REIT Public Storage Has Been And May Continue To Be A Terrible Investment (NYSE:PSA)

Public Storage (NYSE:PSA) rode the wave of soaring demand for self-storage units for decades, but with a huge increase in construction of new storage facilities using “free” money supplied by the Federal Reserve, there is now over-capacity in the industry. With interest rates expected to stay much higher for longer, this REIT faces a bleak future, in my opinion. I recommended selling PSA in a July 2016 article. The total return for PSA holders since July 2016 was only 41% compared to almost 162% for the S&P 500. I am maintaining my PSA sell recommendation.

PSA Returns to Investors Since July 2016

I recommended selling Public Storage in a July 21, 2016 article for a number of reasons. I thought that investors were over valuing PSA on a per square foot basis, I was expecting interest rates to increase, there was increased competition, and there were customer service issues. While PSA stock price has increased 7.67% from $241.83 when the article was published, it has greatly underperformed the S&P 500 Index, which increased 129.42%. PSA stock price had some wide price swings over the last eight years, so I assume there are some PSA holders who actually have done well, but much of the dramatic stock price increase was before 2016. The major publicly traded self-storage REITs underperformed the S&P 500 ETF (SPY), which had a total return of 161.9%. PSA had the worst total return of the self-storage stocks of only 41.1%.

Total Returns Since July 21, 2016

Impact of Higher Interest Rates

Higher interest rates have had significant negative impact on PSA investors. Like many REITs PSA’s stock price often trades on its dividend yield. When my July 2016 article was published, the stock was yielding 2.86% ($1.80 quarterly dividend) at the same time 10-year UST notes were yielding 1.57% and 2-year notes 0.70%.

10-Year UST Note Yields

With 10-year notes currently yielding 4.62% and 2-year notes yielding 5.0% investors are pricing REITs to reflect those high comparable UST yields. PSA currently trades at 4.61% dividend yield ($3.00 quarterly dividend), but if PSA was currently priced with the same 2016 yield of 2.86% it would be trading at $420 per share instead of $260.

The reality is just because dividends increase over time does not necessarily mean the stock price will also increase over time because higher interest rates often have more of a negative impact than the positive impact of increased dividends.

Higher interest rates have also impacted the REIT’s cost of capital. For example, in 2016 PSA was paying 2.125% and 1.54% on their two notes. On April 16, 2024 they issued two notes. One note has a coupon of 5.35% and the other note is SOFR+70, which is higher than the SOFR+.47 maturing notes. I expect that PSA will have to pay much higher coupons when they roll-over $500 million notes with a 0.875% coupon that matures February 15, 2026, and $650 million notes with a 1.50% coupon that matures November 9, 2026. Much of their business structure is currently based on cheap capital, but going forward this formerly cheap capital could get expensive to roll-over.

Long-Term Debt December 31, 2023

Because interest rates could go even higher and that the new “normal” yield curve will be significantly higher than it has been since 2007, in my opinion, PSA’s stock price will remain under pressure from high interest rates. I am actually urging the Federal Reserve to raise their Fed funds target 0.25% at their May 1 meeting in order to get inflation down to their 2.0% target.

Rapid Growth Followed by Over-Capacity

The self-storage industry benefited from a number of dynamics over the last 25 years. As many baby boomers retired, they moved into smaller residences and stored some of personal items and furniture. During the 2007-2010 financial crisis, a broad cross-section of the country downsized and moved some items into storage. It has often been cheaper to rent a self-storage unit than to rent or buy a larger residence with large closets to store “stuff” such as seasonal items – skis, golf clubs, and winter clothing. Monthly rentals and home ownership costs have increased faster than the overall CPI Index. The latest CPI Index is 312.332 (1882-84=100) but rented residences index is 415.219. The increased costs associated with larger closet space at home sometimes is much greater than renting the same amount of space at a self-storage facility, depending upon local market pricing.

With a very low cost of capital with “free” money from the Federal Reserve, the self-storage industry was able to build new facilities to keep up with the increased demand, especially since many of these new facilities were relatively inexpensive to build and have low operating expenses.

Self-Storage Industry Construction Spending by Month

Since those who rent their residences are more likely to rent self-storage units than those who own their residences, I like to look at the home ownership metric. Home ownership percentage was dropping for a number of years, but then it reversed and trended higher over the last seven years.

Home Ownership Percentage

Despite increased industry competition caused by a nation-wide increase in the number of self-storage facilities, PSA has been able to increase their rental rates slightly more than the rate of inflation. Their 2023 reported REVPAF was $21.38 compared to $15.73 in 2016. Using the CPI Index calculator, the 2016 $15.73 adjusted for inflation is equivalent to $19.99 in December 2023. There is, however, a major yellow flag. Average annual contract rent per square foot for tenants moving in dropped to $13.73 in 4Q’23 from $16.71 4Q’22. This drop is even worse if you factor in the 3.35% inflation rate year over year.

Even with these lower average rental rates in 4Q’23, occupancy dropped to 91.6% in 4Q’23 from 92.3% in 4Q’22. Other self-storage competitors also had lower occupancy rates in 4Q’23 compared to 4Q’22. Extra Space Storage (EXR) dropped from 94.1% to 93%, National Storage Affiliates Trust (NSA) dropped from 91.0% to 87.1%, and CubeSmart’s (CUBE) year-end occupancy dropped from 91.3% to 90.3%. There is just too much capacity caused by newly constructed facilities compared to demand.

PSA tries to offer fairly competitive move-in rental rates, but after the initial period rental rates are increased significantly and keep increasing significantly the longer a tenant rents. A long-term renter is paying a much higher monthly rental amount than a relatively new one for the same type/size unit. For example, the average move in rate per square foot was $13.73 4Q’23, but the average move-out rate was much higher at $21.18. This often creates a customer service problem. Many consumers feel that a long-term relationship with a business should be rewarded – not penalized. Unlike most REITs, self-storage is very consumer oriented and has a relatively high customer turnover rate. Competition can be intense depending upon the specific market area.

Management’s Guidance

While Public Storage is structured as a REIT, I consider it more of a traditional operating company. Many investors tend to use just the traditional REIT metrics, but I also consider earnings per share and P/E ratios to be also important. Remember PSA does have typical REIT long-term leases associated with malls and office building REITs. They often just have month-to-month short term rentals with fairly high turnovers – not leases. Management, however, follows the more traditional REIT approach when issuing guidance numbers.

Management Guidance’s Numbers (February 20, 2024)

I think that management’s revenue guidance is too optimistic. First, with 4Q’23 move-in rates so low it will be more difficult to raise rates to the prior year’s level. Second, consumers are being squeezed by higher prices at grocery stores and may decide that storing “stuff” is a luxury expense. They will be much more price sensitive to PSA raising introductory rates and may decide instead to move out. Third, looking at their various local websites and their competitor website’s it looks like they are currently offering highly discounted move-in rates. Usually their websites offer enticing move-in deals, but it seems to be even more discounted than when I have looked at their websites on multiple occasions in the past.

First quarter 2024 results are expected to be released after the close on April 30. It will be interesting to see if management keeps their current guidance or reduces it. It is highly unlikely, in my opinion, that their guidance will be raised given current conditions.

PSA Valuation

For 2023 Public Storage reported EPS of $11.06, which results in a current P/E of 23.5x using the latest PSA price of $260.38. The 2023 core FFO was $16.89, which results in a 15.4x multiple. Neither of these multiples are cheap, in my opinion, because I think the new normal for appropriate multiples does not accurately reflect that the entire yield curve will remain higher for longer compared to 2007 to 2022. In addition, I don’t consider PSA a growth stock. I actually expect results to trend lower over the next few years. Combining lower multiples and lower FFO it would indicate that PSA is over-priced at $260.38. A current dividend yield of 4.61% is not high enough to protect the stock from any selling pressure. I would not be shocked if PSA reported core FFO of $15.00 for 2024 compared to guidance of $16.60-$17.20. Using $15.00 and a 12x multiple that reflects the new normal for valuations based on higher for longer interest rates, the stock price would be $180 yielding 6.67%.

Conclusion

The self-storage industry has been following the perfect classical example we were taught in Micro Econ 101. The industry is in the last stage when there is over-capacity and companies resort to cutting prices in an attempt to remain competitive.

The sharp drop in prices for new move-in renters for 4Q’23 was a major yellow flag that indicated that competitive pressure from over-capacity in the self-storage industry was negatively impacting Public Storage. Because I feel interest rates will remain high and over-capacity will continue to have a significant negative impact on results, I continue to rate PSA a “sell”.