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A good place to Store your cash

Updated: Jul 1, 2022

Contents


FFO

NAV


Introduction


Self-storage, a relatively simple business, is the process whereby individuals rent containers or units of space to store their property/possessions. The service has sources of demand which are not expected to diminish/go out of fashion – student life; traveling; marriage; starting a family; divorce; and dealing with death and inheritance. Not to mention businesses, who also use them to store stock for distribution.


Companies


The following companies are contenders for investment, where I will choose to invest in one or more:

  • Big Yellow Group Plc (BYG LN) – now operating a platform of 99 stores, including 24 branded as Armadillo Self Storage, in which it holds a 20% interest. Due to the popularity of UK Universities around the world, students make up for a solid and significant line of business.

  • Safestore Holdings Plc (SAFE LN) – the UK’s largest self-storage group with 163 stores, consisting of 125 in the UK, 28 in Paris, 6 in the Netherlands ,(a 20% stake) and 4 in Barcelona. It acquired the French group “Une Pièce en Plus” in 2004 which was founded in 1998 by the current Safestore Group CEO Frederic Vecchioli.

  • Shurgard Self Storage SA (SHUR BR) – a much more geographically diversified company with 237 facilities in the Netherlands, France, Sweden, UK, Belgium, Germany, and Denmark. Public Storage, the largest self-storage operator in the US, is a minority shareholder, with a stake of around 25%.

  • CubeSmart (CUBE US) – One of the top three owners and operators of self-storage properties in the US, with 523 owned self-storage properties located in 24 states and the District of Columbia, as of 31st December 2019. The total number of stores they own and/or manage is 1,1725.

  • Life Storage (LSI US) – As of December 2019, this company had an ownership interest in and/or managed 854 self-storage properties in 29 US states. They began managing properties in Ontario, Canada in 2019, under the Bluebird Self Storage brand.


Sector Analysis


Low tax


All of these companies are REITS, which means they benefit from unique tax advantages, paying very little or none. Big Yellow, for example, converted to a REIT in 2007, and since then only pays tax on profits attributable to residual business (e.g. sale of packing materials, insurance, and management fees). Safestore only pays tax on its business in France. This perhaps makes them immune to any fiscal tightening by governments with respect to corporation tax, unless this standard were to change.


Dividend yield


In order to qualify as a REIT in the US, the company must pay a minimum 90% payout ratio on income in the form of dividends. This means they each offer a naturally higher yield compared to many other sectors, which is ideal for any investor seeking a steady and generous stream of income. A similar set of standards also exist in Europe. For the 5 REITs in question, dividend yields currently range between 3.5-5.5%!


Note that the dividends of the US companies in this group - CubeSmart and Life Storage - are subject to withholding tax (WHT) for non-US investors. This is typically at a rate of around 30%, and we adjust for this in our financial analysis later on.


Recession resistant


They are also relatively – but not perfectly – economically resilient. With respect to interest rates, it is suggested that this sector is very dynamic. Low-interest rates mean less interest expense on mortgages for property & development, whereas high rates mean people are more willing to rent than to buy property, causing greater moving activity and demand for these services.


Risk of overcrowding


The most resounding challenge in this sector currently is overdevelopment and spending on new sites. We already see this in US construction spending displayed in Figure 1 below.


Figure 1: Self Storage construction spending from 2006-2018.

This paves way for a decrease in occupancies, rent, and asset prices, which we can already see from the ‘significant slowdown in Same Facility Revenue Growth to less than 2% year over year in 2018’ (US market). It is also extending the lease-up (the time it takes for a newly built property to reach stabilised occupancy). Market players must be careful not to bring about “stupid growth”.


Despite this concern, there is still a strong belief that this sector will not only weather the crisis but provide strong results thereafter, providing both capital gains and a generous stream of income for the average investor.


Of course, to maximise our chances of benefitting from this, we must choose the companies that perform well relative to their peers and offer solid growth prospects.


Market Outlook


With respect to the market cycle, Europe appears to be embryonic compared to America, which is maturing. This paves way for growth and expansion in Europe, as opposed to mass acquisition/consolidation in the US. Approximately 20.2% of core self-storage properties in the US are owned and/or managed by the 10 largest operators, which indicates a highly fragmented industry, where smaller players with not as much financial capacity are targets to be bought out. Looking at Figure 1 below, we see how much larger the USA market is.

Figure 1: Extract from UK Self Storage Annual Industry Report 2020

The UK is a distant second, holding the largest self-storage market in Europe.

One of the reasons for this is culture. Since the US is heavily a buying nation, there is always a need to put things somewhere. Self-storage is also relatively cheaper over there, accounting for around 1-2% of income. This figure is some 4-5% in the UK.

Current climate & Coronavirus


It goes without saying that the COVID-19 catastrophe has warped both the economy and our daily lives, with unemployment reaching levels not seen since the 1930s, along with the UK now in a technical recession.


However, with each crisis comes opportunity. BofA analysts identified five REIT sectors that are either immune to a recession or stand to benefit from the outbreak. This included self-storage. The sector is seen to be ‘recession-resistant because of stable demand for self-storage’. “As far as the tenant base, we don’t expect the economy to have a great effect on the industry. During the Great Recession, self-storage was one of the least foreclosed real estate sectors” says Brian Somoza, MD of JLL Capital Markets.


Furthermore, the crisis has accelerated the digital age of these services. Life Storage launched their “Rent Now 2.0” scheme – an online platform – ahead of schedule to cater to these difficult times, where customers self-serve and “skip the counter”. Shurgard also has this avenue, where they have seen customer sales using smartphone technology increase from 15% to 60% up to 2019.


Additionally, NeedASpace – a smaller Kent-based REIT – say they can now offer solutions as a result of the recession, catering to small and medium-sized businesses that don’t want to take on long-term expensive contracts with warehouses.

Financials


To conduct a peer-to-peer assessment of these companies, I have chosen an array of financial metrics which I consider indicative of a good investment in this sector, including dividend yield & growth (reduced by the WHT of non-US investors, as mentioned above), revenue growth, and Debt-to-Equity. Other REIT-specific metrics are also incorporated into the model – Price-to-Net-Asset-Value, FFO margin, and an augmented ROE. The latter two are explained in detail in the REIT metrics section of the Appendix at the bottom of this post.


We score every company using the normal distribution by calculating z-scores for each metric, followed by an average of all these scores to give a final coefficient for how financially adept each company is relative to one another.


I choose the company with the highest z-score and, therefore, the most desirable. Looking at Figure 3, we can see below that each constituent has had a different journey so far, with Big Yellow Group gradually rising to the top since the GFC. CubeSmart have also had a healthy run, maintaining its position in the positive part of the distribution for most of the decade.


Figure 3: Z-score ranking of all 5 Self Storage REITs based on a set of financial metrics considered to be critical in this sector

Although Shurgard is a laggard, it currently has the best growth prospects out of all the Europeans, purely due to its geographical diversification. This is seen in their mixed results throughout the bloc (see Figure 4) during the coronavirus crisis, where website visits and move-ins have recovered for the Netherlands, Sweden, and Denmark, but are still down for France, the UK, and Belgium. In addition, they also enjoy experience and support with Public Storage as a shareholder.

Figure 4: Change in average weekly customer visits to the Shurgard storage facilities, by country.

Final decision & Conclusion


Looking at all factors considered above, we can conclude that Self Storage is generally a good long-term sector play, and has a place in one's portfolio. With the sweet combination of strong sources of demand, low taxation, high dividend yields & room for capital growth, I feel this is an overlooked industry that, albeit not the most exciting, is extremely effective at ensuring superior returns.


At the individual stock level, I would consider Big Yellow Group (BYG LN) and Cubesmart (CUBE US) smart choices for this sector allocation, due to their superior financial metrics over the last 10-12 years. What's more, a wide European outreach makes for a strong argument in favour of investing in Shurgard (SHUR BR), who should not be ignored.


Therefore, a good sample allocation might look something like 70-75% in BYG LN and CUBE US, along with around a quarter in Shurgard.


Appendix


REIT metrics


FFO


With respect to valuation & earnings, REITs are generally appraised equally. There are, however, differences when looking at the way European vs Americans report, mainly due to the fact they follow reporting frameworks of different associations – EPRA (European Public Real Estate Association) and NAREIT (National Association of Real Estate Investment Trusts).

The most relevant measurement of bottom-line earnings for American Real Estate companies is FFO (Funds from Operations). This differs from net income mainly through the exclusion of depreciation & amortisation of real estate assets, as well as gains & losses from most property sales. There also tends to be adjustments for unconsolidated joint partnerships & ventures. On the other side of the pond, EPRA Earnings – which are very similar to FFO, with the main twin-component being adjustments for gain/loss on sale of assets – are used widely.

Both have ‘similar adjustments aimed at providing an indication of core recurring earnings’, though they are not identical due to the differences between IFRS and US GAAP accounting. With only myself doing the analysis, the time-associated costs of making these adjustments (not picked up by the S&P Capital IQ database) year-on-year for each company outweigh the benefits. It is the CFO (Cash Flow from Operations) that I shall use as a proxy for ‘raw’ earnings since almost all the same alterations (such as depreciation and loss on the sale of assets) are made to compute this.


The US REITs do provide FFO data and mirroring this against CFO over time, we see no material difference.


NAV


Next, we must determine the NAV (Net Asset Value). This is the present market value of all the company’s property minus any liabilities. It differs from the book value (equity) of the company in a few ways. First, it does not include goodwill, which is appropriate for a company with most of its value coming from tangible assets. Second, EPRA NAV does not deduct depreciation, as this is not considered to be realistic for investment property that is likely to go up in value.


To calculate NAV, a future cash flow model is necessary, with a common method being to divide the operating income of each property by a cap rate. Identifying the cap rate is no easy task, where deep market knowledge and relationships with brokers and private investors is required. Sometimes even cash flow growth prospects are taken into account. Given all of this, I see it appropriate to use another proxy – tangible book value (TBV).


TBV is representative of the ‘hard’ assets a company holds. I have, however, cross-checked this with the EPRA NAVs – a NAV measurement calculated under EPRA guidelines – and there still seems to be a considerable difference: the deferred tax items. Adding/subtracting the deferred tax liabilities/assets is appropriate since most of this comes from the revaluation of properties, which is not expected to crystallise unless the property is sold. By doing so, we arrive very close to the readily provided figures, as well as following the European guidelines.

For Americans, there are no deferred tax items as revaluation is generally prohibited under US GAAP principles. Thus, we see no effect here.


Finally, an adjustment for depreciation was made. Under IFRS, investment property – which is most of the assets of these companies – is valued using the fair-value model, which means no depreciation is provided. US GAAP, on the other hand, does not have a definition for investment property, meaning the assets of Life Storage & Cubesmart are treated as PPE, valued as historical cost less depreciation. To remedy this and enhance comparability, accumulated depreciation has been added back.


Augmented ROE


Because both components of return on equity – net profit & shareholders’ equity – have been replaced by the above metrics. I shall use CFO/NAV as an augmented version of this figure. The nature of this number is very similar in that leverage still has an effect.


Disclaimer


This post is not intended as investment or financial advice, and should be used for recreational purposes only. Any financial actions taken using the content of this post are done so at your own risk, and I am not liable for any gains or losses incurred.


I have previously, but do not currently, hold shares in any of the stocks/companies mentioned in this post.

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