Self-Storage REITs Lose Heat
After Years of Strong Performance

After several years of strong performances, the tiny niche of real-estate investment trusts in the self-storage sector is showing some softness. But no one is quite sure why.

Those squat storage facilities scattered around cities lack the pizzazz of gleaming new offices or hotels, but they are considered among the more stable and dependable real-estate sectors. People are always moving in good economic times and bad, including college students who need a place to store their belongings for the summer, and empty nesters and others who need to downsize their living arrangements. "The conventional wisdom is that there is always some level of self-storage demand, irrespective of the economic conditions," says Michael Knott, an analyst at Green Street Advisors, a Newport Beach, Calif., real-estate research firm.

The past few years have been good to the four big public self-storage REITs. With total shareholder returns of 26.7% during 2005, the sector outperformed the REIT industry over all, which had returns of 12.1%, according to BMO Capital Markets.

Last year, the self-storage REITs also outperformed the REIT industry, and some say that was partly because of Public Storage Inc.'s merger with Seattle REIT Shurgard Storage Centers Inc. Public Storage, of Glendale, Calif., packs the biggest punch in the sector, with a market cap of more than $15 billion, compared with less than $4 billion combined for the other three public storage REITs -- Extra Space Storage Inc., U-Store-It Trust and Sovran Self Storage.

But during the first quarter of 2007, "almost every single one of the self-storage REITS had something bad to say," says Wachovia analyst Jeffrey Donnelly. Indeed, same-store growth in net operating income for the four publicly traded storage REITs declined to 3.7% during the first quarter of 2007 from 6.6% in the year-earlier period, according to BMO Capital Markets.

To be sure, REITs in other sectors are down after several years of outperformance, and some of the bloom is off the rose. And it's difficult to say anything definitive about what's happening in the self-storage industry, based on the performance of its publicly traded companies, because they make up such a tiny fraction of an extremely fragmented sector. There are about 18,000 to 20,000 operators in the U.S. that run about 42,000 storage facilities. The top 10 operators, which include all four of the public REITs, have just 11.6% of the market share by the number of facilities, according to the 2007 Self-Storage Almanac.

Still, analysts are searching for reasons for the downturn of the sector's public companies. Some investors seem to be unequivocally blaming the slowing housing market, but that shouldn't necessarily be the assumption, says Paul Adornato, an analyst at BMO Capital Markets. He cities several possible explanations, including that consumers might be stretched financially and not have the discretionary income for self-storage. A slowdown in new-home sales, he argues, isn't necessarily going to upset the self-storage industry.

Even the companies themselves can't exactly pinpoint the cause of the softness. Extra Space Storage, a Salt Lake City-based REIT that is the second-largest self-storage operator in the U.S., reported positive first-quarter results that met expectations. But the company admitted that March and April had weaker rental activity, and it is maintaining a conservative forecast for 2007.

"We don't know what happened" during those months, says Kent Christensen, Extra Space's chief financial officer. He adds that the March and April results could have stemmed from tougher comparisons with the year-earlier period, when there was an inordinate amount of Hurricane Katrina-related demand. But that isn't clear, because demand was also strong at the time in markets such as Phoenix and Chicago, and remains strong. "The next three months will be important, and we are being cautious," he says.

Of course, some of the issues during the quarter were company-specific. Public Storage's first quarter net income fell 48% to $59.8 million, and it said that was the result of charges related to its Shurgard deal last year. U-Store-It, the Cleveland company that is amid a major management turnaround after some operational missteps, reported a first-quarter net loss of $3.4 million, and some analysts remain skeptical that a turnaround will be as successful as advertised.

Sovran, of Buffalo, N.Y., saw its occupancy levels drop, and reported net income below analysts' expectations for the first quarter. The company attributes some of its softness to the housing-market slowdown, particularly in parts of Houston and Florida, where there has been a slowing in construction.

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