CubeSmart

NYSE:CUBE

Earnings Call Transcript 2022-Q1

[Operator]

Good morning. Thank you for attending today’s CubeSmart First Quarter 2022 Earnings Call. My name is Nate and I will be your moderator for today’s call. [Operator Instructions] I would like to now pass the conference over to our host, Josh Schutzer VP of Finance with CubeSmart. Josh, please go ahead.

[Josh Schutzer, Vice President, Finance]

Thank you, Nate. Good morning, everyone. Welcome to CubeSmart’s first quarter 2022 earnings call. Participants on today’s call include Chris Marr, President and Chief Executive Officer and Tim Martin, Chief Financial Officer. Our prepared remarks will be followed by a Q&A session. In addition to our earnings release, which was issued yesterday evening, supplemental operating and financial data is available under the Investor Relations section of the company’s website at www.cubesmart.com.

The company’s remarks will include certain forward-looking statements regarding earnings and strategy that involve risks, uncertainties and other factors that may cause the actual results to differ materially from these forward-looking statements. The risks and factors that could cause our actual results to differ materially from forward-looking statements are provided in documents the company furnishes to or files with the Securities and Exchange Commission, specifically the Form 8-K we filed this morning together with our earnings release filed with the Form 8-K and the Risk Factors section of the company’s annual report on Form 10-K. In addition, the company’s remarks include reference to non-GAAP measures. A reconciliation between GAAP and non-GAAP measures can be found in the first quarter financial supplement posted on the company’s website at www.cubesmart.com.

I will now turn the call over to Chris.

[Chris Marr, President and Chief Executive Officer]

Thank you, Josh. Thank you all for participating as we launch the earnings season for the self-storage sector. We consider the first quarter to have been a very solid one as evidenced by our 23.4% growth in quarterly FFO per share and 21.4% same-store net operating income growth as we continue to execute on our business plan. Our consumer demand trends remained very healthy. We experienced positive rental trends across all of our markets. Those positive demand trends have continued into April and we are optimistic for a successful busy spring and summer rental season. Tim will provide detail and color on our financial results and our improved outlook for the balance of the year.

Looking beyond quarterly results, we believe the self-storage industry and Cube specifically are uniquely and perhaps best positioned to benefit from the current uncertain economic climate. An inflationary cost environment, combined with a rapid escalation in real interest rates, should create a bit of a headwind that will limit future new self-storage developments to only those markets and locations that developers believe can grow rental rates sufficient to generate attractive pro forma returns. What we are seeing and hearing from folks currently in market bidding out new construction projects is that hard costs have escalated above inflationary levels and continue to escalate and rates on construction financing are now in the 5% range and rising. This hypothesis, if proven correct, should create a smooth path for owners of existing self-storage assets to continue enjoy solid performance over the next several years.

In the event the aggressive Fed actions pushed the economy into a recession, we believe our Cube portfolio given our focus on high-quality assets in primary markets with lower volatility should outperform those portfolios that have benefited from the exposure to lower quality markets during the recent cycle. Pandemic-induced consumer trends have created an environment in which we in the self-storage sector and Cube specifically have outperformed other real estate classes. We believe that the current macroeconomic environment, when combined with our sophisticated operating platform, has the potential to lead to continued outperformance relative to other sectors.

With that, let me turn it over to Tim for some color on our results.

[Tim Martin, Chief Financial Officer]

Thanks, Chris and thank you to everyone on the call for your continued interest and support. As Chris touched on, operating fundamentals remain very strong as expected and our first quarter results came in at the high-end of our guidance. Same-store performance included headline results of 15.6% revenue growth and 2.9% expense growth, yielding NOI growth of 21.4% for the quarter. Average occupancy in the first quarter was 93.6% and we ended the quarter with physical occupancy of 94.1%.

We reported FFO per share as adjusted of $0.58 for the quarter, representing 23.4% growth over last year. We remain active and disciplined in our pursuit of external growth opportunities. And after an extremely active fourth quarter, we were a little less active in the first quarter, closing on 1 wholly owned store for $32 million. On the third-party management front, we added 33 stores in the first quarter. Transitioning to the balance sheet, we continue to focus on funding our growth in a conservative manner that’s consistent with our investment grade BBB Baa2 credit ratings.

Our balance sheet is in great shape with an average debt maturity of 6.8 years. Over 94% of our debt is fixed rate and we have no debt maturities in 2022 and only $31 million of maturities in 2023. As you will recall, we called our 2023 bonds and refinanced those at the end of last year. So we are really well positioned from a balance sheet perspective, which is a good place to be given all of the recent market volatility.

Details of our 2022 revised earnings guidance and related assumptions were included in our release last night. Based on the strong operating fundamentals we have discussed and our positioning entering the spring leasing season, we have increased our guidance range for the full year FFO per share by $0.01 at the midpoint. We also improved guidance for same-store revenue growth, same-store expense growth and same-store NOI growth as detailed in our release. So, we are off to a great start here in 2022.

Thanks again for joining us on the call this morning. At this time, Nate, let’s open up the call for some questions.

[Operator]

Absolutely. [Operator Instructions] Our first question goes to Smedes Rose with Citi. Smedes, your line is open. Please go ahead.

[Smedes Rose, Citi]

Hey, good morning. This is Smedes. I really just was interested in hearing what you guys are seeing, I guess, in occupancy levels now thus far in the second quarter and kind of how you are thinking about occupancy trends over the course of the year, anything changes from kind of how you have talked about it previously? It seems like from – at least from my perspective, the occupancy is maybe a little more sticky than we had initially anticipated, but I am interested in your thoughts?

[Chris Marr, President and Chief Executive Officer]

Hey, Smedes, it’s Chris. So as of yesterday, I believe the physical occupancy here at the end of April 94.6% in the same-store pool, which is I think the same 10 yet – the same 10 basis points difference to last year’s 94.7%, same 10 basis points as we would have experienced at the end of March. So, occupancy has been very solid. It is performing a little bit better than how we thought about it from just our planning for the year. But again, broken record, we don’t manage to that occupancy number. It’s really an output of how we think about pricing. But I would say from a volume perspective, rental activity since January has been very good and quite strong. We saw good year again in April. And on the vacate side, a little bit elevated from last year, which was what we would have anticipated. And again, as we move here into April, things were coming in right about on plan as we think about the pace of vacate. So all-in-all, I would say, as I noted in my opening remarks, it’s pretty constructive environment for storage and nice to get the first 3, almost 4 months behind us and we are cautiously optimistic as we go into the rental season.

[Smedes Rose, Citi]

And then in your updated guidance, you brought down the expense expectations a little bit. I was just wondering, was there anything in particular driving that?

[Tim Martin, Chief Financial Officer]

Yes, part of that, Smedes, is the first quarter – first quarter had a little bit of good news on real estate taxes and some other efficiencies. And I mean it’s a modest improvement in that range. So, overall, no material changes in our expectations. I think the pressure over the balance of the year that will bring the rate up into – closer into the guidance range is going to be a little bit of pressure on real estate taxes as we have a tough comp at the end of the year in the back half of the year and then a little bit higher growth in personnel expenses as we continue deeper into the year.

[Smedes Rose, Citi]

Okay. Thank you, guys.

[Tim Martin, Chief Financial Officer]

Thanks, Smedes.

[Operator]

Thank you, Smedes. Our next question goes to David Balaguer with Green Street. David, your line is open please go ahead.

[David Balaguer, Green Street]

Good morning. Just wanted to touch on movement rates. Obviously, last year was special in the sense that there was that positive re-leasing spread out there. Can you update us on where that spread is today and how it looks moving forward?

[Chris Marr, President and Chief Executive Officer]

Sure. Good morning. As we sit here today, that negative spread is better than what we would have experienced historically, but that positive spread slipped to the more historical pattern of a negative spread. The first quarter is always the deepest in terms of that negative spread. And in the quarter, it was about 10%.

[David Balaguer, Green Street]

Great. And just wanted to touch on cap rates, obviously, with interest rates rising rapidly and more hawkish stance from the Fed? Have you seen any change in cap rates out there in the transaction market? It seems like there would be some perhaps negative carry for a lot of the more levered buyers out there. Just curious on that?

[Chris Marr, President and Chief Executive Officer]

Yes, great question. It’s – I think it’s a little too early to see it show up in the transaction market. At some point, you would think that there would be an impact of higher borrowing costs, but it’s still today a pretty aggressive market out there. There are a lot of bidders who want to grow their portfolio of self-storage holdings. And so I think it will take a little bit longer time for it to show up in the transaction market.

[David Balaguer, Green Street]

Great. Thank you.

[Chris Marr, President and Chief Executive Officer]

Thanks.

[Operator]

Thank you, David. Our next question goes to Juan Sanabria with BMO. Juan, your line is open please go ahead.

[Juan Sanabria, BMO]

Hi, thanks. I just wanted to ask about rental bumps in the CRIs, if there is any signs of any stress with the consumer? It doesn’t sound like it, but I just wanted to sanity check I mean we’re hearing some signs of consumers pulling back items like inflationary Netflix or whatnot. So just curious how the markets react to the different tests you’re running on rent bumps?

[Chris Marr, President and Chief Executive Officer]

Yes. Juan, good morning, it’s Chris. We have not seen any change in our customers behavior in their reaction to receiving an increase in their monthly rent. We continue to test. We have pretty significantly closed the gap to the spread between the in-place and the asking for a new customer. I think psychologically, I’ve said this before, when you’re going to the gas pump and paying $5 a gallon or you’re going to the grocery store and being shocked by what the bill looks like as you checkout, I think getting a rate increase is just another fact of the current inflationary environment. So we continue to test, haven’t seen any change at this point in vacate rate or other communications from our customer compared to what we’ve seen over the last few years.

[Juan Sanabria, BMO]

Great. And then, I know CapEx really doesn’t get a lot of attention, but just curious on what the budget is on a dollar per square foot basis, given the inflationary environment and what you noted in the intro on development costs?

[Chris Marr, President and Chief Executive Officer]

Yes. In terms of like a per square foot on the CapEx side, no real move. When you think about it, it’s the large dollar items are always when you have to paint every so often depending upon the climate repairing or replacing the roof and then seal coating the drive aisles. Those are the three big drivers. We’ve seen cost increases, certainly, but nothing when you look at it across the overall portfolio that has really changed that number in any meaningful way. On the construction side, yes, to your point, you’re seeing 20% to 40% increases in construction costs overall, again, specific to the type of construction you’re doing. But certainly, it’s gotten to be a lot more expensive on a per square foot basis to build than it was even 12 months ago.

[Tim Martin, Chief Financial Officer]

And then in addition to the recurring type of CapEx, we do have some specially focused investments over the past 2 years, we had some upgrades in air condition system – air conditioning systems, which are disclosed in part of our ESG efforts, solar investments as well as some lighting upgrades that are consistent, both with our objectives under ESG, and also provide some cost savings and some relatively short payback periods over time.

[Juan Sanabria, BMO]

And Tim, if I may just prod the solar and HVAC equipment, such as that materially keeping down your utility costs relative to what you would see given the inflationary environment today? Just trying to understand the payback there?

[Tim Martin, Chief Financial Officer]

No, I wouldn’t say it’s materially impacting short-term. You’re looking at a return. If you’re looking at return on those investments measured in multiple years, 3, 4, 5 years, over time, certainly, those do have an impact on helping to reduce our energy costs. Energy costs on the solar side, repair and maintenance expenses on the air conditioning investment. So there is a payback that it’s helpful. I wouldn’t say that it’s material to a quarter or 2 a year, but helpful on the margin.

[Juan Sanabria, BMO]

Thank you.

[Chris Marr, President and Chief Executive Officer]

Thanks.

[Operator]

Thank you, Juan. Our next question goes to Jeff Spector with Bank of America. Jeff, your line is open please go ahead.

[Jeff Spector, Bank of America]

Good morning. One follow-up based on the prior questions. What is the current length of stay? I know that’s been increasing for a number of years now. What’s happening now in the portfolio with length-of-stay?

[Chris Marr, President and Chief Executive Officer]

Yes. Good morning. It’s Chris. It continues to grow in terms of the existing customers and thinking about how long they have been in the portfolio. And right now, it’s in that kind of 15, 16 months type of range. And I think about 40 – almost 46% of our customers have been with us longer than 2 years. And clearly, that’s pushing out that length of stay. On the median side, when you think about the reality that we have a whole bunch of really short-term customers and then we have that 46% or so who have been with us for quite a long period of time. We did see a trend at the end of last year with an increase in the short-term customer, which was kind of interesting. I think it’s likely related to what was going on in the housing market at the end of last year. I think we saw a lot of customers who had delays in their homes or new homes or remodeling whatever it was being completed and they needed unexpectedly self-storage for a month or 2. That’s normalized a bit here as we’ve gotten into 2022. And then we do expect, in certain markets, that the college student will be back in a more normalized way this year as well.

[Jeff Spector, Bank of America]

Okay, thanks, Chris. And then, Chris, I guess if we could dig a little bit more into April, maybe tying that into the increase in the same-store core guidance because the guidance – new guidance is – was well above our estimate. And I’m assuming the Street. But clearly, the market is a bit concerned of maybe what will transpire as the year continues?

[Chris Marr, President and Chief Executive Officer]

Yes. I mean April – again, we have, what, 60 days since we initially provided the guidance. So at the margin, we’ve seen support from our customers on the move-in side and we’ve seen vacates that have been in line with expectations. That gives us comfort that the lower end of our range of expectations is likely not in that area that we originally provided. Obviously, nature of our business is when we’re back together in July. We will have significantly more certainty as to how the rest of the year goes. Feeling good about customer behavior here as we – as I think it was noted in a different question. The back half of the year – last year rental rates, were continuously pushed and quite elevated. So what will play out here over May and June is just giving us a sense for how that summer season is going to play out, what the market looks like from a rental rate perspective, and I think that will influence how we think about updating guidance for the back half of the year.

[Jeff Spector, Bank of America]

Okay, thank you. And then my last question, Chris, you commented that some markets may have benefited more over the past few years than others, any particular watch markets?

[Chris Marr, President and Chief Executive Officer]

No, I think just macro. The concept and thesis is that the smaller markets have experienced greater volatility than the larger, better demographic markets. And I think you can see that in Tucson. You can see that in – boy, off the top of my head, I’m not coming up with other smaller markets we’re in. But you can see in markets like that. I think in the current environment, if you look forward, I think the better demographic markets that have less volatility are likely to benefit from the way the economy seems to be shaping up.

[Jeff Spector, Bank of America]

Great. Thank you.

[Operator]

Thank you, Jeff. Our next question goes to Samir Khanal with Evercore. Samir, your line is open. Please go ahead.

[Samir Khanal, Evercore]

Thanks so much. So Chris, when I look at New York, it held up pretty well in the first quarter. And maybe just kind of just provide a bit more color on how you think that New York MSA plays out for the balance of the year, both from an occupancy and rate growth standpoint? Just trying to see if your views have changed from the last time you provided a guidance here.

[Chris Marr, President and Chief Executive Officer]

Yes. Thanks for the question. So at the margin, New York is performing a bit better than what our view would have been 60 days ago. I think for – again, rolling here into April, occupancies continue to be up nicely over last year, 80, 90 basis points or so, which is the continued strength of the consumer across the entire MSA and each of the boroughs. So, that’s given us some comfort. You continue to have supply pressure in Queens. You have supply pressure in Brooklyn, nothing new, and we are navigating through that. I think from a performance perspective, we had 20 basis points of acceleration from Q4 to Q1 in New York, that is with the change in the same-store pool. I think I don’t have the data right here in front of me, but if we look at the old pool Q4 to Q1, I think that would have gone the other direction, we would have had 20 basis points, 30 basis points or so of deceleration. So plus or minus the stores in New York are performing at about an 8% top line growth from that perspective. And we feel pretty good about that. Again, I think I have said before, when you think about the pace and the shape of the rest of the year, those markets that have had 25%, 20% same-store revenue growth are going to decelerate throughout the year at a more rapid pace than New York. And we feel pretty constructive about it at this point, recognizing that the supply that we are navigating through does continue to impact us specifically in those two boroughs.

[Samir Khanal, Evercore]

And then I guess my second question is around transactions. I know you said there hasn’t been much change on sort of cap rates at this point, but have you seen any changes on sort of product coming to market where sellers are saying, look, this is maybe the time to load off some of these assets because valuations may have come down a little bit, but who knows what happens over the next six months to nine months? Are you seeing more products sort of come into the market now?

[Tim Martin, Chief Financial Officer]

We are still – this is Tim. We are still seeing quite a bit of opportunity to underwrite and evaluate potential acquisitions. It’s still very, very active from a quantity standpoint. Not at the level it was last year. Last year was an exceptional level of volume. But it’s still a very, very active market to get deeper into your question as to the motivation, I don’t know everybody’s motivation as far as why – it’s hard to say why somebody is selling, when they are selling. But certainly, there is an awful lot of stuff that’s out there. I think there will be some portfolios that will come to market here as the year progresses. And it’s an interesting backdrop because there is a lot of volatility in the market. And at some point, that’s going to impact some buyers more than others as to how they think about their returns, their utilization of leverage and the like. So, it’s going to be an interesting couple of months here to see how all of the stores and the portfolios that are out there, work through the process.

[Samir Khanal, Evercore]

Thanks very much.

[Chris Marr, President and Chief Executive Officer]

Thanks.

[Operator]

Thank you, Samir. Our next question goes to Ki Bin Kim with Truist. Ki, your line is open. Please go ahead.

[Ki Bin Kim, Truist]

Thanks. Just to go back to a prior question. When you said after adjusting for the change in the same-store pool in New York City, there was actually a 20 basis point to 30 basis point deceleration, were you referring to in-store revenue?

[Chris Marr, President and Chief Executive Officer]

Yes.

[Ki Bin Kim, Truist]

Okay. And just, I guess higher level, New York City included, what are you seeing in terms of the COVID-induced demand from last year and the prior year, how that’s changing? And are you seeing any notable trends in people moving out quicker?

[Chris Marr, President and Chief Executive Officer]

No. Again, the vacate rate right in line with our budget as we think about the year-to-date, especially here in April and that’s across all markets. So, we expect that is slightly elevated just given those customers that moved in, in 2020 will have been in the portfolio for quite a period of time. And then we are seeing, as I mentioned before, last year, we saw that uptick in the pace of the short-term customer, which again, we attribute to the housing market. So, overall, I think the impact of COVID tends to be – if we think about the variant back in January, we just didn’t see a lot of activity in some of the more urban markets. Chicago or Downtown LA, New York City, Boston, you didn’t see quite the pace of move-ins. You didn’t see any move-outs. As that variant and the impact started to wane, you saw a bit of a return to more normal patterns. And I think that’s kind of the market – that’s kind of our expectation as we go forward here. Hopefully, brighter days are ahead. So, no trends at this point other than we continue to see I think positive impact from the pressure in multifamily rents that you see in most markets across the country, I think it is starting to impact folks that are living in smaller square foot apartments, they are getting a roommate, etcetera, and that naturally just lends itself to using our product as an ancillary use.

[Ki Bin Kim, Truist]

And I might have missed this, but did you comment on Street rates year-over-year in the quarter and maybe in April?

[Chris Marr, President and Chief Executive Officer]

No, I don’t think anybody asked that. We were up around 10% year-over-year in the first quarter. And then that trend as we – you think about the pattern of how rates moved last year, that comp gets tougher and tougher. So, as we sit here in April, it’s pretty flat to 21% still up about 31% to 2019.

[Ki Bin Kim, Truist]

Okay. Thank you.

[Operator]

Thank you, Ki. Our final question goes to Mike Mueller with JPMorgan. Mike, your line is open. Please go ahead.

[Mike Mueller, JPMorgan]

Yes. Hi. Thanks. So, you have two developments that looks like they are opening this quarter. I am curious – what are you budgeting for stabilized returns? And how do you think that return expectation has changed relative to when you initially started to underwrite the projects?

[Tim Martin, Chief Financial Officer]

What we typically target over time for a new development is a stabilized yield that’s 200 basis points to 250 basis points higher than what a cap rate would be in that market. And that’s been relatively consistent. I would say if you go back 6 years, 7 years, 8 years ago, you probably would have been able to achieve a wider spread than that. But that’s about where we are on our developments and have been for the last couple of years. Nothing has really changed. The projects that we have haven’t had any material changes in cost. Our expectation of cash flow has improved a little bit from when we would have committed to those projects given what’s happened here with rates and occupancy and market fundamentals here over the last 18 months or so. So, the growth in cash flow expectation is probably a little bit more than offset the growth in costs. Timing has been a little bit of an issue for us and many others to get things approved through local governments and then to deal with labor issues and getting projects done. They have tended to take a quarter or two quarters longer than we would have originally planned. But from all other aspects, they are very much in line.

[Mike Mueller, JPMorgan]

Got it. Okay. That was it. Thank you.

[Chris Marr, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you, Mike. We have a follow-up question from Ki Bin Kim with Truist. Ki, your line is open. Please go ahead.

[Ki Bin Kim, Truist]

Thanks for taking me back. Just a quick one here. Longer term, going back to your rate question, being flat in April. I know the comps are really tough. But even when you compare it to 2019, up 31%, I think that’s actually down a little bit when you compare to rate growth versus ‘19. Eventually for this sector to continue to perform well, we need rate growth to come back, right, not just off of comps, but we want real rate growth to come back as we grow through the year. Given what’s happening in the macro picture and trends that you are seeing, what do you think the probability is for this sector to continue to produce real rate growth year-over-year?

[Chris Marr, President and Chief Executive Officer]

Yes. Feel good about that, Ki Bin, in terms of the inflationary environment, certainly that we are in right now that there is that opportunity to continue to grow. If you think about going back in time and saying, what has been the overall growth if you go back to kind of compound growth back to, say, post-recession January of ‘09. In terms of same-store revenues, if you have indexed back to then, it’s in the 5% to 6% range. So, from that perspective, if you think about the consumer still has – it’s not like we have outpaced broader trends in costs to the consumer. So, I have comfort that we are in a good spot relative to where rates are I don’t know how to quantify the amount as we go forward. But I think the ability to continue to grow rates, real rates, not necessarily the growth over the prior period is there for the sector.

[Ki Bin Kim, Truist]

Okay. Thank you again.

[Operator]

Thank you, Ki. There are no further questions registered at this time. So, I will turn the conference back over to the management team for any closing remarks.

[Chris Marr, President and Chief Executive Officer]

Okay. Well, thank you all for participating as we launch the self-storage sector first quarter earnings season. We look forward to seeing many of you at the conferences that are coming up over the next several months and tours and other things that are going on as life starts to be a little sunnier. And we look forward to talking to all of you at the end of our second quarter results call. And thank you very much, and have a great day.

[Operator]

That concludes today’s CubeSmart first quarter 2022 earnings call. Thank you for your participation. You can now disconnect.