Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the Company’s consolidated financial condition and results of operations should be read in conjunction with the unaudited financial statements and notes thereto included elsewhere in this report.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this document, the words “intends,” “believes,” “expects,” “anticipates,” and similar expressions are intended to identify “forward-looking statements” within the meaning of that term in Section 27A of the Securities Act of 1933 and in Section 21E of the Securities Exchange Act of 1934. All forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements of the Company to be materially different from those expressed or implied by such forward-looking statements. We may also make additional forward-looking statements from time to time. All such subsequent forward-looking statements, whether written or oral, by us or on our behalf, are also expressly qualified by these cautionary statements. All forward-looking statements apply only as of the date made. We undertake no obligation to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.
There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report. Any forward-looking statements should be considered in light of the risks referenced in "Part I. Item 1A. Risk Factors" in our 2022 annual report on form 10-K filed with the Securities and Exchange Commission on February 24, 2023. Such factors include, but are not limited to:
•adverse changes in general economic conditions, the real estate industry and in the markets in which we operate;
•risks associated with our ability to consummate the Mergers with Extra Space and the timing and closing of the Mergers including, among other things, the ability of the Company to obtain shareholder approval required to consummate the Mergers, the satisfaction or waiver of other conditions to closing the Mergers, unanticipated difficulties or expenditures relating to the Mergers, potential difficulties in employee retention as a result of the Mergers, the occurrence of any event, change or other circumstances that could give rise to the termination of the Mergers and the outcome of legal proceedings instituted against the Company, its directors and others related to the Mergers;
•the effect of competition from new self-storage facilities or other storage alternatives, which would cause rents and occupancy rates to decline;
•impacts from the COVID-19 pandemic or the future outbreak of other highly infectious or contagious diseases on the U.S., regional and global economies and our financial condition and results of operations;
•potential liability for uninsured losses and environmental contamination;
•the impact of the regulatory environment as well as national, state, and local laws and regulations including, without limitation, those governing real estate investment trusts ("REITs"), tenant reinsurance and other aspects of our business, which could adversely affect our results;
•the Company’s ability to evaluate, finance and integrate acquired self-storage facilities on expected terms into the Company’s existing business and operations;
•the Company’s ability to effectively compete in the industry in which it does business;
•disruptions in credit and financial markets and resulting difficulties in raising capital or obtaining credit at reasonable rates or at all, which could impede our ability to grow;
•the Company’s existing indebtedness may mature in an unfavorable credit environment, preventing refinancing or forcing refinancing of the indebtedness on terms that are not as favorable as the existing terms;
•interest rates may increase, impacting costs associated with the Company’s outstanding floating rate debt, if any, and impacting the Company's ability to comply with debt covenants;
•exposure to litigation or other claims;
•risks associated with breaches of our data security;
•the regional concentration of the Company’s business may subject the Company to economic downturns in the states of Florida and Texas;
27
•the Company’s cash flow may be insufficient to meet required payments of operating expenses, principal, interest and dividends; and
•failure to maintain our REIT status for U.S. federal income purposes, including tax law changes that may change the taxability of future income.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our securities.
RESULTS OF OPERATIONS
FOR THE PERIOD JANUARY 1, 2023 THROUGH MARCH 31, 2023, COMPARED TO THE PERIOD JANUARY 1, 2022 THROUGH MARCH 31, 2022
We recorded rental revenues of $240.5 million for the three months ended March 31, 2023, an increase of $35.0 million or 17.0% when compared to rental revenues of $205.5 million for the same period in 2022. This increase in rental revenues was driven by a $20.7 million, or 10.8%, increase in rental revenues at the 664 core properties considered in same store sales (the Company will include stores in its same store pool in the second year after the stores achieve 80% sustained occupancy using market rates and incentives; therefore, the 664 core properties considered in same store sales are those included in the consolidated results of operations since December 31, 2021, excluding stores not yet stabilized, three stores significantly impacted by natural disasters, and seven stores that were significantly expanded or fully replaced). The increase in same store rental revenues was a result of a 13.6% increase in rental income per square foot, partially offset by a 280 basis point decrease in average occupancy. Also affecting the overall increase in rental revenues was an increase of $14.3 million in rental revenues contributed by stores not included in the same store pool, primarily those acquired in 2022. We recorded tenant reinsurance revenues of $20.3 million for the three months ended March 31, 2023, an increase of $3.0 million or 17.5% when compared to tenant reinsurance revenues of $17.3 million for the same period in 2022. The increase in tenant reinsurance revenues is primarily due to the increase in stores owned or managed in 2022 and 2023. Other operating income, which includes merchandise sales and management fees and acquisition fees, increased by $2.1 million for the three months ended March 31, 2023 compared to the same period in 2022 primarily as a result of increased management fees due to an increase in managed properties and increased acquisition fee income earned related to the acquisition of self-storage facilities by certain of the Company's unconsolidated joint ventures.
Property operations and maintenance expenses increased $4.9 million or 11.7% during the three months ended March 31, 2023 compared to the same period in 2022. Property operations and maintenance expenses related to the 664 core properties considered in the same store pool increased by $1.8 million, or 5.1%, primarily as the result of increases in payroll expenses, utilities costs, insurance, internet marketing, and repairs and maintenance expenditures. The remainder of the increase in property operations and maintenance expenses is primarily the result of the net activity of the stores not included in the same store pool. Tenant reinsurance expenses increased $2.4 million or 34.7% in three months ended March 31, 2023 compared to the same period in 2022 primarily as the result of the increase in stores owned or managed in 2022 and 2023. Real estate tax expense increased $2.9 million during the three months ended March 31, 2023 as compared to the same period in 2022. The 664 core properties considered in the same store pool experienced a 5.3% increase in real estate taxes which is reflective of a net increase in property tax levies on those properties. In addition to the same store real estate tax expense increase, real estate taxes increased $1.7 million from stores not included in the same store pool.
Net operating income increased $30.6 million or 19.1% resulting from a 12.8% increase in our same store net operating income coupled with an increase of $13.2 million related to tenant reinsurance related income, management fee income, the gain on sale of non-real estate assets, and the properties not included in the same store pool.
Net operating income, or “NOI,” is a non-GAAP (generally accepted accounting principles) financial measure that we define as total continuing revenues less continuing property operating expenses. NOI also can be calculated by adding back to net income: interest expense, impairment and casualty losses, operating lease expense, depreciation and amortization expense, any losses on sale of real estate, acquisition related costs, general and administrative expense, and deducting from net income: income from discontinued operations, interest income, any gains on sale of real estate, and equity in income of joint ventures. We believe that NOI is a meaningful measure to investors in evaluating our operating performance because we utilize NOI in making decisions with respect to capital allocations, in determining current property values, and in comparing period-to-period and market-to-market property operating results. Additionally, NOI is widely used in the real estate industry and the self-storage industry to measure the performance and value of real estate assets without regard to various items included in net income that do not relate to or are not indicative of operating performance, such as depreciation and amortization, which can vary depending on accounting methods and the book value of assets. NOI should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with GAAP, such as total revenues, operating income and net income. There are material limitations to using a measure such as NOI, including the difficulty associated with comparing results among more than one company and the inability to analyze certain significant items, including depreciation and interest expense, that directly affect our net income. We compensate for these
28
limitations by considering the economic effect of the excluded expense items independently as well as in connection with our analysis of net income.
The following table reconciles our net income presented in the consolidated financial statements to NOI generated by our self-storage facilities for the three months ended March 31, 2023 and 2022.
|
|
|
|
|
|
|
|
|
|
|
Three Months ended
March 31, |
|
(dollars in thousands) |
|
2023 |
|
|
2022 |
|
Net income |
|
$ |
83,266 |
|
|
$ |
75,418 |
|
General and administrative |
|
|
27,818 |
|
|
|
15,826 |
|
Depreciation and amortization |
|
|
47,769 |
|
|
|
46,401 |
|
Interest expense |
|
|
33,113 |
|
|
|
24,240 |
|
Interest income |
|
|
(12 |
) |
|
|
(15 |
) |
Equity in income of joint ventures |
|
|
(1,629 |
) |
|
|
(2,118 |
) |
Net operating income |
|
$ |
190,325 |
|
|
$ |
159,752 |
|
Net operating income |
|
|
|
|
|
|
Same store |
|
$ |
152,523 |
|
|
$ |
135,169 |
|
Other stores, tenant reinsurance related income
management fee income, and gain on sale of
non-real estate assets |
|
|
37,802 |
|
|
|
24,583 |
|
Total net operating income |
|
$ |
190,325 |
|
|
$ |
159,752 |
|
Our 2023 same store results consist of only those properties that have been owned by the Company and included in our consolidated results since December 31, 2021, excluding stores not yet stabilized, three stores significantly impacted by natural disasters, and seven stores that were significantly expanded or fully replaced. We believe that same store results are meaningful measures to investors in evaluating our operating performance because, given the acquisitive nature of the industry, same store results provide information about the overall business after removing the results from those properties that were not consistent from year-to-year. Additionally, same store results are widely used in the real estate industry and the self-storage industry to measure performance. Same store results should be considered in addition to, but not as a substitute for, consolidated results in accordance with GAAP. The following table sets forth operating data for our 664 same store properties. These results provide information relating to property operating changes without the effects of acquisitions.
Same Store Summary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months ended
March 31, |
|
|
Percentage |
|
(dollars in thousands) |
|
2023 |
|
|
2022 |
|
|
Change |
|
Same store rental income |
|
$ |
211,534 |
|
|
$ |
190,883 |
|
|
|
10.8 |
% |
Same store other operating income |
|
|
1,746 |
|
|
|
2,062 |
|
|
|
(15.3 |
)% |
Total same store operating income |
|
|
213,280 |
|
|
|
192,945 |
|
|
|
10.5 |
% |
Payroll and benefits |
|
|
12,754 |
|
|
|
12,368 |
|
|
|
3.1 |
% |
Real estate taxes |
|
|
23,613 |
|
|
|
22,418 |
|
|
|
5.3 |
% |
Utilities |
|
|
5,413 |
|
|
|
5,083 |
|
|
|
6.5 |
% |
Repairs and maintenance |
|
|
6,295 |
|
|
|
5,995 |
|
|
|
5.0 |
% |
Office and other operating expenses |
|
|
5,782 |
|
|
|
5,342 |
|
|
|
8.2 |
% |
Insurance |
|
|
2,250 |
|
|
|
2,045 |
|
|
|
10.0 |
% |
Advertising |
|
|
— |
|
|
|
60 |
|
|
|
(100.0 |
)% |
Internet marketing |
|
|
4,650 |
|
|
|
4,465 |
|
|
|
4.1 |
% |
Total same store operating expenses |
|
|
60,757 |
|
|
|
57,776 |
|
|
|
5.2 |
% |
Same store net operating income |
|
$ |
152,523 |
|
|
$ |
135,169 |
|
|
|
12.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change |
|
Quarterly same store move ins |
|
|
58,659 |
|
|
|
58,042 |
|
|
|
617 |
|
Quarterly same store move outs |
|
|
61,161 |
|
|
|
57,040 |
|
|
|
4,121 |
|
We believe the increase in same store move ins was due to additional spaces available to rent as well as incremental demand linked to elevated levels of mobility, decluttering, and home buying during the three months ended March 31, 2023 as compared to the three
29
months ended March 31, 2022. We believe the increase in same store move outs was a result of a higher number of existing customer rent increases during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022.
General and administrative expenses for the three months ended March 31, 2023 increased $12.0 million or 75.8% when compared with the three months ended March 31, 2022. The most significant driver of this increase was advisory and other costs related to the merger agreement with Extra Space Storage and the evaluation of other offers received by the Company.
Depreciation and amortization expense increased to $47.8 million in the three months ended March 31, 2023 from $46.4 million in the same period of 2022 as a result of depreciation and customer list amortization related to those properties acquired in 2022.
Gain on sale of non-real estate assets increased by $0.7 million in the three months ended March 31, 2023 compared to the three months ended March 31, 2022 due to the strategic decision made by the Company to sell off its fleet of rental trucks in 2022 which continued in the first quarter of 2023.
Total interest expense increased by $8.9 million during the three months ended March 31, 2023 as compared to the same period in 2022 primarily as a result of higher interest rates on variable rate debt coupled with an increase in the amount outstanding on the Company's revolving credit facility.
FUNDS FROM OPERATIONS
We believe that Funds from Operations (“FFO”) provides relevant and meaningful information about our operating performance that is necessary, along with net earnings and cash flows, for an understanding of our operating results. FFO adds back historical cost depreciation, which assumes the value of real estate assets diminishes predictably in the future. In fact, real estate asset values increase or decrease with market conditions. Consequently, we believe FFO is a useful supplemental measure in evaluating our operating performance by disregarding (or adding back) historical cost depreciation.
FFO is defined by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) as net income available to common shareholders computed in accordance with GAAP, excluding gains or losses on sales of properties, plus impairment of real estate assets, plus depreciation and amortization and after adjustments to record unconsolidated partnerships and joint ventures on the same basis. We believe that to further understand our performance, FFO should be compared with our reported net income and cash flows in accordance with GAAP, as presented in our consolidated financial statements.
Our computation of FFO may not be comparable to FFO reported by other REITs or real estate companies that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently. FFO does not represent cash generated from operating activities determined in accordance with GAAP, and should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of our performance, as an alternative to net cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity, or as an indicator of our ability to make cash distributions.
Reconciliation of Net Income to Funds From Operations (unaudited)
|
|
|
|
|
|
|
|
|
|
|
Three Months ended March 31, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Net income attributable to common shareholders |
|
$ |
81,608 |
|
|
$ |
73,575 |
|
Net income attributable to noncontrolling common
interests in the Operating Partnership |
|
|
1,333 |
|
|
|
847 |
|
Net income attributable to noncontrolling preferred
interests in the Operating Partnership |
|
|
330 |
|
|
|
— |
|
Depreciation of real estate and amortization of
intangible assets exclusive of debt issuance costs |
|
|
47,573 |
|
|
|
45,866 |
|
Depreciation and amortization from unconsolidated
joint ventures |
|
|
3,187 |
|
|
|
1,802 |
|
Funds from operations allocable to noncontrolling
interest in the Operating Partnership |
|
|
(2,154 |
) |
|
|
(1,389 |
) |
Funds from operations available to common
shareholders |
|
$ |
131,877 |
|
|
$ |
120,701 |
|
30
LIQUIDITY AND CAPITAL RESOURCES
Our line of credit and term notes require us to meet certain financial covenants measured on a quarterly basis, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness, and limitations on dividend payouts. At March 31, 2023, the Company was in compliance with all debt covenants. In the event that the Company violates its debt covenants in the future, the amounts due under the agreements could be callable by the lenders and could adversely affect our credit rating requiring us to pay higher interest and other debt-related costs. We believe that if operating results remain consistent with historical levels and levels of other debt and liabilities remain consistent with amounts outstanding at March 31, 2023, the entire availability under our line of credit could be drawn without violating our debt covenants.
Our ability to retain cash flow is limited because we operate as a REIT. To maintain our REIT status, a substantial portion of our operating cash flow must be used to pay dividends to our shareholders. We believe that our internally-generated net cash provided by operating activities and the availability on our line of credit will be sufficient to fund ongoing operations, capital improvements, dividends and debt service requirements.
Cash flows from operating activities were $121.0 million and $105.3 million for the three months ended March 31, 2023 and 2022, respectively. The increase in operating cash flows in the 2023 period compared to the 2022 period was primarily due to the increase in net income after adjusting for non-cash items.
Cash used in investing activities was $27.8 million and $368.8 million for the three months ended March 31, 2023 and 2022, respectively. The decrease in cash used in investing activities in the 2023 period compared to the 2022 period was primarily due to the decreased volume of acquisitions, partially offset by an increase in investments in improvements and equipment additions in 2023.
Cash used in financing activities was $83.7 million for the three months ended March 31, 2023 and cash provided by financing activities was $142.1 million for the three months ended March 31, 2022. The change is primarily a result of a reduction in the Company's sales of shares of common stock under the Company’s continuous equity offering programs and increased dividends paid during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 in addition to a decrease in net borrowings on the Company's line of credit in the 2023 period compared to the 2022 period.
Note 6 and Note 7 to the consolidated financial statements include details related to the Company’s unsecured line of credit, term notes, mortgages, and other indebtedness. Note 13 to the consolidated financial statements includes details of our shareholders’ equity and activity related thereto.
Our line of credit facility and term notes have an investment grade rating from Standard and Poor’s (BBB) and Moody’s (Baa2).
We expect to fund operating expenses, future acquisitions, our expansion and enhancement program, and share repurchases, if any, and any other cash requirements with future cash flows from operations, draws on our line of credit, issuance of common and/or preferred stock, the issuance of unsecured term notes, sale of properties, and private placement solicitation of joint venture equity. Should the capital markets deteriorate, we may have to curtail acquisitions, our expansion and enhancement program and/or any share repurchases.
31
ACQUISITION AND DISPOSITION OF PROPERTIES
The Company did not acquire any self-storage facilities during the three months ended March 31, 2023.
In 2022, we acquired 49 self-storage facilities comprising 3.8 million square feet in Arizona (7), California (8), Florida (7), Georgia (2), Illinois (1), Maryland (1), Massachusetts (2), Minnesota (1), Missouri (5), Nevada (1), New York (3), North Carolina (5), South Carolina (1), and Texas (5), for a total purchase price of $974.0 million. The Company held an 85.8% ownership interest in one of the properties acquired prior to the acquisition of the remaining 14.2% ownership interest in the second quarter of 2022. Additionally, during the third quarter of 2022, the Company purchased an 83% ownership interest in a self-storage facility in New York from an unrelated joint venture partner that has been consolidated in the Company's financial statements. Additionally, nine of these facilities were managed by the Company for a third-party prior to acquisition. Based on the trailing financial information of the entities from which the properties were acquired, the weighted average capitalization rate for these acquisitions was 3.2%.
We may acquire additional stabilized or newly constructed properties in 2023, however, there is no assurance that the Company will do so. Additionally, there can be no assurance that if significant additional opportunities were to arise, we would be able to raise capital at a reasonable cost to allow us to take advantage of such opportunities. We are actively pursuing acquisitions in 2023 and at March 31, 2023, the Company was under contract to acquire three self-storage facilities for an aggregate purchase price of $60.0 million. The purchase of the self-storage facilities under contract is subject to customary conditions to closing, and there is no assurance that these facilities will be acquired.
The Company did not sell or otherwise dispose of any properties during the three months ended March 31, 2023 or during 2022.
As part of our ongoing strategy to improve overall operating efficiencies and portfolio quality, we may seek to sell self-storage facilities to third-parties or joint venture partners in 2023.
FUTURE ACQUISITION AND DEVELOPMENT PLANS
Our external growth strategy is to increase the number of facilities we own by acquiring suitable facilities in markets in which we already have operations or to expand into new markets by acquiring several facilities at once in those new markets. We are actively pursuing acquisitions in 2023, including potential acquisitions by unconsolidated joint ventures.
During the three months ended March 31, 2023, we added 106,000 square feet to existing properties for a total cost of approximately $14.8 million. We plan to complete a total of $50 million to $60 million of additional expansions and enhancements to our existing facilities in 2023, of which $33.8 million was paid as of March 31, 2023.
We also expect to continue investing in capital expenditures on our properties. This includes roofing, paving, and remodeling of store offices. For the three months ended March 31, 2023, we invested approximately $7.9 million in such improvements and we expect to invest approximately $25 million to $30 million for the remainder of 2023.
REIT QUALIFICATION AND DISTRIBUTION REQUIREMENTS
As a REIT, we are not required to pay federal income tax on income that we distribute to our shareholders, provided that we satisfy certain requirements, including distributing at least 90% of our REIT taxable income for a taxable year. These distributions must be made in the year to which they relate, or in the following year if declared before we file our federal income tax return, and if they are paid not later than the date of the first regular dividend of the following year. As a REIT, we must derive at least 95% of our total gross income from income related to real property, interest and dividends.
Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause our Board of Directors to revoke our REIT election.
32
UMBRELLA PARTNERSHIP REIT
We are formed as an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) and, as such, have the ability to issue Operating Partnership Units in exchange for properties sold by independent owners. By utilizing such Units as currency in facility acquisitions, we may obtain more favorable pricing or terms due to the seller’s ability to partially defer their income tax liability. As of March 31, 2023, 1,602,323 common Units and 1,190,407 preferred Units are outstanding. These Units had been issued in exchange for self-storage properties at the request of the sellers. During April 2023, holders of 1,190,407 preferred noncontrolling redeemable Operating Partnership Units elected to convert their preferred Units to common noncontrolling redeemable Operating Partnership Units. A total of 268,880 common noncontrolling redeemable Operating Partnership Units with an aggregate value of $29.8 million were issued as part of this conversion.
INTEREST RATE RISK
The primary market risk to which we believe we are exposed is interest rate risk, which may result from many factors, including government monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control.
Based on our outstanding unsecured floating rate debt of $619.0 million at March 31, 2023, a 100 basis point increase in interest rates would have a $6.2 million effect on our annual interest expense. This amount was determined by considering the impact of the hypothetical interest rates on our borrowing cost on March 31, 2023. This analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, we would consider taking actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in our capital structure.
INFLATION
We do not believe that inflation has had or will have a direct effect on our operations. Substantially all of the leases at our facilities are on a month-to-month basis which provides us with the opportunity to increase rental rates in a timely manner in response to any potential future inflationary pressures.
SEASONALITY
Our revenues typically have been higher in the third and fourth quarters, primarily because self-storage facilities tend to experience greater occupancy during the late spring, summer and early fall months due to the greater incidences of residential moves and college student activity during these periods. However, we believe that our customer mix, diverse geographic locations, rental structure and expense structure provide adequate protection against undue fluctuations in cash flows and net revenues during off-peak seasons. Thus, we do not expect seasonality to materially affect distributions to shareholders.
RECENT ACCOUNTING PRONOUNCEMENTS
None that materially affect the Company.
33