U.S. Markets open in 3 hrs 13 mins

Edited Transcript of EXR earnings conference call or presentation 1-Aug-18 5:00pm GMT

Q2 2018 Extra Space Storage Inc Earnings Call

SALT LAKE CITY Aug 10, 2018 (Thomson StreetEvents) -- Edited Transcript of Extra Space Storage Inc earnings conference call or presentation Wednesday, August 1, 2018 at 5:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* 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

================================================================================

Conference Call Participants

================================================================================

* Bennett Smedes Rose

Citigroup Inc, Research Division - Director and Analyst

* Eric Joel Frankel

Green Street Advisors, LLC, Research Division - Analyst

* George Andrew Hoglund

Jefferies LLC, Research Division - Equity Research Analyst

* Juan Carlos Sanabria

BofA Merrill Lynch, Research Division - VP

* Michael Bilerman

Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research

* Robert Jeremy Metz

BMO Capital Markets Equity Research - Director & Analyst

* Ronald Kamdem

Morgan Stanley, Research Division - Research Associate

* Stephen Thomas Sakwa

Evercore ISI Institutional Equities, Research Division - Senior MD & Senior 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

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Extra Space Storage Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded. I would now like to introduce the conference over to your host, Mr. Jeff Norman. Sir, you may begin.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Valerie. Welcome to Extra Space Storage's Second 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 statement 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, August 1, 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.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thanks, Jeff. Hello, everyone. Thank you for joining us for our second quarter call and for your interest in Extra Space Storage.

We have crossed this year's midpoint and to date, the year is right in line with our expectations and with our guidance, with the exception of some uncontrollable expense items.

Revenue is on budget, and occupancy continues to be strong, ending the quarter at 94.2%. We have maintained pricing power during the busy summer leasing season with achieved rates up mid-single digits. This led to same-store revenue growth of 4.1%.

New supply continues to be at the forefront of most operators and investors' minds, and we are certainly focused on it as well. Our view continues to be the same. We are seeing an impact from new supply in certain submarkets and its impact varies by location.

We are benefiting from our highly diversified portfolio across primary and secondary markets. This reduces the impact of individual market volatility. In addition, our best-in-class platform continues to drive high-quality traffic to our stores and our proprietary revenue management systems are optimizing price and promotion to convert that traffic to rentals.

As I mentioned on our last call, our scale and technology advantages become more apparent in periods of elevated supply. We continue to focus on and invest in our platform to maintain this advantage.

These advantages reflect a significant growth in our third-party management platform. We added 42 stores in the second quarter, and we are approaching 100 stores year-to-date. Between our third-party and JV programs, we now manage 700 stores, which continues to be the largest in the business. We are happy to report that Inside Self-Storage Magazine just named us as the best third-party management company for the seventh year in a row.

The acquisitions market continues to be competitive, with numerous types of capital seeking exposure to the sector. We have yet to see any expansion in cap rates despite elevated interest rates and supply. We continue to be selective and disciplined in our acquisition efforts.

This year, we have primarily sourced accretive acquisition opportunities through existing relationships rather than in the open bid auction market. In the quarter, we invested $274 million through a combination of wholly owned and joint venture acquisition, which includes the buyout of a JV partners interest in a 14 property portfolio for $204 million, which we highlighted in our first quarter call.

Year-to-date, our acquisitions closed or under contract to close in 2018 totaled just under our annual guidance of $600 million.

Before I turn the time over to Scott, I want to reiterate, revenue performance year-to-date is solid and exactly as we expected. As we discussed on our last call and as our guidance implies, we knew revenue would deaccelerate and elevated discounts would create a headwind in the second and third quarters. We are pleased with our strong rate growth in occupancy, which has allowed us to increase our FFO guidance.

I would now turn the time over to Scott.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thanks, Joe, and hello, everyone. Last night, we reported core FFO for the quarter of $1.15 per share, exceeding the high end of our guidance by $0.01. The beat was primarily due to stronger-than-expected tenant reinsurance income. Rental rates to new customers continue to be strong. Throughout the quarter, our achieved rental rate was up approximately 5% to 6% year-over-year. As expected and as discussed on our last call, discounts as a percentage of revenue were also up, partially offsetting revenue growth. We anticipate elevated discounting levels to continue in the third quarter. Discounts should taper off later in the year, reducing the impact on fourth quarter revenue growth.

Our guidance included outsized expense growth in the first half of 2018 due to negative expense comps in the first and second quarters of 2017. Same-store expenses were up 4.9% in the second quarter, which was in line with our forecast, with the exception of property taxes. We had 3 properties receive unbudgeted tax increases for 2016, '17 and '18 that totaled $872,000. Without the impact of these 3 stores, expense growth for the quarter would have been 3.5%.

We continue to execute our balance sheet strategy to increase our percentage of unsecured debt and the size of our unencumbered pool and to prudently ladder our maturities.

During the quarter, we announced a 10-year, $300 million private placement, which was funded on July 17. We also negotiated better terms for a number of existing secured loans, which lowered rates, extended maturity date and reduced maturity concentrations in 2020. Subsequent to the quarter end, we sold $34 million on our ATM at an average price of $99.75 per share. The decision to access the ATM was based on lower-than-expected OP unit issuance as well as last quarter's increase in acquisitions guidance.

We've updated our guidance and annual assumptions for 2018. We raised the bottom end of our same-store revenue guidance by 25 basis points to be 3.75% to 4.25%. We've increased the top and the bottom end of our same-store expense growth by 50 basis points to 4% to 4.75% due to uncontrollable expenses in the first 2 quarters.

The changes to revenue expense guidance result in unchanged same-store NOI guidance of 3.25% to 4.5%. We've increased our core FFO guidance to be $4.60 to $4.67 per share.

In 2018, we anticipate $0.06 of dilution from value-add acquisitions and an additional $0.15 of dilution from C of O stores for a total dilution of $0.21. Our investment in C of O stores and value-add acquisitions continue to improve the quality of our portfolio and generate long-term growth for our shareholders.

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

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Scott. (Operator Instructions) And with that, Valerie, let's go ahead and start our Q&A.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Juan Sanabria of Bank of America.

--------------------------------------------------------------------------------

Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [2]

--------------------------------------------------------------------------------

Just hoping we could talk a little bit about supply and your latest expectation for '19 deliveries versus '18 and thinking about things on a 3-year rolling basis, maybe how '19, at least to your thoughts now, compare to '16?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Sure. Our supply outlook hasn't really changed that much from last quarter. We would expect '19 to be similar to slightly moderating down from 2018, subject, of course, to things getting delayed and being pushed from '18 to '19, which seems to happen a lot in this business. Things just don't deliver on time. So overall, when you look at national numbers, I would expect a similar to slightly down number. But what's more important is where the product is being delivered. And we do see a shift in the markets to where folks are concentrating, less people looking -- less if any people looking at markets like Dallas and more people looking to secondary markets or markets, which haven't yet been impacted as much by new supply.

--------------------------------------------------------------------------------

Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [4]

--------------------------------------------------------------------------------

Great. And then just on the same-store revenue, how should we expect the trajectory of the second half growth to be? And would you characterize a fourth quarter run rate as a good sort of starting block in terms of thinking about '19 growth?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [5]

--------------------------------------------------------------------------------

Yes. So Juan, it's Scott. So if you look at our guidance and you look at kind of how we're looking at the year, I think our top line revenue growth -- kind of ignoring discounts for a second here, our top line revenue growth implies deceleration throughout the year. So we've implied that in our guidance. We've talked about that. The impact of discounts are going to be larger in the second and third quarter, with that impact moderating into the fourth quarter. So you could potentially see the fourth quarter be slightly higher year-over-year than the third quarter. So that's kind of the current year. I'm not sure we're ready to give 2019 guidance, but that's our outlook for the current year.

--------------------------------------------------------------------------------

Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [6]

--------------------------------------------------------------------------------

And could you quantify the drag in the second quarter from the discounting?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. The discount drag in the second quarter was about 40 basis points.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

Our next question comes from Jeremy Metz of BMO Capital Markets.

--------------------------------------------------------------------------------

Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [9]

--------------------------------------------------------------------------------

Joe, I just wanted to go back to your comments on supply just now about 2019 at this point, kind of expectations feel like it could be in line to even slightly down. I'm just wondering what you're seeing out there in the market today that gives you that confidence that it doesn't actually ramp up, just given that returns are still quite good and obviously, fundamentals are holding in there.

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [10]

--------------------------------------------------------------------------------

So it's hard to have perfect transparency to 2019 or a high level of confidence as you characterize it. But what we do see is our costs are certainly going up. Interest is going up, labor's going up, materials, steel is going up. So you have an increased cost basis, and we know projects that are being canceled, they're not pursued because of costs and you do have -- moderating all those solid fundamentals. So I think between discipline of some of the developers who have been in this business for a while and understand the business and lending, some discipline from lenders. And I'm not going to say that there is discipline all the way across the board. I think you will have some market forces that had moderate development. Certainly, you'll see that in markets where it's saturated, right? It's hard to find -- [it is that --] keep using Dallas as the punching bag, but it's hard to find a site in North Dallas that makes sense now.

--------------------------------------------------------------------------------

Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [11]

--------------------------------------------------------------------------------

No. That makes sense. But -- and it sounds like lending is at least one of those factors that you're seeing maybe get a little tougher at this point?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [12]

--------------------------------------------------------------------------------

Situationally, I think there's a lot of local folks who -- at their local banks who can get loans, but it is a factor that's getting tougher.

--------------------------------------------------------------------------------

Robert Jeremy Metz, BMO Capital Markets Equity Research - Director & Analyst [13]

--------------------------------------------------------------------------------

Okay. And then just second one for me. I mean, you talked about the advantages the larger players have on revenue management, technology front, especially at points in the cycle like we're in where supply is rising. So Joe, as you look at your systems today, the results you're generating, are you happy with where the system is at today? Or will you continue to put more capital into it? And where do you really see the biggest opportunities for improvement? Or what are you most excited about on that front going forward?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [14]

--------------------------------------------------------------------------------

So we're happy with our systems and always never happy with our systems. So we're always seeking to improve, particularly in the world of technology, any time you stand still, you're just [hoarding duck]. So we spend a lot of time and effort trying to improve on models, improve our systems, do many, many different tests to find out how we can maximize revenue, deliver a better product to our customer, and I just think it's something that we do well, and I hope we continue to do well.

--------------------------------------------------------------------------------

Operator [15]

--------------------------------------------------------------------------------

Our next question comes from Todd Thomas of KeyBanc Capital.

--------------------------------------------------------------------------------

Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [16]

--------------------------------------------------------------------------------

First question, just back to the discount drag that you talked about, the 40 basis points, the same-store revenue in second quarter. Will that drag in the third quarter be the same? Or more than it was in the second quarter?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [17]

--------------------------------------------------------------------------------

Comparable to slightly higher. You have summer months, we typically don't discount as months as much and in this quarter, you really have July and August, where last quarter, you had May and June but typically more rentals in July and August.

--------------------------------------------------------------------------------

Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [18]

--------------------------------------------------------------------------------

Okay. And then Scott, your comments, so it sounds like same-store revenue growth might trough in the third quarter and then begin to improve sequentially into the fourth quarter just based on your comments. Is that the right read?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

That's the way we're looking at it, correct.

--------------------------------------------------------------------------------

Todd Michael Thomas, KeyBanc Capital Markets Inc., Research Division - MD and Senior Equity Research Analyst [20]

--------------------------------------------------------------------------------

Okay. And then just last question on -- for the third-party management business, how many net additions are you anticipating at year-end? And is this sort of pace of additions to the platform anticipated to continue in 2019?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [21]

--------------------------------------------------------------------------------

So we're 75 net additions to our third-party management platform through the second quarter, and we expect that pace to continue for the rest of this year. I would not be surprised to see it slow down in 2019 as about 2/3 of our additions are development. And as development starts to moderate, I would expect we would feel that in our third-party management platform.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Our next question comes from Smedes Rose of Citi. Our next question comes from George Hoglund of Jefferies.

--------------------------------------------------------------------------------

George Andrew Hoglund, Jefferies LLC, Research Division - Equity Research Analyst [23]

--------------------------------------------------------------------------------

Just one thing looking at the trends in third-party management, just kind of following on that question line. What have you seen recently in terms of canceled contracts, whether it's customers who are exiting to go to another manager or customers internalizing their own management?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [24]

--------------------------------------------------------------------------------

We only had one experience with the customer internalizing its own management. That was last year when we lost a large portfolio, and we talked about that. Part of the business is that people will sell their properties or have some type of transition, and you will occasionally lose properties. So we've lost 6 in the first quarter, and we lost 2 in the second quarter. That's just part of the business. I don't think we've seen any trends increase or a different behavior in terms of owners.

--------------------------------------------------------------------------------

George Andrew Hoglund, Jefferies LLC, Research Division - Equity Research Analyst [25]

--------------------------------------------------------------------------------

And those 6 in the first quarter, 2 in the second quarter, were all those due to basically properties getting sold and then the new owners looking to switch management? Or are any of these is people switching for any other reason?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [26]

--------------------------------------------------------------------------------

So we lost one contract for someone switching to another manager. We were not willing to make the fee concessions necessary to retain that contract and that happens. To date, that has happened very, very occasionally, but when it happens, that's part of business.

--------------------------------------------------------------------------------

George Andrew Hoglund, Jefferies LLC, Research Division - Equity Research Analyst [27]

--------------------------------------------------------------------------------

Okay. And then also, just looking at acquisitions going forward, kind of what trends are you seeing in competition for assets in terms of any new sort of players in the market that have new recent inflows of capital they're looking to put to work?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [28]

--------------------------------------------------------------------------------

We continue to see a lot of interest in self-storage investment. I mean, the basic fundamentals of the property type are still very strong. We're at 94% occupancy, positive revenue growth and to the extent, people are concerned about the downturn in the economy, this is an asset class that performs well in a downturn in the economy. So there's a lot of reasons that people are interested in that -- in this asset class. And for that reason, there's a lot of different types of money from big private equity funds to more local or regional people who put together pools of money -- are looking to invest in asset classes. And it's our opinion that, that's why we haven't seen expansion in cap rates, is that there's such a demand for the asset class.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

Our next line comes from Smedes Rose of Citi.

--------------------------------------------------------------------------------

Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [30]

--------------------------------------------------------------------------------

Can you hear me?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [31]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [32]

--------------------------------------------------------------------------------

Sorry, we're still learning our phones here, apparently. I just wanted to ask you, so 3 -- the tax increase on 3 stores cost you $1 million. So with 800 own stores and another 200 in JVs and 250 managed, like what -- how do you think about maybe the risk going forward for kind of unbudgeted tax increases? And what's the risk across your other assets, I guess?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [33]

--------------------------------------------------------------------------------

Yes. Smedes, this is Scott. This is actually kind of a unique situation where a school board challenged the valuation that was put on by the local municipality and obviously had a negative impact on us. That affected 2016, '17 and '18. In terms of prior years, the risk on this happening in this situation to other properties is not an issue. It's -- the statutes are run in that. We constantly are looking at reassessments. This was one that went against us. It happens occasionally. But I wouldn't tell you the risk is any greater today that has been in the past. More often than not, we win appeals when we have these types of surprises.

--------------------------------------------------------------------------------

Operator [34]

--------------------------------------------------------------------------------

Our next question comes from Eric Frankel of Green Street Advisors.

--------------------------------------------------------------------------------

Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [35]

--------------------------------------------------------------------------------

Joe, do you have any sense just based on the -- what you perceive as a more moderating supply growth challenge in 2019? How much of a decrease do you think that's attributable to rising construction costs?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

To the extent we have moderation in 2019, I don't think I have any way to kind of allocate the causes between rising construction cost or tighter lending or just the top line going down, so development yields are getting suppressed. I'm not sure I can divide up those different causes.

--------------------------------------------------------------------------------

Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [37]

--------------------------------------------------------------------------------

Maybe I can ask that question a little differently. How much overall cost increases are your development partner seeing today versus, say, a year ago, to construct the self-storage facility, excluding land?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [38]

--------------------------------------------------------------------------------

So I would tell you that we were hearing about 10% to 15% increases in steel before the tariffs were announced. So we know we have some increases there, labor, interest rates. So I think if you put that all together, you probably have 10% to 15% increases in overall cost ex land.

--------------------------------------------------------------------------------

Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [39]

--------------------------------------------------------------------------------

Okay. That's helpful. And just a final follow-up question. Do you perceive in your budgeting weeks going forward, the next foreseeable future, wage rates appreciate the same pace it has this year?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [40]

--------------------------------------------------------------------------------

So our current year increase, I would tell you, is attributable not so much to wage rate pressure. It's attributable more to the fact that our benefits saw some outsize growth this year. Our health insurance and benefits increased faster than they have in the past. And then the second thing I would attribute it to is a very tough comp. Last year through 2 quarters, we were negative 2% on payroll. So if you kind of look at it on a 2-year rolling number, it's pretty much inflationary. Our health care has not gone up for several years. So we experienced an outsize this year. We hope to be able to control more than inflationary number.

--------------------------------------------------------------------------------

Operator [41]

--------------------------------------------------------------------------------

Our next question comes from Ronald Kamdem of Morgan Stanley.

--------------------------------------------------------------------------------

Ronald Kamdem, Morgan Stanley, Research Division - Research Associate [42]

--------------------------------------------------------------------------------

I just had a quick question on San Francisco. Just looking at some of the deceleration this quarter. Just curious if you can maybe provide any color there? And how you guys are thinking about the market and maybe the West Coast in general?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

So our numbers in San Francisco are really driven by San Jose. So San Jose is weaker than San Francisco and Oakland, which are doing better.

--------------------------------------------------------------------------------

Ronald Kamdem, Morgan Stanley, Research Division - Research Associate [44]

--------------------------------------------------------------------------------

Got it. And then if I could just ask another quick one about acquisitions. Clearly this year, a lot of success being able to source a lot of off-market deals. Maybe if you can just kind of comment on what that pipeline looks like? So is there a kind of 1-, 2-year runway where you can continue to kind of source these attractive deals?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [45]

--------------------------------------------------------------------------------

Our pipeline of off-market opportunities is really hard to predict, right because you never know when these opportunities are going to come up. We know that some of our joint ventures that we have are in either finite life funds or funds that we'll be seeking exit at some point, and we hope to have an opportunity to acquire those assets, but there's no guarantee. But what I can tell you is, if history is any guide, if you look back, we've been pretty successful year after year after year in generating a significant portion of our acquisition pipeline from our relationships, either on the management side or on the joint venture side or just our relationships with people we've done business with for many, many years. And I don't see any reason why that shouldn't continue in the future.

--------------------------------------------------------------------------------

Operator [46]

--------------------------------------------------------------------------------

Our next question comes from Steve Sakwa of Evercore.

--------------------------------------------------------------------------------

Stephen Thomas Sakwa, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [47]

--------------------------------------------------------------------------------

Just wanted to maybe talk a little bit about customer rate increases and just how you're sort of looking at the new customers, folks staying kind of on the short end of the curve and then the longer state customers. And are you seeing any kind of trends in length of stay or ability to absorb rent increases in the 2 different buckets of customers?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. Our length of stay, Steve, continues to increase mildly or moderately here. So customers are behaving very similar to the way they have in the past. Our existing customer rate increases are still high single digits. We continue to do those on a monthly basis. We have a roll down in rates of between 5% to 10% depending on the time of the year, similar to what it's been in the past. And customers are reacting very similar to where they have in the past to rate increases and rates in general.

--------------------------------------------------------------------------------

Stephen Thomas Sakwa, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [49]

--------------------------------------------------------------------------------

Okay. And then, I guess, maybe just circling back on the expense question. I know it's been asked a bunch of different ways. But as you kind of look into next year, and you look at kind of just overall operating expense growth, is there anything that would kind of get you nervous outside of that onetime sort of hit your head, you're in the second quarter? I mean, do you sort of look at expenses being at a similar rate next year? Or do you think things could accelerate because of wages potential, still upward pressure on real estate taxes?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. The 2 or 3 areas that we -- I would kind of point you to, one is, I think you will continue to have some pressure on property taxes just with valuations where they are, municipalities, reassessing things. So property taxes are always a risk. Our insurance, our property insurance is going up also. You'll see an increase in the back half of this year. We renewed it the 1st of June, and that's due to the fact that we've actually been -- kept it very low for several years. And with the hurricane year that we had last year, it went up. But overall, I think we hope to keep things inflationary, with property taxes probably being the biggest risk and then the current year bump in insurance.

--------------------------------------------------------------------------------

Operator [51]

--------------------------------------------------------------------------------

(Operator Instructions) We have a question from Todd Stender of Wells Fargo.

--------------------------------------------------------------------------------

Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [52]

--------------------------------------------------------------------------------

Just looking at the investments you made alongside your JV partner, I wanted to compare those to what you would consider, I guess, to your wholly owned investments. Can you go through the 5 operating stores, maybe how they compare to the 7 silo properties that you made alongside your JV partner?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [53]

--------------------------------------------------------------------------------

It was actually combined. So it was stores that were in lease-up as well as some stores made a Certificate of Occupancy. So the stores that were in lease-up have been open between 1 and 2 years. So it's all one joint venture investment.

--------------------------------------------------------------------------------

Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [54]

--------------------------------------------------------------------------------

And what kind of growth -- or can you go into some of the economics around that, maybe growth rates just to see if a property opening now or whether it's in lease up? The economics around that -- growth rates, yields expect in the first 2 years, call it and then sale of old properties?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [55]

--------------------------------------------------------------------------------

In terms of our underwriting assumptions?

--------------------------------------------------------------------------------

Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [56]

--------------------------------------------------------------------------------

Yes. See where we are in the cycle.

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [57]

--------------------------------------------------------------------------------

So we'll -- yes. So we'll typically underwrite -- all of these stores had a significant portion of lease up. The C of O stores obviously had 100%, and the others were lightly occupied. So still had significant lease up. So we'll look at the markets. We'll determine the rates we believe we can achieve based on what we're achieving in our stores around what's coming in the way of development, what the local economic situation is. We'll underwrite those rates. We typically grow them at 3%, and we will attach certain discounting to those rates to achieve lease up to economic stabilization. When we underwrite C of O stores, we want to get to an 8, maybe 7.5 to an 8 on stabilization. The yield to us in a joint venture is much higher. It's in the double digits because of the effect of the joint venture.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

And that will be leverage and third-party management fees?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

No, that's -- those are all unleveraged numbers but including management fees.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Okay. And all these properties, are they included in your 42 third-party management additions?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

No. When we talk about third-party management stores, we talk just about stores we manage where the owner owns 100%. We also manage our joint venture stores, but we don't refer to those as managed stores.

--------------------------------------------------------------------------------

Operator [62]

--------------------------------------------------------------------------------

Our next question comes from Smedes Rose of Citi.

--------------------------------------------------------------------------------

Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [63]

--------------------------------------------------------------------------------

It's Michael Bilerman here with Smedes. Joe, just wanted to get your sort of views around equity issuance, especially with the furthering of the external growth through the acquisitions that you just talked about. You tapped the ATM as the stock got to almost $100, raising just over $30 million. Stock's back down to the low $90s, still trading at a low 5% implied cap rate. I guess, how do you -- give us some sort of goalposts of how you think about using the ATM and then doing equity, especially as external growth pipeline, which you desire, continues to be there to expand.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. So we -- our goal and our strategy is to maintain -- to be leverage neutral, to maintain leverage neutrality as we grow. So we need -- as we find acquisitions, we need to find ways to capitalize those. And as you point out, as our pipeline grows, our need for capital grows. We will certainly -- and as we did tap our ATM or seek equity when we have a need for it, and we also use other sources of capital, for example, sales proceeds. We'll have some sales, it is used when we use those capital. So equity, certainly, is an option for us and when we have a use for it, we'll consider it.

--------------------------------------------------------------------------------

Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [65]

--------------------------------------------------------------------------------

Right. But I guess, how do you think about the pricing of that capital? It seems that during the second quarter, even though you had, call it, a $300 million to $400 million forward commitment between the acquisitions and the developments, you didn't do it. It wasn't only until the stock really ratcheted up close to $100. I'm just trying to get your sort of views around how you view the common equity at various prices relative to selling assets.

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [66]

--------------------------------------------------------------------------------

Yes. So from our perspective, as we gave guidance this year, we looked at OP unit issuance. It was coming in a little bit light. Clearly, we want to issue equity when we feel like we're appropriately priced. This year, we will sell an asset here in the third quarter that is one that's going to go for a very below market cap rate. It's a higher better-use situation. So our issue we're up against today is we're trying to balance cash on hand with the equity needs, and so at this point, we felt like this was the best way to do it and remain leverage neutral.

--------------------------------------------------------------------------------

Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [67]

--------------------------------------------------------------------------------

And how big is that asset sale, just dollar wise?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [68]

--------------------------------------------------------------------------------

It's about $40 million.

--------------------------------------------------------------------------------

Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [69]

--------------------------------------------------------------------------------

And is there any other sales occurring in the back half of the year that we should be aware of?

--------------------------------------------------------------------------------

P. Scott Stubbs, Extra Space Storage Inc. - Executive VP & CFO [70]

--------------------------------------------------------------------------------

That's the only one under contract.

--------------------------------------------------------------------------------

Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [71]

--------------------------------------------------------------------------------

And you said that will be below market cap rate. So are we talking somewhere in the 3% to 4%, 4% to 5%, 5% to 6%?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [72]

--------------------------------------------------------------------------------

So it's a -- it's being sold to a nonself-storage user, and it will be substantially low cap rate.

--------------------------------------------------------------------------------

Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [73]

--------------------------------------------------------------------------------

And when you say appropriately valued, I guess, should we view $100 as appropriately valued? Or is the current price at $92 appropriately valued to where you would execute?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

I think it's on the table. In the range where it is today if we have a place to put it.

--------------------------------------------------------------------------------

Operator [75]

--------------------------------------------------------------------------------

Our next question comes from Steve Sakwa of Evercore.

--------------------------------------------------------------------------------

Stephen Thomas Sakwa, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [76]

--------------------------------------------------------------------------------

Just one quick follow-up. Can you just maybe talk about the business demand that you're seeing? And has there been any real change in that kind of line? And do you expect that to change in '19?

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [77]

--------------------------------------------------------------------------------

We have not seen any change in demand from business customers. We -- I think it's been very steady for many, many, many years. So we don't expect a change in 2019. We also -- and maybe this is different between us and our peers. We like the retail customers better than the business customers. The business customers can drive high -- hard bargains. They're difficult to raise rent time, and if we can fill our stores to 94% and maintaining our current percentage of business customers, we're very happy with that.

--------------------------------------------------------------------------------

Operator [78]

--------------------------------------------------------------------------------

I'm showing no further questions at this time. I'd like to turn the conference back over to Joe Margolis, Chief Executive Officer, for any closing remarks.

--------------------------------------------------------------------------------

Joseph D. Margolis, Extra Space Storage Inc. - CEO & Director [79]

--------------------------------------------------------------------------------

Thank you. Thanks, everyone, for joining us today. We are pleased with our ability to drive rental rates and occupancy in the face of heightened new competition. 2018 is following our expectations. And our diversified portfolio, investment class platform are performing well. We continue to execute our strategy to combine steady property-level NOI performance with consistent external growth to produce strong FFO growth per share. Thank you, and I hope everyone enjoys the remainder of the summer.

--------------------------------------------------------------------------------

Operator [80]

--------------------------------------------------------------------------------

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.