What’s in a Name?

Nearly six years after self storage industry veteran Dean Jernigan took the helm of the former U-Store-It Trust and set out to turn around the publicly traded REIT, the firm is quickly moving out from behind the shadow of its peers.

Last year, the company rolled out an $8 million rebranding campaign that changed its name to CubeSmart (NYSE: CUBE). The company also announced a blockbuster acquisition that upon closing will give it the largest number of self storage properties in the coveted New York City market.

The rebranding is aimed not only at alleviating confusion among consumers—which, according to Jernigan, was costing the company some $2 million a year in revenue lost to competitors with similar names—but also at boosting the appeal of its storage facilities among business customers. To woo more business customers, CubeSmart has begun offering an array of complementary services, ranging from a free mobile inventory-tracking application to local package delivery. Commercial tenants, who tend to rent larger spaces and stay on longer than their residential counterparts, account for about 20 percent of the company’s customers but rent about 30 percent of its leased space, Jernigan explains.

"The name U-Store-It no longer described the business we are in. We are no longer a passive storage company."

—Dean Jernigan

Among the self storage sector’s four publicly traded REITs, CubeSmart is the third-largest as measured by square footage, with a portfolio of 353 owned facilities in 27 states as of the third quarter of 2011, according to the company. It also manages 103 properties for third parties. The company had a total market capitalization of $1.5 billion at the end of the third quarter.

Urban Revival

In October 2011, CubeSmart announced a $560 million acquisition that will increase the value of its portfolio by about 30 percent, according to Green Street Advisors. The deal is a major step forward in a continuing effort by CubeSmart to reposition its portfolio, which has long had lower occupancy rates than those of its peers, by expanding its presence in certain urban markets. Large cities tend to be somewhat insulated from new competition, owing to the high costs and difficulties associated with development.

"The portfolio is in better shape than it has been in the past, and the deal they announced [in October] is doubling down on that transformation by buying in the New York City metro area."

- Michael Knott, analyst with Green Street.

CubeSmart raised $277 million through a combination of common and preferred equity offerings to partially fund the acquisition of 22 facilities from privately held Storage Deluxe. It assumed $88 million in secured debt and used a new $200 million unsecured loan for the balance. A final closing is expected in the first quarter of this year.

“While we acknowledge the high price tag of $350 per foot,” wrote Raymond James analyst R.J. Milligan in a note on the Storage Deluxe portfolio acquisition, “we believe the net asset value dilution from the offering and increased leverage will be offset by greater rental growth prospects, higher margins and an improved quality perception that should help close the valuation gap between (CubeSmart) and its peers.” The other listed self-storage REITs are Public Storage (NYSE: PSA), Extra Space Storage Inc. (NYSE: EXR) and Sovran Self Storage, Inc. (NYSE: SSS).

Reclamation Job

CubeSmart has come a long way since Jernigan took the reins, setting out to right an underperforming company that was staggering under the weight of rapid growth since its IPO in 2004. Jernigan was a seasoned, well-regarded figure in the sector when he joined U-Store-It at age 60, having made a name for himself at the helm of Storage USA Inc.

Jernigan developed his first self storage facility in 1985 in Memphis, Tenn., took Storage USA public in 1994 and oversaw its subsequent rapid growth. By the time he sold it in 2002 to a unit of General Electric Co., Storage USA owned 570 facilities nationwide and had a total capitalization of $2.4 billion.

At the time, it was the second-largest publicly traded REIT in the sector, behind Public Storage, which remains the industry leader. GE eventually sold Storage USA to a joint venture between Prudential Financial Inc. and Extra Space Storage.

Jernigan concedes that he initially underestimated the challenges involved in turning around U-Store-It, and his early tenure was marked by some disappointing results. “I found it much easier to start a company from scratch and grow it than to take an existing company and turn it around,” Jernigan says.

His first steps included assembling a new management team comprised of executives with significant experience running publicly traded real estate companies. He also oversaw the implementation of new systems, including a more sophisticated information technology system, and the relocation of the company’s headquarters from Cleveland to the Philadelphia area, where most of its new senior executives lived.

Among others, Jernigan tapped his former chief financial officer at Storage USA, Christopher P. Marr, now the company’s president and chief investment officer and, according to analysts, his heir-apparent. Marr, who had gone from Storage USA to Brandywine Realty Trust (NYSE: BDN), recruited former Brandywine colleague Timothy M. Martin to serve as senior vice president and chief accounting officer. Martin is now the company’s chief financial officer.

In early 2008, the new team completed an evaluation of the company’s portfolio and began to sell assets in the bottom quartile. They developed a system to rank assets according to factors including market demographics and supply and demand. Proceeds from asset sales were used to begin to reduce the company’s leverage, which at the end of 2008 stood at 51 percent, as measured by debt to gross asset value, company officials say.

CubeSmart’s debt maturity risk weighed heavily on its share price during the financial crisis, but the company pulled through by raising equity and institutional capital through a joint venture in 2009. It used the proceeds, as well as capital generated by asset sales, to continue to reduce leverage in 2010.

At the end of last year’s third quarter, CubeSmart’s leverage was 37 percent as measured by debt to gross asset value. Leverage is expected to increase to 42 percent, by the same measure, as a result of the Storage Deluxe portfolio acquisition, according to the company.

“They had to do a costly equity raise in 2009, but that was the cornerstone for improving the balance sheet,” says Knott of Green Street.

Demand in the Downturn

CubeSmart was also fortunate to specialize in a sector that held up relatively well during the last recession, although many suburban markets were hit hard because of the large amount of development they experienced prior to the downturn.

The sector “suffered because the recession came after a building boom, but a lot of the development was in suburban markets, where expected growth didn’t materialize,” explains R. Christian Sonne, manager of the self storage industry group at Cushman & Wakefield.

In some hard-hit areas of the country, demand actually increased. Commercial customers sought out lower-cost alternatives to warehouse space or shuttered offices. Demand among residential customers also grew in places like Detroit, where foreclosures largely affected primary residences, explains Milligan.

Thanks to the recession-resistant nature of the sector, each of the four publicly traded REITs saw revenues decline by only about 3 percent in 2009, according to Jernigan. “The sector performs exceedingly well in down times and even better when the economy is doing well,” he says.

As the economy turned a corner in 2010, CubeSmart began to use capital from asset sales to buy facilities in the major metropolitan areas that it considers core markets, including New York City, the District of Columbia, Dallas-Fort Worth, Miami and Chicago.

Since early 2008, the company has raised about $250 million through asset sales and spent nearly $850 million on acquisitions, including the 1.6 million-square-foot Storage Deluxe portfolio. After that deal closes, about 60 percent of its revenues will come from core markets, up from about 40 percent in early 2008, according to the company.

Slowly rising demand, a dearth of development in the sector and an improved portfolio have enhanced CubeSmart’s performance. Same-store physical occupancy was just over 80 percent at the end of the third quarter of last year, up from about 78 percent in the prior-year period.

Funds from operations were up more than 38 percent per share for the third quarter, and same-store total revenue grew 4 percent. Same-store net operating income increased nearly 8 percent, according to the company.

Until recently “it was tough to gauge the success of the new management team because they took over going into the downturn,” says Milligan of Raymond James. “Now they are starting to fire on all cylinders, and we are seeing what they can do.”

Jernigan believes the company can grow same-store occupancy to 90 percent over the next several years, although he says top-line growth is his main concern. “When the recession hit, we held our rates as much as possible and lost more occupancy than some of our competitors who cut their rates,” he says. “Occupancy is not that important to us. It is all about revenue.”

A “Super” Strategy

To bolster demand, the company has been rolling out a new superstore concept in conjunction with its rebranding, which is expected to be complete by mid-year with the installation of new signage at all facilities. The superstores offer climate-controlled storage space, workstations and free Wi-Fi as well as optional services including individual alarms and remote-controlled access.

CubeSmart is converting many of its existing facilities and newly acquired properties into superstores by reconfiguring some space and installing new technology, including 46-inch touch-screen monitors that property managers use to demonstrate services to visitors. The company expects to have 100 superstores by next summer.

Jernigan says CubeSmart is responding to the results of a 2009 survey of its business customers that revealed they want access to services that help them run their businesses more effectively. In some cases, CubeSmart simply provides referrals to vendors. In others, it generates ancillary income by collecting a portion of fees paid to service providers.

However, CubeSmart isn’t the first self storage company to venture down this path. Eight years ago, Public Storage abandoned a similar effort, exiting or outsourcing ancillary business lines including containerized storage and truck rentals, according to Knott.

CubeSmart’s “strategy is somewhat different, yet Public Storage’s experience supports the case that keeping it simple may be the optimal way to run a large-scale, self storage business,” Knott wrote in a report on the company.

Some observers say the company’s biggest challenge is on the acquisitions front, where, even in a highly fragmented industry, good deals can be hard to find.

“Self storage has increasingly been an accepted and popular asset class,” Knott says. “Capitalization rates compressed as the sector’s many positive elements have been better understood.”

CubeSmart officials say the company’s growing third-party management business has already provided access to attractive acquisition opportunities. They also say the large amount of debt coming due in the sector over the next couple years—coupled with a tighter commercial mortgage-backed securities market—is likely to force many cash-strapped owners to put properties up for sale, resulting in a greater number of acquisition opportunities for publicly traded REITs.

The amount of debt coming due in the sector “creates an enormous opportunity for well-capitalized companies, like CubeSmart, that have access to multiple sources of capital to be consolidators,” says Martin, the company’s CFO.