Smartstop Self Storage REIT, Inc. quarterly report, Q1 FY2015

Business context and reporting period

Strategic Storage Trust II, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2015. It is a self-storage REIT sponsored by SmartStop Self Storage, Inc.; the filing describes properties operating under the SmartStop brand, which the company does not own. The company had 26 facilities in seven states, with approximately 14,340 units, 1.55 million rentable square feet and 85.0% physical occupancy at quarter-end.

The company was in an early acquisition and growth phase. It closed on 21 facilities from a 26-property portfolio during the quarter; five existing facilities had been acquired in November 2014. On May 8, 2015, it subsequently closed on three more portfolio properties and expected to close on the final two during the second quarter.

Financial performance and condition

Operating expenses totaled $5.93 million, including $2.04 million of acquisition expenses payable to affiliates, $0.99 million of intangible amortization, and $0.57 million of depreciation. Revenue and operating results for the 2014 quarter were zero; the filing cautions that the periods are not meaningfully comparable. The company reported no formal full-year guidance.

Material changes versus the prior comparable period

• Revenue rose from none in Q1 2014 to $3.01 million, primarily reflecting the five facilities acquired in November 2014 and 21 acquired in Q1 2015.
• Real estate facilities, net, increased from $20.77 million at year-end to $120.96 million at quarter-end. Total assets rose from $35.05 million to $153.35 million.
• Secured debt increased from $13.49 million to $74.63 million, principally following the January 2015 KeyBank facility and draws used to fund acquisitions. Of the debt, approximately $61.2 million was variable-rate and $12.6 million fixed-rate.
• Funding also included approximately $49.8 million of preferred-unit proceeds and $8.2 million of common-stock proceeds. The Operating Partnership had received approximately $56.5 million from the preferred investor by quarter-end.

Outlook, commentary, risks and unusual items

• Management expected revenue, property operating costs, depreciation, amortization and interest expense to rise as acquired properties contributed for full quarters and further acquisitions closed. The filing provides no quantified earnings or acquisition guidance.
• Management said distributions may be funded from offering proceeds or borrowing when operating cash flow is insufficient, reducing capital available for investment or increasing interest expense. Although the filing’s distribution-source table attributes Q1 distributions to operating cash flow, management noted that operating cash flow was positively affected by increases in amounts due to affiliates and accounts payable.
• Q1 distributions totaled approximately $407,000. The board declared a second-quarter 2015 common distribution of $0.00164383561 per share per day. The company stated that distributions could exceed operating cash flow and could represent a return of capital.
• The $61.2 million KeyBank facility is variable-rate, fully recourse, cross-collateralized and had an approximately 3.4% rate at quarter-end. A 100-basis-point increase in the applicable index was estimated to raise annual interest expense by approximately $0.6 million. Management was required to enter into an interest-rate hedge by June 30, 2015 or the final advance date, whichever came first.
• Preferred units carry current distributions of one-month LIBOR plus 6.5%, as well as additional paid-or-deferred distributions under the agreement. A 100-basis-point LIBOR increase was estimated to raise annual preferred distributions by approximately $0.6 million. The preferred investor has specified repurchase rights upon certain events.
• Acquisition purchase-price allocations were preliminary and included approximately $11.0 million of in-place lease intangibles; final allocations were expected by December 31, 2015. Acquisition fees to the advisor were approximately $1.9 million for Q1 acquisitions.
• Related-party arrangements are significant: the advisor and affiliates provide management and acquisition services, and property management fees generally equal 6% of property revenue plus reimbursable costs. Management identified competition, occupancy and rental-rate performance, financing and REIT qualification as risks. No material legal proceedings or material changes to previously reported risk factors were disclosed.
• Disclosure controls were assessed as effective; management reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether the final two properties in the 26-property portfolio closed as expected, and the resulting acquisition funding, occupancy and operating performance.
• Actual distributions relative to recurring operating cash flow, including the effect of increases in affiliate payables and other working-capital items.
• Variable-rate debt exposure, completion and terms of the required hedge, and compliance with facility covenants and guaranty requirements.
• The full cost and terms of preferred equity, including paid and deferred distributions, and potential repurchase triggers.
• Final acquisition valuations, lease-intangible amortization, and continuing acquisition and other affiliate-related fees.
• Progress toward REIT qualification and whether future distributions are supported by taxable income and sustainable property cash flows.