How Technology Helps This Sector Outperform the S&P 500

" ... I would like to challenge someone on this call to write a very thoughtful piece on the Self Storage sector to paint us with the different brush." -- CubeSmart CEO Dean Jernigan Aug. 9, 2013

Challenge accepted.

Mr. Jernigan was trying to point out that self-storage REITs will perform well in a rising interest rate environment that is expected to result from the Federal Reserve tapering of quantitative easing. In fact, it appears a well managed self-storage REIT can perform well in almost any economic environment. Here are some reasons for this sector's success.

You might think technology and self-storage go together as naturally as Tesla and buggy-whips. If so, you'd be wrong. The incredible five year outperformance of Public Storage , Extra Space Storage , CubeSmart , and Sovran Self Storage vs. the S&P 500 index happens to coincide with the rapid growth of customers shifting from the Yellow Pages to the Internet in deciding where to store their stuff.

PSA Total Return Price data by YChart.

The transition in the storage industry is similar to how Zillow, Trulia, and Move's have become many people's first step in searching for housing. But the story gets even better when you take a closer look at demographic trends, lack of new construction in urban markets, and the ability to systematically raise rents on short-term leases.

Here's one way technology is helping the bottom line
During a June 5, 2013 REIT Week presentation, Extra Space Storage CEO Spencer F. Kirk shared how the Internet has become "the great divider." As little as five years ago, "the Yellow Pages and drive-ups" were the primary ways to reach customers. Today, Kirk noted, "over 60% of Extra Space customers use the Internet and mobile devices during the decision process." Kirk also shared that "the larger more sophisticated operators have a tremendous advantage -- on average, we spend more than $34,000 per day on interactive marketing." That is roughly $12.4 million per year being spent for branded websites, call centers, SEO, and pay-per-click advertising.

Public Storage CEO Ronald L. Havner reinforces how critical Internet marketing has become for the big players in self-storage: "Now, the Internet and mobile telephones have replaced the phone book. In 2012, we spent over $15 million with Google." This is a huge advantage compared to private owner-operators, who don't have the resources to compete for the customer.

Please do the math
After packing up your storage space, you lock the door and leave the facility, with your "stuff" securely stored. Congratulations! At Extra Storage, you have just become one of "56 inputs into a predictive, forward looking pricing model." In the normal course of business, Extra Storage aggressively raises rents for existing customers initially after five months, and then every nine months afterwards. This results in 50,000 customers per month paying an average of 9% more per month, out of a total number of about 650,000 customers. The company also does studies -- 10,000 customers at a time -- to make sure raising rates is optimal versus a control group of 10,000 customers.

Big picture, I believe more data and more technology will equal better long-term operations. This is a very sophisticated industry.

Investor takeaway
Unfortunately, these self-storage REITs are not a secret on Wall Street. They trade between almost 20 times funds from operations for Sovran Self Storage, to nearly 23 times FFO for Public Storage. That means that these stocks are highly valued by Mr. Market. However, that's not the entire story. Better access to capital markets allows these public REITs to acquire properties from private owners and manage them profitably thanks to economies of scale.

Check back later this week as I compare and contrast these four public self-storage REITs and make recommendations for my two top picks. In the meantime, I encourage readers to do your own research, and make some room in your portfolio for companies that grow profitably, while paying investors dividend yields that range between 2.5% and nearly 4%.

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Bill Stoller has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors and Zillow. The Motley Fool owns shares of Tesla Motors and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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