Industrial REITs are potentially risky as the Fed’s mission to fight inflation will ultimately slow down industrial output. However, there is a unique class amongst industrial REITs with growth prospects that are not so correlated to the underlying industrial output of the economy. These are the self-storage REITs. In this article, we are looking at Public Storage (NYSE: PSA) and Extra Space Storage (NYSE: EXR), whose investment cases are backed by unique qualities and robust dividend growth prospects.
That said, their valuation multiples continue to appear modestly elevated. Thus further headwinds are not unlikely. Accordingly, I am neutral on both names.
Demand for Storage Space Continuously Increases
Unlike traditional industrial properties, the demand for self-storage is ever-accretive. In other words, there are more items coming in to be stored than items going out of storage, resulting in net positive demand for extra space over time. This is due to some items getting stored only to be “forever forgotten” (e.g., items with sentimental value that we want to just store somewhere but don’t really want to keep around).
Furthermore, storage facilities do not rely on a few big tenants the way other REITs like data-center industrial properties do. Instead, they rely on thousands of smaller tenants. As a result, PSA and EXR enjoy fantastic cash flow diversification. For example, PSA features around 1.7 million customers in place as its 2,807 properties have thousands of customers each.
Due to such customer scale, PSA and EXR can achieve great economies of scale, which include reducing operating expenses as a percentage of total rental revenues. Another great benefit can be securing advantageous financing terms, as creditors have milder demands from such credit-worthy companies.
To exemplify this, PSA’s EBITDA margin has gradually expanded from around 65.8% in 2010 to 70.8% last year. EXR’s EBITDA margin over this period has also expanded from 52.0% to 68.8%. Therefore, with creditors enjoying a greater margin of safety, PSA currently features a weighted average interest rate of just 1.9%, while EXR has one of just 3.1%.
These rates exhibit the two companies’ ability to attract below-average financing costs, which is a great advantage during a rising-rates environment against their sector peers.
PSA and EXR Stocks Have Strong Dividend Growth Prospects
Backed by their unique qualities, PSA and EXR are likely to keep delivering robust results despite the tough underlying environment, as was the case in their most recent results. PSA delivered FFO/share growth of 26.7%, while EXR delivered growth of 29.9% in the same metric, which is utterly impressive in the current market landscape. Accordingly, their dividend growth prospects should also remain vigorous.
PSA has never cut its dividend since 1990, and while the company does not necessarily increase it annually, the dividend-per-share has grown at a respectable CAGR of 6.91%. Management raised the company’s guidance in its Q2 results, now expecting FFO/share to land between $15.00 and $15.70 for 2022, up from $14.75 to $15.65 previously. At the midpoint, it implies a payout ratio of just 52.5%. Thus, PSA stock’s dividend remains well-covered and with plenty of room for growth ahead.
On the other hand, EXR had to suspend its dividend during the Great Financial Crisis. Nevertheless, vigorous growth over the past decade powered by increasing NOI (net operating income) from its properties and rising margins have permitted potent dividend growth.
The company boasts a lightning-speed dividend-per-share growth track record, including 13 years of consecutive dividend growth and a 10-year DPS CAGR of 23.3%. The company’s latest DPS hike of 20% shows little to no signs of dividend growth slowing down as well.
In EXR’s Q2 results, management also boosted its guidance, forecasting FFO/share of between $8.30 and $8.50, up from $8.05 to $8.30 previously. At the midpoint, it also implies a comfortable payout ratio of around 71% for EXR stock. Not as low as PSA’s, but certainly fine considering the underlying pace of FFO/share growth lately.
Is PSA Stock a Buy?
Turning to Wall Street, Public Storage has a Strong Buy consensus rating based on six buys and two Holds assigned in the past three months. At $365.75, the average PSA stock forecast suggests almost 24% upside potential.
Is Extra Space Storage Stock a Buy?
An equally strong upside is forecasted for Extra Space Storage shares. The stock has a Moderate Buy consensus rating. That’s based on four Buys and three Holds assigned in the past three months. The average Extra Space Storage price target of $210.14 implies 21.7% upside potential.
Conclusion: PSA and EXR are Resilient Businesses with Expensive Stocks
In my view, both companies should be well-positioned to continue growing shareholder wealth while catering to dividend growth investors. That said, investors should be wary of their elevated valuation multiples. Despite both stocks declining substantially as of late, investors continue to price the two names at a premium thanks to their aforementioned qualities and growth prospects.
Based on the midpoints of each management’s guidance, PSA and EXR trade at a P/FFO of 19.5 and 20.8, respectively. These multiples may be deserved but could also imply further headwinds during the current market setup.