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Public Storage: Uninterrupted Dividends Since 1981

Public Storage (PSA) was founded in 1972 by two California business men who invested $50,000 in a single storage unit initially to generate temporary income. PSA, America’s largest self-storage REIT, now owns close to 2,500 storage rental properties in 38 states and seven European countries. 

Approximately 81% of the REIT's properties are in the U.S. and account for the majority of its cash flow. Here is Public Storage's breakdown of revenue and net operating income (NOI):

  • U.S. self-storage (74% of revenue, 76% of NOI): operates close to 2,000 storage warehouses in the U.S. and earns rental income primarily from month-to-month leases.
  • European self-storage (7% of revenue, 6% of NOI): owns 35% of Shurgard Self Storage, which operates storage warehouses in seven European countries
  • Commercial properties (12% of revenue, 12% of NOI): owns a 42% stake in PS Business Parks (PSB), which leases commercial space to small and mid-size businesses.
  • Ancillary products (6% of revenue, 6% of NOI): sells locks, provides self-storage insurance, and generates third-party management fees.

While Public Storage doesn't raise its dividend every year, it has reliably paid uninterrupted dividends since 1981. 

Business Analysis
Since inception in the early 1970s, the storage industry has been the fastest-growing segment of the commercial real estate industry, according to the Self-Storage Association. 

Increased population density and an aging population have helped drive the surge in storage properties, providing a nice tailwind for Public Storage. However, there's much more to the company's story.

Public Storage looks like a durable business for several reasons, starting with its sheer size. The firm is larger than its top three competitors combined and locates many of its facilities in close proximity to each other, which allows it to leverage its costs (property management, maintenance, and advertising) across the company to achieve better profitability.

Public Storage also focuses on major metropolitan areas with favorable demographics. Over 70% of the company's same-store revenues are generated in the 20 metropolitan areas with the highest population levels. The density of these urban areas results in a steady flow of demand for storage space. 

Self-storage warehouses are also attractive because they require relatively low costs to operate. Unlike most other types of buildings such as offices and apartments, these facilities do not need carpet, furniture, or much equipment that needs to be maintained.

They are also largely self-serve, and much of the work needed can be automated (e.g. security cameras instead of security guards; online reservations). In fact, on average, Public Storage has less than three employees per self-storage warehouse location.  

Switching costs, in terms of moving to a new storage facility, are relatively high as well. Few consumers are willing to deal with the hassle to move to a rival facility to save $10 to $15 per month, allowing Public Storage to moderately grow monthly rental fees without impacting its high retention rates.

As a result, once a storage facility reaches a high enough occupancy level, it generates excellent profit margins, has risk spread across a large tenant base, and requires little capital to maintain. 

Thanks to these qualities, Public Storage will break even on a property at just 30% occupancy, according to management. Simply put, Public Storage’s warehouses easily pay for themselves and the valuable land owned underneath them, making them excellent cash cows.

Even during a recession, people need a place to store their stuff. In fact, the self-storage industry’s free cash flow per share fell by less than 5% during the financial crisis, according to a 2013 report by Bank of America Merrill Lynch.

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

Overall, the industry is quite stable and predictable with a slow pace of change – all good things for long-term dividend growth investors. 

Looking ahead, Public Storage will likely continue to gradually consolidate the highly fragmented self-storage market. Despite its size, Public Storage has just 7% market share in U.S. self-storage facilities. With close to 90% of self storage units owned by regional and local operators, there remains a long runway for Public Storage to take more share.

Key Risks
While there are plenty of qualities about Public Storage for dividend investors to like, including its excellent "A" credit rating from Standard & Poor's, nonetheless there are two main risks to consider.

Most notably, the self-storage market still goes through ups and downs just like any other market. 

The years between 2011 and 2016 were somewhat of a golden age for storage REITs, thanks to the new supply of storage facilities growing much slower than demand following the financial crisis. This allowed for strong rental increases while occupancy rates also rose to record highs.

However, barriers to entry are still relatively low in the self-storage industry and the strong economics of this business has attracted unprecedented new supply, causing earnings growth to drastically slow in recent years. 

For investors, this well-known oversupply risk means Public Storage's cash flow and dividend growth rate will likely remain somewhat below their long-term averages for at least the next year or two. Low single-digit growth in same-store NOI is a reasonable expectation and should help keep the industry stable by avoiding excess capacity build outs in the future. 

Nevertheless, the self-storage industry is still expected to continue growing over the long term, thanks in part to America’s aging demographics. Between 2012 and 2060, America’s population of those over age 65 is expected to grow by nearly 50 million, according to U.S. Census Bureau projections. These older Americans are expected to downsize out of large homes to much smaller homes and apartments, which creates demand growth for public storage facilities.

However, it's really hard to know when today's growing supply and demand imbalance will abate. Until then, continued rent growth and occupancy rate deceleration could persist, causing storage stocks to see their valuation multiples re-rate lower. 

Finally, while not a risk to the business, income investors considering the stock should note that Public Storage hasn't increased its dividend since late 2016. While PSA's dividend remains one of the most secure in the sector, this means that anyone desiring annual dividend increases to help offset inflation could be disappointed.

Closing Thoughts on Public Storage
There's a lot to like about Public Storage. Its business generates recession-resistant cash flow, owns premier real estate locations, is managed conservatively, has a solid balance sheet, and should have a long runway for growth given the industry's fragmentation. 

However, industry supply headwinds could continue to weigh on the firm's short-term dividend growth prospects. The good news is that investors are largely aware of this risk and have already re-rated the valuation multiples of self-storage stocks lower in recent years. 

Regardless, an investment in the company could require a good deal of patience as the storage industry's unique fundamentals continue to adjust.

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