Valley-Based Self-Storage Firm Will Thrive, Experts Predict

GLENDALE — Real estate investment trusts took a beating in 1998, but some believe the time is right for recovery, at least for companies with the financial firepower to outperform the competition.

A leading candidate, according to some Wall Street analysts, is Public Storage Inc., the Glendale-based owner and operator of mini-warehouse facilities and pioneer of the self-storage industry.

Jefferies & Co.’s Mark D. Benson, based in Los Angeles, put a buy rating on Public Storage’s stock, projecting that funds from operations--a cash flow measurement that analysts consider the best indicator of real estate investment trust performance--will increase 23% this year, from $2.24 per share to $2.76.

He put a 12-month target price of $32 on the stock.

Jeff S. Langbaum, an analyst with BT Alex. Brown in New York, recently increased his target price on the stock from $29 to $33 (or 12 times its estimated funds from operations per share this year).

Public Storage closed at 26 15/16 on Monday in trading on the New York Stock Exchange, down one-sixteenth on the day.

Wall Street’s enthusiasm springs from the strength of Public Storage’s balance sheet. The company generates $120 million of operating cash flow annually, and total debt stood at $85 million at the end of the third quarter. In addition, the company has an unused credit line of $150 million, plus around $50 million in cash.

Benson points to Public Storage’s size--around half a billion dollars in annual revenue--and leading market share as a key advantage in one of the fastest-growing sectors in real estate. The self-storage industry has 27,535 buildings nationwide and more than $9 billion in annual revenue, according to Self-Storage Almanac, an industry publication.

It’s a highly profitable industry, but most companies in it are mom and pop operations. The top 10 companies account for only 17.7% of the market, according to Peter Conti, a vice president at MiniCo., an Arizona-based provider of insurance to the self-storage industry.

The industry’s growth in the past 20 years reflects a national propensity to collect stuff. Indeed, we are a country of pack rats. Demand is particularly keen in states such as California, where frequent change--in jobs, marriages, lifestyles, hometowns--is a way of life, according to Public Storage President Harvey Lenkin.

“I refer to it as controlled chaos,” Lenkin said. “In Sioux Falls, Iowa, where not much is going on in the way of change, demand for storage is far less per capita. It’s driven by events that occur in people’s lives--a divorce, a marriage, a death, a business expansion or contraction, getting old and moving to a smaller residence.”

Public Storage, already by far the biggest player in its industry, will grow even bigger when it closes a deal to buy Storage Trust Realty of Columbia, Mo., the fifth-largest self-storage operator in the U.S. and a key competitor. The sale, for $400 million and assumed debt, is supposed to happen sometime late in the first quarter, if the deal is approved by two-thirds of Storage Trust’s shareholders.

Jim Sullivan, a real estate analyst with Green Street Advisors of Newport Beach, says the purchase--creating a firm with nearly 1,300 storage facilities in 37 states--makes both strategic and financial sense.

Public Storage said the expanded company would have higher revenues and lower administrative expenses because it can eliminate redundant departments, such as investor relations and accounting.

Sullivan expects Public Storage’s management will boost occupancy at Storage Trust’s properties, which now averages 84%. Occupancy rates at Public Storage’s facilities in common markets are 7% higher, at 91% to 92%.

“Storage Trust has been under-managed,” Sullivan said.

Sullivan also likes the price--around $23 a share, in line with Storage Trust’s net asset value (the value of its underlying assets). “Unlike so many deals where companies have paid too much, Public Storage is paying a fair price for Storage Trust,” Sullivan said.

Public Storage’s strength has served it well during a tough period for real estate investment trusts in general.

These companies, usually traded on stock exchanges, manage portfolios of real estate to earn profits for shareholders. To avoid corporate taxes, 75% or more of such a trust’s income must be from real property and 95% of its taxable income must be distributed to shareholders. In a good year, trust dividend yields can be 10% or more, and there’s always the possibility of capital gains too when properties are sold.

But 1998 was decidedly not one of those good years for the industry as a whole. After two years of big jumps in their stock prices, real estate investment trusts began the year on a roll, attracting a steady flow of capital from Wall Street.

But by year’s end, it was over. The trust prices plunged as it became clear that they could no longer buy buildings for less than it would cost to construct them. Such bargains could be found in much of the real estate business in the years immediately after the recession of the early 1990s, helping to generate the boom in such trusts.

“The play for the last four or five years has been a company’s ability to access equity capital, cheap debt and deploy the capital into buying new properties. That ability has gone away for most REITs,” Benson said.

With the end of the fat times, Wall Street shut off the money. According to Morgan Stanley’s REIT Index, REITs fell in value by an average of around 17% last year, compared with a 20% gain by the Standard & Poor’s 500 stock index. Public Storage felt the pinch too, but its 2% decline on a total return basis made it a standout in the dismal real estate investment trust field. “It definitely outperformed the market,” Benson said.

In addition to buying competitors, Public Storage has been trying to build market share by developing new business.

For about three years, the company has been offering Public Storage Pick-Up and Delivery, a new service in which the company will deliver a container--6 feet wide, 6 feet deep and 8 feet high--to a customer’s home for packing, pick it up later, and store it at one of its warehouses. “This does away with the physical drudgery of hauling it down to a mini-warehouse,” Lenkin said.

Prices for the service vary property-by-property. Lenkin described it as 15% to 35% more expensive than simply renting a storage space. (The typical 7-by-5-foot, 8-foot tall storage space at Public Storage rents for $85 to $90 a month, but that also varies by location.)

“They’re trying to capture the people who are either too old, too lazy or too busy to go to a storage facility,” Sullivan said. “It should work.”

Public Storage executives say pickup and delivery should be especially attractive to consumers in high-income areas with high-density populations, such as West Los Angeles and the Silicon Valley. At present, the service is available in 18 to 20 cities nationwide, including Los Angeles.

Start-up costs have been heavy--more than $57 million in net losses over the past three years, according to Jefferies & Co.’s estimates.

But the losses are shrinking. In the third quarter of 1998, pickup and delivery operating losses were $6.9 million (6 cents per share), compared with $12 million (12 cents per share) in the same period the previous year.

Public Storage’s Lenkin said he expects the service to become profitable by mid-year.

In Northridge, at 9341 Shirley Avenue near the western boundary of the Northridge Plaza, Public Storage is offering the pickup and delivery service alongside its traditional self-storage business. This setup, the first of its kind, is a test to determine whether Public Storage can offer both services at the same location and make money, Lenkin said.

So although Public Storage could rest on its laurels, it’s choosing not to.

“We’re trying to put assets in place that will pay off next year and every year thereafter,” Lenkin said.