our quarterly dividend to $1.25 per share, representing an increase of 14%. Since 2007, our dividend has more than doubled. Our consistent long-term dividend policy has been to distribute only our taxable income. With that, I will now turn it over to Ron.

Thank you, John. The fourth quarter benefited from solid demand, resulting in record high occupancies and higher realized rents. Customer acquisition cost continued to decline, while customer move-in volumes increased and move-outs declined. At the end of January 2013, occupancy and in-place rents were higher than last year. In Europe, same-store NOI improved by 1% despite a difficult operating environment. Of note, in the U.K. market, Q4 revenue declined by 8.6% compared to last year and compared to a 4% growth in Q3 as we reduced rental rates to compensate for the introduction of the value-added tax in October. In Q4, we acquired 10 facilities for approximately $82 million. We're adding about 910,000 net rentable square feet to the portfolio. With that, operator, let's open up for questions.

[Operator Instructions] Your first question comes from the line of Christy McElroy with UBS.

With regard to the reduced seasonal impact on occupancy that you saw in Q4, is the 200 basis point occupancy gap that you had at year end something that you'll try to sustain through Q2 and Q3? Or is it really more a function of your efforts to sort of smooth out the occupancy cycle throughout the year?

Christy, I'd say it's the latter. We're trying to smooth out the seasonality of our occupancies, and so you saw us -- and we talked about this on our last conference call that we were going to try to do that during the fourth quarter, which we did. We gapped up versus last year by the 200 basis points that you mentioned. We should continue that into the first quarter. But by the time we get into the summer months, it's going to be probably more difficult to keep that gap just because the year-over-year comps are going to be much tougher for us.

Okay. And then just to follow up on that, in regards to the ultimate goal being to maximize REVPAF growth, given the different levers that you have, would you expect that you could see a similar level of REVPAF growth in 2013 versus the 5% you saw in 2012?

Christy, that kind of borders on guidance.

A little.

Yes.

I'd say this, Christy. If you look at where we started the year, we started the year, and I'm talking about 2013, where we have the 200 bps of occupancy gap, our in-place rents were up 2.9%. So if you add those together, we were kind of looking at a 4.9 starting the year. If you look -- if you go back 1 year prior to that, as we started 2011, that same number, comparable number was at 3.6. As we move forward into this year -- so we're starting at a better place than we did last year, and as we move forward into 2013, we expect that we will continue to send rental rate increase letters to our existing tenant base. That's where we're going to get and have been getting a significant amount of our rental rate growth. We expect that the rates that we will send will be comparable to 2012. But one thing -- one benefit we do have in addition to that is, is that we have more tenants that have aged longer than 1 year as we start this current year by about 2%. So we have a higher base of tenants to send rental rate increases to. So we're pretty confident that we can continue to grow our rental rate, and I'm not giving guidance. I'm just saying we can continue to grow our rental rate as we move forward.

Those notices have been around 8% to 10%, is that right?

Correct. On average, I believe it's about 8.5% increases.

Our next question comes from the line of Todd Thomas with KeyBanc Capital.

Just a question on rents to new customers. You've been at or above 90% occupancy now for some time, and I think you've commented in the past that you've tried to raise rates across the portfolio several times over the last few years, but the industry wasn't really quite ready to raise rates since it was still filling up. But now that the industry is at a higher occupancy level, are results this year on your efforts to increase asking rents any different? Is there any comments on pricing power that you can make?

Todd, we'll have to see that as it unfolds in 2013 and kind of what the competition does vis-à-vis rental rate increases. But there's 2 levers here that I think you need to think about. If you look at the average move-in rate for last year, it was about flat. However, promotional discounts, which is mainly the dollar special upfront, were down about 9% for the year and down about 20% for the quarter. And for last year, we gave away about $90 million in our same-store pool promotional discounts. So irrespective of what's happening to street rates, there's a big opportunity in terms of promotional discounts, money that we're -- or the incentives that we give to customers to move in. There's a big opportunity there to improve the top line just by reducing those.

Okay. And then just one last question on the expense side. You've talked about implementing some new on-site training systems that might help reduce payroll costs, and we also saw a real big decrease in repairs and maintenance. Is there a lot more savings here? What might we see sort of, going forward, a little bit on the expense side?

Well, I think the 2 big items -- touch on 3 big items that you should think about. Property taxes last year were 3%, and I know this sounds like a broken record that we keep saying they're going to be 4% to 5%, but we're pretty confident that they're going to be somewhere between 4% to 5% in 2013. Property and supervisory payroll will be up slightly, probably below 2%. R&M baseline should be down 2013, but that will be offset in part by snow. And here in Q1, we're looking at probably $1 million more of snow at least in Q1 than last year. 2012 was a pretty moderate year in terms of weather up until Q4. And then the big swing item is media advertising and we -- at the current time, we expect television will be down $1 million, $1.5 million in Q1. That's a big variable. That'll depend quarter-to-quarter, depending on what's happening to demand and customer volumes.

Your next question comes from the line of Gaurav Mehta with Cantor Fitzgerald. Gaurav Mehta - Cantor Fitzgerald & Co., Research Division: You talked about U.K. a little bit on -- in the prepared remarks. Can you talk about the European market as to what you are seeing in Europe?

Well, big picture, it's ugly. Europe's in a -- basically, in a recession, has been. It's a very challenging operating environment. The team over there, I will say in 2012, far exceeded my expectations, John's expectations. We expected negative NOI growth in 2012, and yet the team over there produced positive NOI growth, which was very, very impressive to me. Our challenging markets over there, U.K., 20% VAT tax implemented in October. And the way we dealt with that is we passed it on to new customers, but existing customers, we basically absorbed it. So think of it as taking your in-place rents and writing them down 20% which is -- largely drove the 8% decline in revenue in the U.K. in Q1. Overall, for the year, the U.K. had a great year with 8% NOI growth despite a tough Q4, but most of the markets in Europe were up. Our other challenging market continues to be Holland. My gut is it's bottoming out so it should start to improve, but it's a challenging operating environment in Europe. Does that help? Gaurav Mehta - Cantor Fitzgerald & Co., Research Division: Yes, that's very helpful, and one follow-up question on investing. In your press release, you mentioned that you acquired a conversion property. Is it the same redevelopment opportunity in Bronx? And are you expecting to see more redevelopment opportunities as you go ahead?

Yes.

Your next question comes from the line of Michael Knott with Green Street Advisors.

I think, in the past, you've been a little less optimistic about the far-out impact of new supply hitting the industry. I think you've thought it would come sooner. What's your current thinking on the supply picture?

Well, Michael, I think, we -- last call or maybe it was 2 calls ago, we told people we were starting some developments, and we're doing that. That's accelerating. We are seeing some regional operators across the country start to develop or they have been developing. Is it in mass quantity? I mean, it's pretty miniscule relative to the overall industry supplier -- yes, supply product in the industry. I think though development is inevitable because as acquisitions continue to move above -- significantly above replacement cost, certainly in some markets, that will precipitate the regional guys looking at that price or at which the acquisitions are trading, saying, "Hey, I can build it for a lot less. I'll build it, fill it up and sell it." So I think it's inevitable. How much? I don't know. Today, it's pretty small.

And then a question on your realized rents, I think 3.5% growth in the quarter, which was slower than the first part of 2012. Why do you think there's a slowdown there? Why shouldn't that be going the other way, especially if discounts are being reduced, et cetera?

Michael, because we were reducing rental rates to attract more tenants, as well as you have to think about the move-outs portion side of the equation. So even though, as Ron mentioned, our move-out volume was down, the rental rate that they were moving out at versus last year was higher. So on a net-net, basis, that brought our net rent down. That's not surprising that they would move-out at a higher rental rate. It's because we've been more aggressive increasing their rates over the past 2 years. But with that said, their move-outs velocity, if I could say here, is slowing down because our move-outs -- the actual numbers are slowing down. Customers are staying longer. The tenant base is aging out better, and I think you'll see that as we move forward.

One other quick one out there. Did you guys ever think you'd see a 76% NOI margin?

Thanks, Michael.

Your next question comes from the line of Eric Wolfe with Citi.

I just want to follow up on Michael's question a moment ago. Curious as you look at development today, I mean, what do the development economics look like versus, say, 2005 and 2006 when we are seeing a bit more of normal supplies in the market?

I can't really comment on what yields were for, say, in 2005, 2006. That's a long time ago. I could tell you that we're looking probably at somewhere between 9% and 11% today in our kind of ground-up development. It varies by market. The other thing that we have in the pipeline is what we call redevelopment, where we're taking existing properties that maybe had raw land sitting there, where we had cars parked on them, and we're building out self-storage or if you take the old Shurgard headquarters -- we're on our what, third?

Third.

Third redevelopment of that property. We will be over 2,000?

2,300.

We'll be over 2,300 units when that property is done. It's unbelievable. It's in the Lake Union part of Seattle. So as we redevelop that, it continues to fill up, and so we're in the process of adding another 75,000, 80,000 square feet onto that property. We've got both developments and redevelopments in the pipeline about $160 million, $170 million or so.

Got you. That's very helpful. I guess my second question is, obviously, the economics sound good from what you're saying, maybe it's something specific to your portfolio. But with where cap rates are today, I mean, why don't you think we're seeing a bit more ground-up development? Is it just lack of construction financing? It seems like the returns are starting to get there. So I'm just curious as to why we're not really seeing it quite yet.

Well, if you look historically at who has built self-storage and add a product in the industry, it really hasn't been the public guys, the 4 public companies. I mean, we've added -- extra space was developing. We've always been developing. It just hasn't been a meaningful amount, but we've been developing even through the downturn and redeveloping properties, but we add 10, 15, 20 properties a year relative to the supply that was added in the early part of the 2000s, it's miniscule. So the new supply has come from the local sharpshooters, the local developer, and financing in that arena is very, very limited. In fact, a lot of the product we bought last year was foreclosures or short sales from guys that had developed in '06, '07, gotten financing and were not able to fill up their properties, got crushed and, therefore, went into some kind of foreclosure. So I think it'll be quite a while before we see those operators come back into the marketplace and start developing. And it's the same thing that I've heard in the homebuilding industry. Large public companies with capital are the ones building homes and the local guys, local home developer is pretty much out of the market, and I think the same thing applies to self-storage.

Our next question comes from the line of Michael Salinsky with RBC Capital Markets.

Operations question, Ron. Where do street rates today -- I mean, you mentioned you were discounting a bit in the first quarter to drive occupancy. Where do street rates stand kind of on a year-over-year basis? And also, just in the context of where you gave some statistics on the number of renewals, as we think about the delta between move-in and move-out rates, how does that compare currently versus this time last year?

Well, Mike, this is John. Street rates, I think, today, our street rates are probably down about 2% to 3%. Notwithstanding that, I would tell you that the move-in rate's probably still flat. So there's a different rate that people are actually moving in vis-à-vis what we're asking. As for your question on move-ins, move-outs, our move-ins right now are, I would say, probably a little down compared to last year as we move forward. And that's due to the fact that we're more occupied, and we're giving away less discounts, and we're doing less television. So we're not surprised by what's going on with the move-ins slowing down. We can probably ramp that up if we reverse course on our pricing and our promotions. Move-outs, though, what we're seeing is, again, as I mentioned earlier, people are staying longer. So that's a huge benefit for us because more people are starting to fall into the bucket of being here long enough for us to now send them a rental rate increase for an annual renewal.

As they stay longer, are you seeing that gap then when they do move out widen?

In terms of rate, the rental rate?

The delta between a move-in and a move-out rate.

Yes, it does widen because, one, we're really increasing rates to the existing tenant base while the move-in guy is not really getting his rate moved up. Remember, they're coming in flat while the move-out is going out at a higher rate. So on a net-net basis, yes, we basically rent-roll down on that equation.

[Operator Instructions] Your next question comes from the line of Michael Mueller with JPMorgan. Michael W. Mueller - JP Morgan Chase & Co, Research Division: Ron, it looks like the quarterly acquisition volumes have been slowly moving up as you kind of went throughout 2012. I mean, what's the expectation as you move into 2013? Are you still seeing, I guess, more product than you were this time last year?

Well, Q1's not a high-volume quarter for new product coming to the marketplace. So it's a little hard for me to say what is going to happen in 2013 other than the amount and pricing of financing for acquisitions continues to improve, meaning, there's more capital at lower prices chasing deals, and so I think it's going to be a challenging, very competitive acquisition environment in 2013. That's one more reason why we're expanding our development program. Michael W. Mueller - JP Morgan Chase & Co, Research Division: Got it, and did you say how big, how much in terms of development you have, dollar-wise, in terms of total projects up and running at this point?

Yes, well, we got stuff that's under construction, stuff where we've pulled the trigger. We're -- I mean, we're going to start any day and then stuff where we're kind of in the permitting process. If you add all of that together, it's somewhere between $160 million, $170 million. It will come online in 2013, 2014, and that's today. It changes every week. That's a combination of -- Mike, that's a combination of kind of new developments as well as expansions, modifications of existing properties. We touched on -- we're on our third expansion of the old Shurgard headquarters.

Your next question comes from the line of Tayo Okusanya with Jefferies. Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division: You did make some comments earlier about the U.K. and the VAT taxes. I'm just wondering what you're hearing domestically in the U.S. in regards to states starting to put sales tax onto self-storage?

Well, that's been -- I mean, that's an ongoing thing that's -- for the last decade, 15 years, I think Philadelphia's got a sales tax on self-storage and has for 15 or so years. So there's always various initiatives across the country. We work closely with other operators in the self-storage association to try to mitigate or prevent that from happening, but it's an ongoing thing, has been for years. Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division: But the movement doesn't sound like it's getting a little bit more probable or less probable. Is it kind of like same as usual, a lot of conversations?

I wouldn't say it's changed. It's an ongoing thing from -- I mean, a town in Illinois last year, Rhode Island, I think, tried it. California tried it. So it's ongoing. Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division: That's helpful. And then if you could also just give us your thoughts on if you think Prop 13 could actually happen or whether commercial real estate is kind of exempt from it and what the potential impact could be on PSA?

I have no idea.

Your next question comes from the line of Michael Knott with Green Street Advisors.

Ron, wanted to ask about your tenant insurance business. Your margins on an after-tax basis, I believe, are -- I think your margin has been about 80% over time. Just curious how that's so high, and is there any risk that maybe there's some tax yields that burn off eventually that's embedded in that number?

No, Michael. We've been running the tenant insurance business the same way for -- well, even before Public Storage bought it. So I don't think that's a concern at this time.

Margin is after-tax, correct?

Yes.

Your next question comes from the line of Michael Salinsky with RBC Capital Markets.

Ron, can you talk a little bit about what you're seeing on the transaction front? And also, if activity were to exceed cash generated from operations in '13, would you look to the preferred markets or to the equity markets or even the debt markets there as a source of funding and where the stock price is trading today?

Well, Mike, I think I touched on acquisition activity. Someone else asked that question in terms of acquisitions, the amount of financing available out there, and I think it'll be a competitive market. There's not a lot of deals in the market today. Q1's usually a pretty slow quarter so that -- we'll see how the year unfolds. I hope there's activity. I hope that's a reason price will participate, but we'll see as the year unfolds. With respect to how we'll raise capital, we have several billion dollars of preferred capacity. Each new issue seems to be -- we test new rates. I hope one of these days, we break a 5 handle on preferred. So we'll continue to test that, and see if we can continue to raise very low coupon preferred stock going forward.

The final question comes from the line of David Harris with Imperial Capital.

I just sneaked in there. Ron, a couple of questions on development, if I may. One of the challenges of development in your space has been the long stabilization period. Is there anything different about what -- these project that you've got on stock or should we be still thinking of, what, 2 years?

Yes, David, it really depends on the size of their property. Yes, the typical self-storage property, kind of the old genre, was 500 to 600 units, 50,000 to 60,000 square feet, 2.5 to 3 years to stabilization. Some of the properties we're building like the one in the Bronx is much larger. My guess will be that'll be -- that could be a 4-year stabilization period, and some of the projects that we have under way are add-ons to existing properties where you already have a good customer flow, and so that could be much shorter. It really depends on the size of the property. If you take the basic model of 500 to 600 units, 2.5 to 3 years, that kind of fill up generally applies just adjusting for size.

Okay. And to be clear, none of these developments are in Europe?

No.

Okay. It's all in the U.S. Any particular geography or is it just kind of they're one-offs, opportunistic as per the specific locations rather than an attempt to build up more in Florida or California?

One-off opportunistic.

We do have a question from the line of Michael Mueller with JPMorgan. Michael W. Mueller - JP Morgan Chase & Co, Research Division: Real quick, just following up on the development, redevelopment. Of that $160 million you mentioned, what's a rough split between new development and then the redevelopment expansion, and what are order target of returns for the aggregate?

Well, the targeted -- I wouldn't say there's a targeted return, Mike, because it depends on the property, the opportunity. So if I were to say what are we looking for, it's somewhere between 8% and 10% stabilized, assuming some costs for fill up. We've got, if I add it up here, probably about 7 or 8 that you would consider kind of ground-up developments or conversions, and then the balance are -- and we've got about 25 properties here. The balance are some form of expansion or modification of an existing property. Michael W. Mueller - JP Morgan Chase & Co, Research Division: So dollar-wise, maybe 1/3 of it is new development and 2/3, expansions?

About 100 new and 60 expansions. Michael W. Mueller - JP Morgan Chase & Co, Research Division: Okay, the opposite.

Yes.

That was our final question. I'd like to turn the floor back over to Clem for any closing remarks.

I want to thank everybody for attending our conference call this morning, and we look forward to talking to you next quarter. Have a good afternoon.

Thank you. This concludes today's conference call. You may now disconnect.