Unlocking Extraordinary Returns With Extra Space

NEW YORK (TheStreet) -- Extra Space Storage (EXR) is the second-largest publicly listed self storage REITs in the U.S. With more than 900 facilities (owned and managed) in a portfolio that spans 34 states, Extra Space has an exceptional, well-balanced revenue model.

In addition to its diverse operating platform, Extra Space is best known for its innovative marketing initiatives that have allowed the Salt Lake City-based REIT to leverage technology to drive consumers to rent storage space.  

With a strategic focus on quality and innovation, Extra Space has produced exceptional operating results, as evidenced by an extraordinary year-over-year total return of 73.73%. 

 

 A few days ago I had an opportunity to sit down with Spencer Kirk, the CEO and president, at The Street's New York headquarters. During the interview, Kirk talked about the company's leading results and innovatively successful operating platform.  

Thomas: Spencer, first off I want to congratulate you and your team on some exceptional and remarkable results. Starting with your most recent results, Extra Space led the sector in both revenue gains (up 6.7%) and net operating income (up 10.2%). What is driving the performance?  

Kirk:  One of the strongest factors driving the performance of Extra Space Storage has been our use of technology. Technology is the enabler that is driving the results of well-performing operators and is the bane of other operators who have yet to harness its benefits. The Internet was often hyped up as "the great equalizer," but we've found that it's proven to be "the great divider."

We've realized that we have to identify, embrace and embed technology into every aspect of our business. Extra Space has a team of more than 40 people who focus strictly on e-marketing. We're in a need-driven business, so when our customers are looking for convenient, clean, secure and well-priced storage, they turn to the Internet. And when they turn to the Internet, we'll be their top search result.  

Thomas: Remarkably, Extra Space has racked up 26 quarters of average same-store outperformance. What is the secret to the highly sustainable income performance?  

Kirk:  Extra Space Storage has three distinct advantages that drive our operational outperformance:  

Our people: Our senior management team has worked together for more than a decade, so we're well-versed on the company and the industry trends. We also hire exceptional team members at the store level. With each customer having a lifetime value to the company of approximately $1,500, it's vital that we close every deal. We hire and train only the best.  

Our properties: We have more properties in the top 20 metro areas than any of our competitors. Because we're in larger markets, we attract customers with higher median household incomes. Our properties in these markets are high-quality and extremely well located.  

Our platform: The Extra Space technology platform is a key driver of our success. Our analytical approach to running the business allows us to take an objective approach to increase shareholder value.

Thomas: Today your company has around 900 facilities, including around 200 managed. What is your plan for growing the third party management model and what are your target markets for growth?- 

Kirk:  During the economic downturn, when acquisitions and development were unproductive levers of growth, Extra Space was able to turn to our third-party management platform to continue to drive revenue. This platform has seen substantial growth over the past three years, and there are three primary benefits in providing this service:  

Access to a pipeline of properties that can fuel our growth through acquisition. While we may not always get the best deal, we get the first shot at it and typically avoid a broker fee.

Retention of 100% of tenant insurance revenue. Since we assume all of the risk through our captive insurance company, we retain all of the profits from the program.

Growth of our footprint, across which we can spread fixed costs and expand brand awareness.  

We'll continue to selectively grow our third-party management platform by carefully choosing the markets we enter with the goal of creating mutually beneficial partnerships. Our track record of providing proven industry-leading results is the best calling card we can have.  

Thomas: You have a strong background in technology. Can you tell me a little bit about your background and maybe shed some light on the importance of your technology experience and self-storage?  

Kirk:  In early 1985 I was in graduate school and fortunate to associate with some very smart individuals. We saw a new and emerging technology industry and knew we wanted to be a part of it. In the garage of one of my partners, we started a company through building a component that increased the effectiveness of the 80286 processor by 33%. I am certainly dating myself, as I would bet that less than 20% of the folks in this room ever had the pleasure of using this technology.  

To give you some perspective, at the time you could purchase an IBM PC AT for $6,000, and for $99 bucks our Turboswitch boosted speeds by 1/3. As with any technology, the 80286 processor had a very short life cycle, and our Turboswitch was becoming obsolete, too.

This new and growing company we had started was on the verge of obsolescence. We needed to reinvent and redefine ourselves. We saw the market for laptops exploding, but to make this tool impactful it had to be connected using modems.  

We saw the need for mobile communications growing and felt this could be an opportune area for growth.  We developed modems to meet the needs of a growing "anytime, anywhere" business environment and rapidly grew to become the world's leading supplier of solution-oriented mobile data communications products. The innovative developments that Megahertz had come up with have become the genesis for today's mobile world.  

In 1993, we took Megahertz public, and in 1995 we were purchased by USRobotics. I found myself retired at the ripe old age of 36. A former board member of Megahertz approached me and told me that I was too young to retire and needed to be actively engaged. Some of you may know that individual. It was the founder of Extra Space Storage, Ken Woolley.

Ken was convinced that I needed to join him in self-storage. All I could think of was cinder-block facilities on the side of a highway with El Caminos and razor wire. I was certain that I did not want to go from the world of high tech to a world of absolutely no tech. 

Those of you who know Ken know that he is a very persuasive individual. He took me to California to see some recently developed, third-generation storage facilities. These beautiful facilities were nothing like what I had imagined. I quickly realized that this was a product that I could stand behind and that I would be proud to own.

In 1998, I joined Ken. He had and continues to have an unparalleled understanding of real estate and the storage industry. I came to the table with experience building a company from the ground up, and together we started on what has been one of the most rewarding journeys of my life.  

After joining Extra Space Storage, I was not satisfied accepting that this was a sleepy industry, impervious to the rapidly changing world of technology. We began recruiting talent out of the high-tech world to build a team that could harness technology and build a world-class organization. It was the only way to take a company with a server room that consisted of a single computer in a broom closet to a publicly traded REIT with a cloud-based platform that is not only best-in-class in the storage industry but rivals top-tier companies in the high-tech and retail spaces. I will add that this team is still largely intact today.  

Now, I said that I was searching for an answer to what could so severely divide the performance of storage companies, and I have come to only one conclusion -- technology. Technology is the enabler that is driving the results of well-performing operators, and it is the bane of other operators who have yet to harness its benefits.  

Thomas: Self-storage is somewhat "boring" in that the business model does not typically have many highs or lows. How would you define your company's seemingly "boring" but profitable business model?  

Kirk: Growth! Extra Space has had 30+% funds from operations growth for the last two years. We feel we can continue to produce double-digit FFO growth through the following levers:

Core performance: We continue to lead the sector in operational performance. (I referred to people, properties and platform earlier.)

Tenant insurance: As mentioned, we are growing this business that is highly profitable.

Acquisitions: We acquired 55 properties in 2011 and 60 so far in 2012. We have been disciplined and paid prices that will make these acquisitions accretive to our shareholders.

Lease-up portfolio: Having developed several assets, we have the largest lease-up portfolio that is poised to add 7+ cents of FFO to the bottom line by the end of 2014.

Third-party management: As I mentioned, we use this program to spread expenses and to provide us with a quasi-proprietary acquisition pipeline.  

Thomas: I believe I saw that your company leads not only the self-storage sector but perhaps even the entire equity REIT sector in total return. What is driving the growth and how much more of a "runway" do you see in future years (for storage)?  

Kirk: Correct, Extra Space Storage is #1 on five-year total return to investors from ALL REITs and has 26 consecutive quarters of double-digit growth.

Within the self-storage space, we top return year-to-date (39.49%), last 12 months (65.73%), last two years (137.23%), last three years (260.38%) and last five years (173.05%). We have a proven track record of growing and delivering solid returns, even during downturns.  

I've touched on many of the drivers of our growth in the previous questions. Another factor is the lack of supply. In the years 2003-2007, the industry averaged 2,600 new facilities per year. Now, only a couple hundred new properties are coming on line each year. This gives us a tremendous opportunity to expand our footprint through acquisition and third-party management contracts.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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