State Of Industry

Self-Storage Business Faces a Test

Wall Street's belief that the self-storage business is recession-resistant is being tested.

These miniwarehouses have sprouted throughout the country like roadside motels, becoming archives of middle-class prosperity and mobility as well as retrenchment in tough economic times. The four publicly traded self-storage stocks recorded a total return, including dividends, of nearly 24% this year through April, outperforming all other real-estate investment trust groups, according to the National Association of Real Estate Investment Trusts, a trade association.

The surge partly reflects sentiment that these companies will benefit from the housing crisis because people being foreclosed out of their homes need a place for their stuff.

"The dislocation of people from their houses through foreclosure is unfortunate," said Dean Jernigan, president and chief executive of U-Store-It Trust, the sector's hottest stock, in a recent conference call with analysts. "But we can never forget that we are a solution ... We are a service to those people who are in transition."

But as self-storage companies head into their peak rental season, evidence is growing that the relationship between foreclosures and demand may be more tenuous than many thought. Also, some analysts are raising concerns that the slowing economy is beginning to hurt self-storage results.

"We expect the weakening economy to take its toll as 2008 plays out and remain cautious on the sector," Citigroup Global Markets noted in a research report.

After an anemic 2007, self-storage REITs improved same-store growth in net operating income to 3.1% in the first quarter, compared with 2.9% in the year-earlier period, according to BMO Capital Markets. But same-store revenue growth slowed to 3.4% from 3.6% a year earlier, suggesting a softening of rents and the use of promotional offers such as a month's free rent for new tenants. Also, same-store occupancy rates, which determine an operator's leverage to raise rents, slipped to 83.5% from 84.3%.

Self-storage is has blossomed since the late 1960s in the U.S. More recently it has taken hold in Europe, and is gaining footholds in Mexico and Asia. Domestically, the four publicly traded REITs represent less than 15% of a highly fragmented market that has up to 50,000 facilities, said Ray Wilson, president of Self Storage Data Services Inc., a Los Angeles research company.

Even within the small REIT universe, the wide discrepancy between self-storage companies can skew the performance picture. Glendale, Calif.,-based Public Storage is the giant, with more than 2,100 storage facilities and a market capitalization of some $15 billion. The next biggest competitor is Extra Space Storage, of Salt Lake City, with a market capitalization of about $1.1 billion. Sovran Self Storage, Buffalo, N.Y., and Cleveland's U-Store-It Trust round out the field.

For the first quarter, Public Storage reported a big profit, thanks largely to the sale of an interest in its lucrative European operations, but missed analysts' expectations for operating performance in the U.S. Its stock fell 6% on Friday, the first trading day after its first-quarter results, and Deutsche Bank downgraded it to a "hold" from a "buy" recommendation.

On the other hand, U-Store-It Trust's quarterly net loss widened to $4 million, from $3.4 million in the first quarter of 2007, but the company raised its financial outlook for the year, and the stock rallied 5.4% on Friday as investors perceived that the two-year-old management is finally turning around operations.

In 4 p.m. New York Stock Exchange trading Tuesday, Public Storage was up $2.52, or 2.9%, at $89.53, and U-Store-It was up 17 cents, or 1.4%, at $12.78.

A few self-storage REIT executives concede there is pressure to reduce rent prices for new customers. Many also are at pains to explain whether the housing crisis was directly affecting their business. The chief executives of both Public Storage and Extra Space Storage told analysts that among their best-performing markets was Detroit, an area hard hit by home foreclosures and economic woes in the automobile industry. At the same time, Florida, which saw a boom in self-storage business after hurricanes in 2005 and 2006 and has since been hit by home and condo foreclosures, was a financial drag on all self-storage REITs.

Mr. Wilson, the Los Angeles analyst, conducted his own survey of five cities hard hit by foreclosures. In three of the markets -- Cleveland, Denver and Detroit -- self-storage facilities experienced a rise in rent collected per occupied square foot between the first quarter of 2008 and the same period a year earlier. In San Diego and Sacramento, rent collections dropped.

"The housing crisis is providing more benefits than detriments to the operating performance" of self-storage facilities, he concluded. But he said that the topic needs further research.

"The industry has satisfied decades of pent-up demand. Now we have to understand what portion of demand comes from convenience and what portion comes from need," Mr. Wilson said.

Paul Adornato, a senior REIT analyst a BMO Capital Markets, is cautious on the demand outlook for self-storage. "Storage is a discretionary spending item," he says. "When push comes to shove, it would be difficult for someone to pay for self-storage if they can't pay for their home."

Write to Jonathan Karp at jonathan.karp@wsj.com