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Public Storage's Outlook Suggests Dividend Growth Ahead

The nation's largest self-storage REIT, Public Storage, has kept its dividend frozen since 2017 despite having the balance sheet and cash flow to support increasing payouts.

Given Public Storage's strong financial health, many investors question why dividend growth has remained elusive in recent years – especially when considering REITs are required to distribute at least 90% of taxable income to shareholders.

After all, 2021 was a banner year with same store revenue up 11% as more consumers decluttered their living spaces and became self-storage customers. With cash flow rising at its fastest pace in years, Public Storage's payout ratio dropped to historic lows below 70%.

Based on the REIT's current earnings, Public Storage could increase the dividend by around 20% and maintain a payout ratio consistent with historical norms.

This flexibility around the dividend suggests that as long as Public Storage maintains at least a modest level of earnings growth, the payout will inevitably increase. But waiting for a rising payout has felt akin to the old adage, a watched pot never boils.

So, if investors expect Public Storage to continue growing, just how long will they have to wait for an increased dividend?

Unique amongst REITs, Public Storage ties its payout to taxable income, a discrete number filed with the IRS each year. Unlike net income reported in financial statements, taxable income allows for some expenses such as depreciation to be calculated differently to arrive at a firm's tax liability.

Without seeing Public Storage's reported taxable income, it can be tricky for investors to assess the timing and likelihood of an impending dividend raise.

While we don't know the REIT's exact taxable income reported to the IRS, we know adjustments made to the tax code in 2017 allowed for what's known as "bonus depreciation," which enabled firms to depreciate certain property and capital improvements at a quicker rate than previously allowed.

For Public Storage, this resulted in the REIT accelerating certain capital expenditures which effectively reduced taxable income, despite maintaining strong earnings.

Holding taxable income down while the business grew allowed Public Storage to keep its dividend frozen while complying with REIT distribution requirements.

However, the bonus depreciation rules are scheduled to start rolling off in 2023 when the percentage of bonus deprecation allowed drops from 100% to 80% of an item's cost. Each consecutive year will have another 20% reduction until the bonus depreciation rule expires at the end of 2026.

As this plays out, Public Storage will have less incentive to pull forward certain property expenditures and taxable income should increase, forcing the dividend to grow.

We estimate Public Storage will start growing the dividend in the next 12 to 24 months, with the potential to begin with an increase of around 10%.

That said, tax laws are always subject to change, and bonus depreciation rules could be extended if the government feels the need to spur economic development should we fall into a recession.

We will keep tabs on the situation and provide updates as needed. However, Public Storage investors can sleep well knowing the recession-resistant REIT is well-positioned to restore dividend growth.

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