Real Estate Sector Ideas

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Public Storage -- >>> Who Knew Public Storage Could Be The Cool Kid On The Block?


Nov 12 2013



http://seekingalpha.com/article/1830682-who-knew-public-storage-could-be-the-cool-kid-on-the-block?source=yahoo



The CEO of Public Storage (PSA) stated in the 2012 annual report, the four D's were the main contributors to the growth of the company. Here's an excerpt of what he said:


Over the past 40 year, not much has changed in our business (that is good). The key reasons people use self-storage remain the same-the four D's: downsizing, divorce, death and dislocation....



The CEO really meant to say is that constant change, tragedy, and the cyclicals of life (Except for divorce or a breakup which could be a positive thing for a person) are the reasons for the success of the company. I would be hard pressed to argue against the CEO of his own company saying the four D's (maybe three D's) weren't a factor. From a consumer mindset, we've all seen the bright orange signs from the freeway that say "Public Storage," but what is so special about this company that has allowed it to be so successful, in such a fragmented niche industry? I can only think of one thing which all investors should focus on and it's management's actions.

Capital Structure

As I started to read the annual reports and press releases, one of the main differentiators I started to notice versus other publicly traded REITs was the capital structure the company has chosen to use to expand the company. A key-component for REITs is their ability to access capital in order to finance operations and grow. Most REITs issue bonds as their primary source of capital, PSA prefers preferred shares (preferred stock). When thinking about what slice of the capital markets most companies in general raise capital from, it's usually the bond or equity markets, with the preferred market only mentioned in passing.

I know we could argue all day about preferred shares being only debt or only equity. The reality of it is unless you own millions of dollars of senior secured debt or common stock, you really won't get the advantages of the first right of the collateral or voting power in a proxy vote. The advantage for PSA in issuing preferred shares is:

1.Management doesn't have the stress of bank lenders riding their back about paying back debt otherwise the company's properties will be seized

2.Access to capital in the preferred market is easy and interest-rates are at historical lows

3.Issuing preferred shares allows the balance sheet ratios to stay extremely low, allowing the company to access the debt market if necessary

4.The number of common shares outstanding stays low, which allows the company, structured as a REIT to pay out more in dividends (Of course after the preferred get their share)

Let the Numbers do the Talking

PSA is one of the few companies I follow, which issue preferred shares to raise capital. How has it faired? (Refer to the graph below)

(click to enlarge)

Since 2007 the company has outperformed the S&P 500 and the NAREIT Equity Index. The argument is though, is this attributable to the capital structure or the company's business model?

Business Model

PSA is known for its self-storage units as being its main revenue source. Management has acknowledged the company has a concentrated portfolio in storage units, but in reality the company's business goes beyond just storage units in the United States. PSA owns a 43% common equity interest in PS Business Parks, Inc (PSB), which owned and operated approximately 28.6 million rentable square feet of commercial space, primarily flex, multi-tenant office and industrial space. In addition, management has traveled across the pond to seven different European countries, and owns 49% of Shurgard Europe, which operates 188 facilities with approximately 10 million net rentable square feet.

Owning PSA allows an investor to have the luxury of two types of diversification: 1) International exposure to public storage units, and 2) Domestic commercial real estate exposure through small multi-flex office buildings. Both the storage unit business model and the commercial real estate model allows PSA's management to apply their experience over sub-sectors.

The storage unit business is traditionally known as a safe cash-flow generating business, which doesn't require the same capital or time expenditures as a commercial building. A commercial building requires more continuous tenant improvements, common area maintenance, and more building staff to run. In addition, commercial RE is more economically sensitive to downturns as well as upturns in the economy than storage units. In a rising economy, owning commercial RE will add more to PSA's equity in earnings, as higher rental rates will be achieved. From 2010 through 2012, PSB, has added $20.7m, $27.7m, and $10.6m in equity from earnings to PSA's balance sheet. The decrease from 2011 to 2012 is due to the repurchase of preferred shares by PSB.

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