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Edited Transcript of EXR earnings conference call or presentation 31-Oct-18 3:00pm GMT

Q3 2018 Extra Space Storage Inc Earnings Call

SALT LAKE CITY Nov 9, 2018 (Thomson StreetEvents) -- Edited Transcript of Extra Space Storage Inc earnings conference call or presentation Wednesday, October 31, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey Norman

Extra Space Storage Inc. - VP of IR & Corporate Communications

* Joseph D. Margolis

Extra Space Storage Inc. - CEO & Director

* P. Scott Stubbs

Extra Space Storage Inc. - Executive VP & CFO

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Conference Call Participants

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* Bennett Smedes Rose

Citigroup Inc, Research Division - Director & Analyst

* Eric Joel Frankel

Green Street Advisors, LLC, Research Division - Analyst

* Jonathan Hughes

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Juan Carlos Sanabria

BofA Merrill Lynch, Research Division - VP

* Omotayo Tejamude Okusanya

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Robert Jeremy Metz

BMO Capital Markets Equity Research - Director & Analyst

* Samir Upadhyay Khanal

Evercore ISI Institutional Equities, Research Division - MD & Equity Research Analyst

* Todd Jakobsen Stender

Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst

* Todd Michael Thomas

KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst

* Wesley Keith Golladay

RBC Capital Markets, LLC, Research Division - Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q3 2018 Extra Space Storage Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. Jeff Norman. Sir, you may begin.

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Jeffrey Norman, Extra Space Storage Inc. - VP of IR & Corporate Communications [2]

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Thank you, Lisa. Welcome to Extra Space Storage's Third Quarter 2018 Earnings Call. In addition to our press release, we have furnished unaudited, supplemental financial information on our website.

Please remember that management's prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the company's business. These forward-looking statements are qualified by the cautionary statements contained in the company's latest filings with the SEC, which we encourage our listeners to review. Forward-looking statements represent management's estimates as of today, Wednesday, October 31, 2018. The company assumes no obligation to revise or update any forward-looking statements because of changing market conditions or other circumstances after the date of this conference call.

I would now like to turn the call over to Joe Margolis, Chief Executive Officer.

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [3]

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Thank you, Jeff. Good morning, everyone. Thank you for joining us for our third quarter call and for your interest in Extra Space Storage.

2018 is playing out as we expected as we move into the last couple months of the year. Revenue, NOI and FFO growth are all solid and remain within guidance and expectations. Occupancy continues to be strong, ending the quarter at 93.9%, 20 basis points above 2017's mark. This is especially encouraging because last year's quarter-end occupancy benefited from the hurricanes.

We continue to have solid rate growth, which was partially offset by increased but expected discounts, resulting in same-store revenue growth of 3.2%. The year-over-year impact from discounts should taper off in the fourth quarter, and we project higher same-store revenue growth.

External growth was also strong in the quarter. We continue to be selective and disciplined in our acquisition efforts but have been able to find acquisitions with acceptable risk-adjusted returns, primarily through existing relationships. By year-end, we expect to have acquired over $1 billion in properties, with Extra Space investing approximately $600 million. Between acquisitions and third-party management contracts, we've added 140 stores through the quarter. We have more than 500 third-party properties and a total of 734 stores, including joint ventures.

Our report related to new supply remains generally unchanged. We are seeing an impact from new supply in certain submarkets, and its impact varies by location. New starts appear to be down in many MSAs already saturated with new development, and activity is migrating to markets where there may be a better yield. We continue to see delays in deliveries and see many proposed projects being abandoned.

Our highly diversified portfolio, while certainly not immune to the effects of new supply, reduces volatility, and our sophisticated platform is better prepared to respond to competition than ever before.

At this time last year, we were reporting the impact hurricanes had on our customers, our employees and our properties. Unfortunately, the Southeast experienced severe weather again, but I am happy to report that our portfolio was relatively unscathed. We did not have any material disruption with customers or employees, and damage to our properties was minimal.

I would now like to turn the time over to Scott.

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [4]

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Thanks, Joe, and happy Halloween, everyone.

Last night, we reported core FFO for the quarter of $1.20 per share. Rental rates to new customers continue to be solid. Throughout the quarter, our achieved rental rate was up approximately 3% to 4% year-over-year. As expected and as discussed on our last call, discounts as a percentage of revenue were also up, partially offsetting the revenue growth.

As Joe mentioned, we anticipate the impact from discounts to decrease in the fourth quarter, resulting in an increase in same-store revenue growth. We saw expense growth normalize in the third quarter, and we were successful in minimizing increases in our controlling -- controllable expenses. Property taxes, while elevated, were in line our expectations. The increase in insurance premiums was not a surprise due to the elevated level of property claims caused by last year's hurricanes. We also chose to invest more in marketing in the quarter, allowing us to grow rates and keep our stores full heading into the fall and winter.

We continue to execute our leverage-neutral balance sheet strategy. During the quarter, we increased the percentage of unsecured debt and the size of our unencumbered pool and further laddered our maturities. We're also in the process of increasing and extending our credit facility.

In the quarter, we sold $34 million on our ATM at an average price of $99.75 per share. We also disposed of one property in California for $40.7 million. The property was sold at a below market cap rate for an alternative use, and we anticipate the reinvested proceeds will produce a significantly higher yield. This store as well as 3 other stores with large expansions or redevelopment projects were removed from our same-store pool, consistent with our same-store definition, changing our total same-store number to 783 properties.

We've updated our guidance and annual assumptions for 2018. Our same-store revenue guidance remains unchanged. We have increased the bottom end of our same-store expense growth by 25 basis points. We've tightened our same-store NOI guidance by 25 basis points at both the top and the bottom end of the range with the midpoint unchanged. We increased our core FFO guidance by $0.005 at the midpoint. FFO guidance includes $0.06 of dilution from value-add acquisitions and an additional $0.14 of dilution from C of O stores for a total dilution of $0.20. The lease-up of these properties continues to exceed underwriting expectations as a portfolio and will generate long-term growth for our shareholders.

With that, let's turn the call back over to Jeff to start our Q&A.

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Jeffrey Norman, Extra Space Storage Inc. - VP of IR & Corporate Communications [5]

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Thank you, Scott. (Operator Instructions) And with that, Lisa, we'll start our Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) I have the first question that's coming from Jeremy Metz of BMO Capital.

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Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [2]

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Joe, on the supply front, in your opening remarks, you mentioned delays in deliveries and some projects being abandoned, but you also noted no change to your expectations. So just trying to reconcile those because it sounds like some of the items you're pointing to would leave you arguably feeling better about the supply outlook for next year, if there are deals starting to fall out.

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [3]

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Thanks for the question, Jeremy. So I think, generally, our view is unchanged that we're in a supply cycle, a development cycle, and that it's having an impact on our operations in stores. There's some new supply being added, and there's some falling out. But I would say, last quarter, I was asked about 2019, and I said that subject to what is scheduled for 2018 getting pushed into 2019, I said, we thought 2019 would be flat to moderately down in new deliveries. Based on the data we have now and what we're seeing, I would say 2019 is going to be down. So we are seeing a slowing in the development cycle and -- but it's not a material change. I mean, we're still going to have impact on our operations from new supply in 2019, you have the cumulative effect of what's being delivered, but I do see the deliveries slowing.

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Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [4]

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And can you tie that into maybe just some of your bigger metros in terms of where you maybe see supply pressures getting worse even just from deliveries or once where you maybe see it abating more than others and feeling a little better?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [5]

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So the Florida markets, I think, are going to get worse before they get better. We've seen the acceleration in Dallas. Portland, I think, is going to get worse. Washington, D.C. may get worse. Chicago is a market that's on the other end of the spectrum where we're seeing some improvement.

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Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [6]

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Great. Last one from me. Scott, you mentioned the achieved rates holding in that mid-single-digit range. I think you said 3% to 4% this quarter. Discounting has been a drag, which you noted. So if you factor all that in, where are your net effective rates? And how has that been trending?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [7]

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So our achieved rates for the quarter were 3% to 4%. If you look at the impact of discounts in the quarter, discounts decreased our revenue by about 80 basis points in the quarter. So without discounts, our revenue would have been -- had discounts been flat year-over-year, our revenue would have been 80 basis points higher.

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Operator [8]

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Next question is coming from Todd Thomas of KeyBanc Capital Markets.

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Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [9]

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Scott, Joe, your comments about the discounts being lower year-over-year in the fourth quarter and revenue growth being higher, it seems like the comps overall beginning in late 3Q after the hurricanes last year and over the next couple of quarters would be a little more difficult. I understand the discounting dynamic. But I was just hoping you could provide some additional context around that comment and maybe provide some insight around some of those factors heading into 2019?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [10]

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Yes. So the discounting strategy is just part of our overall revenue maximization strategy. So discounts are the lever that we have chosen to pull this year. And the difference this year versus last year is, last year, we did not discount as heavily in the third quarter. So during the summer months of last year, our discounts were low. This year, they were high as we kept to keep -- as we chose to keep rate and use discount. So it was more of a comparable from last year than kind of a change in what we're doing overall. So we expect this year's discounts to be comparable to last year's. So a portion of that 80 basis points that were -- we saw discounts impact our revenue by about 80 basis points this last quarter. We expect a big portion of that to not be there in the fourth quarter. So while overall revenue year-over-year or sequentially continues to get tougher, revenue -- the rate of growth slows, the impact of discounts will lessen in the fourth quarter.

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Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [11]

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And then how should we think about that? So you're anticipating your model shows revenue growth being higher in the fourth quarter versus the third quarter here. Any insight into how we should think about 2019, just in terms of maybe setting expectations?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [12]

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So obviously, we're not ready to give 2019 guidance. We'll give that on the first quarter. But I think, with the supply cycle, we expect things to continue to moderate, but I don't think that we expect things to go negative by any means. So we'll give our guidance in the first quarter of this next year.

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Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [13]

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Okay. And just last question from me. The decrease in net tenant insurance income, I don't know if I missed this in your prepared remarks. But was that attributable to the hurricane expenses? Or is that something else? And how much expense that's nonrecurring was in that number?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [14]

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Yes, it actually was not attributable to the hurricanes. We had some claims from the hurricanes, but not significantly higher. It was primarily due to some water claims from the tough weather during the winter months of this past year.

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Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [15]

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Okay. And how much was that in the quarter?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [16]

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In the quarter, we were $1 million to $2 million high. Some of that was -- some of those claims were made late and processed late. So while they happened in the winter months, they didn't get processed or adjusted until third quarter.

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Operator [17]

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Next question comes from Samir Khanal of Evercore.

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Samir Upadhyay Khanal, Evercore ISI Institutional Equities, Research Division - MD & Equity Research Analyst [18]

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Scott or Joe, I guess, where do you stand on your views on property taxes for '19 based on where you sit today? I mean, you had -- if I look at your numbers, you had higher taxes, especially kind of in the first half of this year, primarily in 2Q. So if that doesn't repeat, comps could be easier, maybe a better NOI growth in -- especially kind of in the first half of '19. It feels like with some of the other companies in our coverage universe have these onetime items of higher taxes, they say it's sort of onetime but then they continue to repeat. So I want to kind of get your view as we kind of think about '19 growth here.

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [19]

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So certain states are pretty fixed in property tax growth. I mean California is relatively fixed. Other states like Texas and Florida reassess quite frequently and are quite aggressive. As those values approach what things are trading for, they typically slow in their reassessments. So I think, property taxes are potentially your biggest risk on expenses and potentially the biggest benefit in expenses, as year-over-year comps become easier or as some of these states slow down in their reassessments.

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Samir Upadhyay Khanal, Evercore ISI Institutional Equities, Research Division - MD & Equity Research Analyst [20]

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Okay. And I guess, my second question is, just looking at your debt maturity, I know you've got roughly $300 million of debt that's sort of maturing between now and '19. How should we think about that piece? How will you address that?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [21]

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Yes, I think you'll look -- we'll continue to do more unsecured debt as we move things forward. '19, if you look at it with extensions, is actually pretty low in terms of the amount of maturities we have. So we'll extend a portion of that, and then we'll continue to fund things with primarily unsecured debt as we move more towards an unsecured balance sheet.

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Operator [22]

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Your next question comes from Smedes Rose of Citi.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director & Analyst [23]

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I wanted to ask you just for the fourth quarter a year ago, do you have a sense as to was there any impact, lingering impact of higher occupancies due to the hurricanes and maybe what do you think sort of what we should be adjusting for this year? And then my second question, I just wanted to ask you on the acquisitions front, and if you're seeing any changes in pricing in the private market, just given the upper bias in interest rates. And if you're not yet, do you have a sense of how long that kind of takes to follow through?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [24]

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Yes. Smedes, I'll address the Florida, Houston question, and then Joe will take the acquisitions one. Florida really provided no benefit for us last year in terms of upside from the hurricanes. What we saw is a lot of people moved in. Most of those people moved in with first month free and then moved out 30 days later. Houston was a little bit different. Houston, we saw a fairly significant benefit. Our occupancy jumped quite quickly, but Houston is less than 2% of our portfolio. So I wouldn't tell you it's going to impact it significantly. And if you look at our occupancy overall as a portfolio, at the end of the third quarter, we are 20 basis points ahead of where we were last year, even though a market like Houston is 400 basis points behind in occupancy. Florida is actually slightly behind as of the end of September. Florida will come back in October in terms of occupancy, but we expect Houston to be a tough comp for the year, but a small percentage of our income.

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [25]

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Smedes, on the acquisition question, we really have not seen any material change in pricing. We have not seen cap rates increasing, although you would expect them to as interest rates go up. I guess, as interest rates started to go up, lenders tightened spreads a little bit, and that made up the difference, but that can't go on forever. So if there are several rate increases next year, at some point, you would expect the cap rates to react, but we just haven't seen it yet.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director & Analyst [26]

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Okay. So I mean, do you guys remain primarily focused, I guess, on your third-party managed as a potential pipeline of acquisitions? Or I guess, sort of where do you stand on external growth at this point?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [27]

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Great question. Thank you. So a little over 80% of the $1 billion of acquisitions gross that we'll do this year came from relationships, either joint venture partners or third-party management or relationships. We've had less than 1/5 that were brokered deals where we were competing in the market. And I think that's going to continue. We just -- we find very few situations where we can be the high bidder in a brokered situation, and we're very lucky and fortunate to have these great relationships and somewhat proprietary pipeline that allows us to continue our external growth.

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Operator [28]

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The next question is from Jonathan Hughes of Raymond James.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [29]

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Happy Halloween. Joe, just wanted to clarify what you said earlier when you mentioned seeing new supply activity migrating to markets with better yields. Are those secondary, tertiary markets you're talking about or suburbs as primary markets?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [30]

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I would say secondary, tertiary markets. A lot of suburbs are primary markets I think of the secondary markets too. So I would include all of those. But moving out of kind of the main downtown or primary suburbs or exurbs of the main markets and moving to these other secondary-type markets.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [31]

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Okay. And then kind of going back to Smedes question about external growth, your percentage of assets or acquisitions bought out of the third-party platform, you said 80% are already managed. That was maybe 30% a few years ago, and they get underwritings perfect on these assets, so lower risk. But the strength in your platform is pretty impressive. And so why not try to go out and buy more nonmanaged stores with more operational upside? I mean, of course, assuming you can buy them. I'm just looking at the integration of these third-party assets, third-party managed properties into your same-store pool going forward and the growth that's going to be lower in the future because there's not as much upside. Is that a fair assessment?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [32]

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For the most part, yes. So not all of that 80% were managed. Some of it is truly from relationships we have with people, and we don't actually manage the properties at the time. Secondly, we've been buying this year more than ever before many of these stores in joint ventures, which even though they are kind of maximized from a management standpoint because we do manage them, we do get outsized returns because we're not investing 100% of the capital, but we get a management fee, we get the insurance proceeds, and we have the opportunity to earn or promote. In a perfect world, I would love to buy more from the mom-and-pops and from undermanaged properties and get more juice out of the deals, but I don't want to pay for it. So we'll do that when the pricing is right. And when the pricing isn't right, we need to remain disciplined and patient.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [33]

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Okay, fair enough. And then just one more and I'll jump off. But could you just maybe give us details on the yields on the operating store acquisitions this quarter scheduled to close by year-end? I know you said transaction market hasn't seen any change. But curious what you paid for those couple stores?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [34]

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Sure. So the stores were in different stages of stabilization with -- the Fort Lauderdale store was fully stabilized. And the other stores, we underwrote between 10 and 22 months to get the stabilization. So they're not -- so the initial yield was not always the stabilized yield. But if you average them all together, first year was in the low 5s and stabilized was in the mid 6s.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [35]

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Okay. Maybe what was the stabilized yield on the Lauderdale acquisition, if that one was fully occupied?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [36]

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6.5%.

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Operator [37]

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The next question is coming from Eric Frankel of Green Street Advisors.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [38]

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Joe, could you comment a little bit on the cause of some of the supply decreases or the drops in attempted starts?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [39]

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Sure, absolutely. So one thing is that there is better information out there in the market today now than there was a couple of years ago. There is some third-party providers that are doing a pretty good job of putting together information. So when a developer or an equity source or a bank is looking at a proposal to build the next store in North Dallas, it's fairly easy to see there's a lot there already, and that may not be the smartest thing to build the next store in North Dallas. Secondly, costs are up, right? Interest rates are up; we talked about that. Land pricing is up, labor is certainly up, materials up. So you have an increased cost. And on other side, you have moderating operating projections, right? If someone honestly underwrites a deal, they're not going to underwrite 8% rent growth. And so if you have increased cost and moderating projections, that squeezes your development deal. And then you have lenders that are somewhat more cautious where you have a little bit more difficulty getting loans. So I think, all those factors make it harder these days to stick the next shovel in the ground.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [40]

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Is it fair to say that a lot of developers were underwriting a lease-up time of, say, 2 years, 3 years at most, which was maybe common a couple of years, but that turned out to be what it's historically been in the 3- to 5-year range?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [41]

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I don't know if it was lease-up time or rate, but in general, developers are optimists. They will create a pro forma that has an aggressive lease-up rate and aggressive lease-up time period and an aggressive unit mix too, which is what we frequently see where the unit mix is meant to maximize revenue but may not actually work in the market. And it's the equity providers and the lenders and the operators, the manager's job to try to make sure the developer has a realistic pro forma. And if that can get financed, then the deal typically goes forward. And if not, sometimes it gets put on the shelf.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [42]

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Interesting. Just another development financing-related question. I think one of your public peers has taken the strategy of underwriting a construction mezzanine loan business, whereas I think you and some of your peers, you do more of the certificate of occupancy type acquisitions, those that are available. Would you consider being in the lending business as well, if it led to more investment opportunities?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [43]

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So we do not want to be in the lending business for development. And the primary reason for that is because if you make a loan, you have to be willing to own that project, and we don't want to own a brokered development deal where we have to continue development, take the project to completion. There is obviously already problems. That's not a risk we're willing to take. We are willing to make loans on completed buildings that we, one, manage, and two, would be willing to own.

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Operator [44]

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Next question comes from Tayo Okusanya from Jefferies.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [45]

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My first question has to do with the comment made earlier about discounts declining in 4Q. I'm just -- again wondering how the confidence level you have in that just kind of given some of the supply issues that are still out there why you wouldn't keep discounting to try to maximize revenues?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [46]

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So I don't think we're necessarily cutting back on discounts. It's more a comp issue. So we will discount in October, November, December, but the difference is, is we also discounted last year in October, November, December. So just seasonally, you typically have more discounts in the fall, winter than you do in the summer, whereas this year, we increased our discounts in the summer months. So our strategy year-over-year is much more similar this year.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [47]

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Okay, that's helpful. Thank you for that clarification. Then the second question, just given your meaningful exposure to L.A. and as well as San Francisco and some of the talk happening around Prop 13 potentially hitting the ballots in 2020. Just wondering kind of what you're hearing about that, what you're thinking about that. And have you done any homework about what kind of impact that could have on EXR?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [48]

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Yes, so obviously, we recognize it is a risk. Some of our properties are legacy properties that we've owned for quite a while that have just had the 3% raises every year. We have done some math. It's pretty simple math where you're basically comparing what you're paying in taxes today compared to if they were assessed at full value. We understand what that is. Clearly, it's an impact. It will depend a little bit on, one, if it gets passed, and then two, how they phase that in. So very difficult to really comment on the impact at this point, but it's a risk we're monitoring. I think the Self Storage Association is aware of that. I think that you'll probably see some lobbying efforts around that.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [49]

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Would you care to share anything you've done in regards just the worst case analysis, like if the law kind of shows up straightaway?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [50]

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We have, but it's probably not something we would want to disclose on the call today.

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Operator [51]

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The next question comes from Wes Golladay of RBC Capital Markets.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - Associate [52]

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I just want to go back to the $0.20 dilution this year from acquisitions of C of O deals. Will those be still dilutive next year? I know you might have some more roll in. But just for this comp set here, will you get to, I guess, a no-dilution point next year? And has there been any change in stabilization of C of O deals as far as timing goes?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [53]

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So we'll continue to add C of O deals. You can see that in our supplement. So as the value add in C of O deals that are causing that $0.20 lease-up, we'll have others added into the pool.

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [54]

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And it depends a little bit on what stage they're at in terms of their lease-up. So a property that opened fourth quarter of this year clearly will be dilutive next year. An acquisition that we bought that was 70% full and we bought it in January of this year, it likely is not dilutive next year. So overall, I would tell you part of that $0.20 continues into next year, but it's a different pool, a different group.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - Associate [55]

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Okay. And then what is still the typical underwriting? And from what I recall, before it was up to 3 years, but they were stabilizing maybe 1 to 1.5 years. Has that changed at all?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [56]

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So we're underwriting C of O deals between 36 and 42 months to achieve economic stabilization, depending on the size of the property and the market that it's in. And we're currently doing maybe slightly better than 36 months, maybe 30 to 36 months to get to economic stabilization, and we're getting to occupancy stabilization earlier than that.

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Operator [57]

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Next question comes from Todd Stender of Wells Fargo.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [58]

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Probably for Joe, just to round out your last thoughts there on the C of O and lease-up duration. I wanted to just get a sense of how you're incorporating maybe potentially higher risk in your underwriting assumptions? It just depends on if it's being acquired within a joint venture, wholly owned. Are your yield expectations upfront coming up? Is leverage assumed for these portfolio deals coming up? I just want to get some color maybe you're going to expect a little more yield upfront because the NOI stream going forward might slow down, just getting your sense of the risk there.

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [59]

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So we -- everything needs to make sense on an unleverage basis. We underwrite on an unleverage basis. And if it doesn't make sense, we don't try to do the deal by adding leverage to it. So that's an easy answer. We've been underwriting pretty consistently at 90% occupancy, 36 to 42 months lease up and 3% rental rate growth. And some of those given where you see our current occupancy and revenue rate growth, some of those may be conservative numbers, but that's -- we feel that's the right way to underwrite these deals. We -- our target stabilized yields on C of O deals is and has been for some time 8%, plus or minus. If someone brings us one in a great location in a barrier to entry market, would we take a little less? Yes, probably, and a little more in other markets, but that's kind of our target yield that we think compensates us for taking the dilution during the lease-up period. And we bring in joint venture partners. So we can stay within our dilution target, and we don't have too much dilution. So we can derisk these deals. So we're doing more of them and spreading our equity out further, and so we can enhance our returns.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [60]

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All right, that's helpful. And then lastly, the Menlo Park property sold, you got a huge gain, but

it's also high barrier, very affluent market. Is that just an offer you couldn't refuse?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [61]

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Yes, so we sold that to an adjacent corporate, large corporation that wanted the property for an alternative use, and it sold around a 3 cap. So we can take those dollars, even though it's probably impossible to build storage in Menlo Park, we could take those dollars and kind of double the yields from them by reinvesting them, which we have done through a reverse 1031 exchange. So every property is for sale, if someone offers us enough money.

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Operator [62]

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Next question is from Juan Sanabria of Bank of America.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [63]

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I just wanted to touch back on supply. Do you have a sense of what percentage of your portfolio is going to be exposed to that 3-year rolling supply '19 versus what that number is in '18 and if that delta is going to be a greater percentage and to what extent?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [64]

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Sure. So let's start by looking at '18. About 1/3 of our portfolio, of our own portfolio of 841 stores, will be facing new supply in 2018. But of those stores, almost half of them had not yet been delivered. So some of those are under construction. So they will be delivered, but they'll be pushed into 2019, and others are under the proposed list. So they may or may not be delivered. Under -- in 2019, that number is less than half of that, of what we've identified. So that's where we see the drop-off into 2019. Did that answer your question?

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [65]

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Yes, when you say less than half, so 15%, if '18 was 1/3?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [66]

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14%.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [67]

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Okay. But do you have a sense of what that is on a 3-year rolling window, not necessarily new deliveries, from a 3-year rolling window of deliveries, is that more or less?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [68]

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So it actually goes up. The 3-year rolling -- I'm sorry, Juan. The 3-year rolling goes up by 9% because you're dropping off 2016, which was a relatively small number, and adding 2019, which is while a smaller number than 2018, a bigger number than 2016.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [69]

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Okay. And that's up 9% to what or from what base, just so we have a sense on the total portfolio exposed on a 3-year basis?

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [70]

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So with the 3-year ending in 2018 is probably close to 50%, and then you're closer to 60% in the 3-year ending in 2019. Was that the right [question]?

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [71]

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Yes, sir. That was perfect. And then just on a -- from a same-store perspective, how should we think about the benefit of the new stores being added next year to the pool? And relative to the benefit you've had this year, which has kind of come down as the year's gone?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [72]

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So we haven't completed the 2019 budgets, but I think, the majority of the benefit will come from C of O stores that are moving into that pool and less from acquisitions. I think that -- I would tell you it's going to be somewhat minimal. It's a big enough same-store pool, and you're not bringing that many properties in that the number is not going to be that significant.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [73]

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Okay. And one last question from me. So you said that the concessions were about an 80 basis point drag to the third quarter same-store revenues and you've kind of described the fourth quarter, given an easier comp is not being an issue. Does that mean that, that 80 point delta goes away to 0 in terms of a drag on a year-over-year basis?

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P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [74]

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Not sure it goes to 0, but a significant portion of it goes away.

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Operator [75]

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There are no remaining questions. I would like to turn the call back over for further remarks.

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Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [76]

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Thank you. Thank you for joining us today. We are pleased with our platform and our team's ability to continue to drive rental rates and occupancy. We have always invested in our platform, our portfolio and our people, and it is paying dividends in the current competitive environment.

2018 is following our expectations, and our diversified portfolio is performing well. We are excited about our outsized external growth as we enhance our size, scale and brand. We thank you for your interest in and support of Extra Space Storage. We look forward to seeing you and speaking with everyone at NAREIT. Have a great rest of the day. Thank you.

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Operator [77]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.