E EXR: Can The Storage REIT Surmount The Intensifying Headwinds Going Forward?

The Extra Space Storage REIT (EXR) has delivered strong returns over the past decade, though over the past year its total return was comparatively mediocre at 20.67%. It has enjoyed strong Net Operating Income (NOI) margins and Funds From Operations (FFO) growth as people’s needs to rent storage space continues to trend higher. However, this solid demand is being confronted by a rising supply of storage choices, which puts into question whether EXR can continue to deliver strong returns going ahead. Despite rising competitive pressures, EXR has various strengths to play and overcome these headwinds.

Industry Dynamics

Before we dig into EXR, let us assess some industry dynamics and catalysts.

Industry Dynamics

The self-storage industry is highly fragmented market, with the top 10 operators controlling about 15.2% of the US market. Out of all the storage REITS operating in the US, only six are traded publicly.

The majority of the customer base is made up of residential customers (70%), while the other 30% comprises of students, military and businesses.

Non-commercial demand is highly composed of millennials, which make up about a third of this division. The fact that the younger generation constitutes such a large portion of demand is bullish for the industry over the long-term, as demand from this generation should be sustainable as long as they continue to incorporate self-storage facilities in their way of living as they go through different phases of their lives over the coming decades.

Homeownership Trends

The chart below reflects the trend in homeownership rates since the 1990s. The descend in homeownership between Q2 2004 and Q2 2016 has played significant role in driving the demand for self-storage facilities, as renters are more likely to use such services as opposed to homeowners.

Source: Federal Reserve Economic Data

Though the home ownership rate has begun to trend upwards again since Q2 2016. If this trend continues, it could weaken demand for self-storage services going forward, and thus undermine the performance of REITs such as EXR. However, the chart reveals that America also witnessed a strong uptrend in home ownership rates between 1994 and 2004. While the average occupancy rate of self-storage facilities experienced some ups and downs during this period, overall it remained relatively solid, as shown in the chart below. In fact, this strength in occupancy rates was witnessed despite the number of self-storage properties almost doubling during these 10 years. Therefore, rising home ownership rates does not necessarily translate to a deteriorating demand for self-storage facilities, given a solid occupancy rate of 84.2% at the peak of the home ownership rate in 2004.

Data Source: The Almanac

In fact, while the industry has been enjoying above 80% occupancy rates for many years, these self-storage REITs would still be profitable even if the occupancy rate fell to as low as 50% (or even lower). This is due to low capex and general & administrative expenses, resulting in higher Net Operating Income margins. However, these favorable industry characteristics have encouraged a development boom, and this increase in supply is a threat to fundamentals going ahead.

Rising competition

The low barriers to entry and attractive margins led to a massive wave of self-storage development in the middle of the last decade. The number of self-storage properties grew from 38,800 in 2004 to 51,475 properties in 2014 (the latest year for which data was available), which marks a 32.67% growth in supply.

Due to mounting supply and rising competition, EXR’s growth rates have become less exciting. The table below reveals EXR’s annual growth rates for Sales Revenue and Funds From Operations since 2015.

Data Source: Wall Street Journal

Both growth rates have slowed over the past few years amid a growing supply of self-storage facilities across the nation, giving consumers more choice and thus undermining the pricing power of the storage REITs.

The table below details the average rent Per Square Foot (PSF) charged by EXR since 2008, and the corresponding growth rates in pricing for each year.

Data Source: EXR Annual Reports

The growth in average rent charged by EXR has certainly slowed recently. However, the company has still been able to continue hiking its prices despite the rise in supply and competition. While supply has grown, demand has also continued to grow over the years, as self-storage services become more and more popular.

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Disclosure: I currently hold no positions in any of the securities mentioned in this article.

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