Real Estate Investment Trusts, or REITs, are one of the most popular types of dividend stocks for yield-hungry investors, especially those living off dividends in retirement.

When it comes to REITs, few have done better for investors than Public Storage (PSA) over the years.

The company has continuously paid quarterly dividends since 1981 while generating excellent total returns for shareholders.

REIT Total Return Since 2005 CAGR Total Return
Public Storage 569.2% 17.16%
Vanguard U.S. REIT ETF 192.5% 9.36%
S&P 500 166.6% 8.51%

Source: Ycharts

While you might think that the company’s strong long-term outperformance means that Public Storage is overvalued and should thus be avoided, a look at the company’s fundamentals reveals a best-in-class industry leader with plenty of growth opportunities left in the coming years.

Best of all, the recent REIT correction has sent shares down 17% since early July, possibly making for a great long-term buying opportunity for what is likely to continue to be one of America’s best dividend growth stocks.

Business Description

Public Storage was founded in 1972 and is America’s largest public storage REIT, owning over 2,500 storage rental properties (as well as business parks) in 38 states, and seven European countries. The company’s self-storage facilities serve over one million customers in total.

The business model provides great short-term visibility, with customers signing month-to-month leases. This gives the REIT excellent protection against inflation due to the ability to continually raise rents.

Business Analysis

Public Storage has become famous for its ability to continually raise rents, especially in key markets such as California where high land costs and restrictive zoning regulations prevent new supply.

Combined with a disciplined growth strategy that’s focused on gradual property growth, as well as aggressive expansion of existing facilities ($542 million into expanding its rentable square footage by 4.2 million square feet in the next two years), Public Storage has put up impressive growth, both in top line sales but also margin expansion.

Public Storage

Source: Simply Safe Dividends

Public Storage

Source: Simply Safe Dividends

Public Storage is a great company for several reasons, starting with the company’s sheer size. The business is larger than its top three competitors combined, which allows it to leverage its costs across the company to achieve better profitability.

Public Storage also focuses on major metropolitan areas with favorable demographics. These areas are characterized by better incomes, greater popular density, and faster growth rates. They also provide consumers with easier access to storage since they are conveniently located.

Public Storage has built up 20%+ market share in many of these cities and benefits from the high visibility its locations receive, further building up the company’s brand value and recognition. While barriers to entry are relatively low in this industry, it is harder for new rivals to enter major metropolitan areas because of higher property costs and increased zoning restrictions.

Self-storage warehouses are also attractive because they require very little costs to operate. Unlike most other types of buildings (e.g. offices and apartments), these facilities do not need carpet or furniture or much equipment that needs to be maintained.

They also require few employees to run them because they are largely self-serve, and much of the work needed can be automated (e.g. security cameras instead of security guards; online reservations). In fact, Public Storage has just 5,300 employees compared to its 2,500+ property locations.

As a result, once a storage facility reaches a high enough occupancy level, they generate excellent profit margins, have risk spread across a large tenant base, and require little maintenance capital expenditures to maintain their appearance. Unlike most REITs (and many other types of businesses, for that matter), Public Storage’s unique qualities have made it a free cash flow machine over the years.

Public Storage

Source: Simply Safe Dividends

As long as people continue experiencing major life events such as an unexpected move or divorce, there will be demand for self-storage warehouses.

In other words, the industry is very stable and predictable with a slow pace of change – all good things for long-term dividend growth investors. Public Storage’s warehouses pay for themselves and the land underneath them, which is quite valuable considering the company’s focus on major metropolitan areas.

Thanks to the industry’s largest economies of scale in terms of property management, maintenance, and advertising costs, Public Storage has some of the highest profitability of any REIT in America.

 

REIT Operating Margin Net Margin Return On Assets Return On Equity Return On Invested Capital
Public Storage 53.4% 45.0% 11.6% 22.4% 21.03%
Industry Average 45.8% 32.0% 4.1% 8.9% NA

Source: Morningstar

Even more impressive is that the company’s management team, led by CEO Ronald Havner, (who’s been in the top spot since the turn of the century), has been able to remained disciplined in the company’s expansion.

That means avoiding reaching for growth by overpaying for new facilities and maintaining the most conservative approach to debt of any REIT. And despite its large size, Public Storage has just about a 6% market share in U.S. storage facilities, which number over 50,000.

The self-storage market is vast in size but also incredibly fragmented. In fact, the top four operators have less than 15% of all facilities. In other words, there remains a very long growth runway for Public Storage to continue expanding and consolidating the market.

Key Risks

While there are plenty of things about Public Storage for dividend investors to like, nonetheless there are three main risks to consider.

First, it’s unlikely that management will be able to continue to maintain the sky-high occupancy rates of recent quarters (95%), especially with several years of aggressive rental increases under its belt.

Going forward, management expects occupancy rates to stabilize at 93% to 94%, and future rental increases are likely to be slower given the rising supply of new storage facilities (1,500 in 2016 and 2017), especially in key markets such as Florida and New York.

The self-storage market goes through ups and downs just like any other market. For example, read this excerpt from a 1990 article in The Los Angeles Times:

“Public Storage has struggled to attract investors to recent projects, owing to the sagging real estate investment market, lower yields on Public Storage’s deals and investor nervousness about Public Storage’s issuance three years ago of $135 million of junk bonds. The surge in competition has also made it harder for Public Storage to find new sites and to raise rental prices.”

As industrial real estate prices have increased over the last few years, Public Storage’s disciplined management team has done the right thing by refusing to chase overpriced growth opportunities.

However, that has resulted in fewer growth opportunities in recent years. Only continued strong pricing power has resulted in the kind of 11% AFFO per share growth that Public Storage reported thus far in 2016.

Essentially, investors need to be prepared for top line growth to slow to the high-single digits unless a decline in storage REIT prices allows management to acquire one of its major rivals such as Extra Space Storage (EXR), CubeSmart (CUBE), or Life Storage (LSI).

Finally, we can’t forget the elephant in the room, interest rates, which have risen by about 0.7% since November 8th, and might rise by as much as 3% over the next four years (according to the Federal Reserve’s projections).

Fortunately, Public Storage has very little debt

1, 23  - View Full Page