Feb. 24, 2021, 5:20 p.m. EST

10-K: PUBLIC STORAGE

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(EDGAR Online via COMTEX) -- ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with our financial statements and notes thereto.

Critical Accounting Policies

Our MD&A discusses our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"), and are affected by our judgments, assumptions and estimates. The notes to our December 31, 2020 financial statements, primarily Note 2, summarize our significant accounting policies.

We believe the following are our critical accounting policies, because they have a material impact on the portrayal of our financial condition and results, and they require us to make judgments and estimates about matters that are inherently uncertain.

Income Tax Expense: We have elected to be treated as a REIT, as defined in the Code. For each taxable year in which we qualify for taxation as a REIT, we will not be subject to U.S. federal corporate income tax on our "REIT taxable income" (generally, taxable income subject to specified adjustments, including a deduction for dividends paid and excluding our net capital gain) that is distributed to our shareholders. We believe we have met these REIT requirements for all periods presented herein. Accordingly, we have recorded no U.S. federal corporate income tax expense related to our REIT taxable income.

Our evaluation that we have met the REIT requirements could be incorrect, because compliance with the tax rules requires factual determinations, and circumstances we have not identified could result in noncompliance with the tax requirements in current or prior years. For any taxable year that we fail to qualify as a REIT and for which applicable statutory relief provisions did not apply, we would be taxed at the regular corporate rates on all of our taxable income for at least that year and the ensuing four years, we could be subject to penalties and interest, and our net income would be materially different from the amounts estimated in our financial statements.

In addition, certain of our consolidated corporate subsidiaries have elected to be treated as TRSs for U.S. federal corporate income tax purposes, which are taxable as regular corporations and subject to certain limitations on intercompany transactions. If tax authorities determine that amounts paid by our TRSs to us are not reasonable compared to similar arrangements among unrelated parties, we could be subject to a 100% penalty tax on the excess payments. Such a penalty tax could have a material adverse impact on our net income.

Impairment of Long-Lived Assets: The analysis of impairment of our long-lived assets involves identification of indicators of impairment, projections of future operating cash flows, and estimates of fair values, all of which require significant judgment and subjectivity. Others could come to materially different conclusions. In addition, we may not have identified all current facts and circumstances that may affect impairment. Any unidentified impairment loss, or change in conclusions, could have a material adverse impact on our net income.

Accrual for Uncertain and Contingent Liabilities: We accrue for certain contingent and other liabilities that have significant uncertain elements, such as property taxes, workers compensation claims, tenant reinsurance claims, as well as other legal claims and disputes involving customers, employees, governmental agencies and other third parties. We estimate such liabilities based upon many factors such as assumptions of past and future trends and our evaluation of likely outcomes. However, the estimates of known liabilities could be incorrect or we may not be aware of all such liabilities, in which case our accrued liabilities and net income could be misstated.

Allocating Purchase Price for Acquired Real Estate Facilities: We estimate the fair values of land and buildings for purposes of allocating the aggregate purchase price of acquired properties. The related estimation processes involve significant judgment. We estimate the fair value of acquired buildings by determining the current cost to build new purpose-built self-storage facilities in the same location, and adjusting those costs for the actual age, quality, condition, amenities, and configuration of the buildings acquired. We estimate the fair value of acquired land by considering the most directly comparable recently transacted land sales ("Land Comps") and adjusting the transacted values for differentials to the acquired land such as location quality, parcel size, and date of sale, in order to derive the estimated value of the underlying acquired land. These adjustments to the Land Comps require significant judgment, particularly when there is a low volume of Land Comps or the available Land Comps lack similarity to the acquired property in proximity, date of sale, or location quality. Others could come to materially different conclusions as to the estimated fair values, which would result in different depreciation and amortization expense, gains and losses on sale of real estate assets, as well as the level of land and buildings on our balance sheet.

Overview

During a significant portion of 2020, the COVID Pandemic has resulted in cessation, severe curtailment, or impairment of business activities in most sectors of the economy in virtually all markets we operate in, due to governmental "stay at home" orders, risk mitigation procedures, closure of businesses not considered to be "essential," as well as other direct and indirect impacts, including a rapid and dramatic increase in unemployment in the U.S. While in certain markets, initial government restrictions were eased in response to reductions in the rate of new infections, there have been increases in the rate of infection in certain markets from time to time and re-imposition of certain restrictions. These restrictions as well as public concerns about the COVID Pandemic continue to have an ongoing negative impact the economy, with unemployment continuing to be at high levels.

Our self-storage facilities have been classified as "essential" businesses under all applicable business closure orders and thus remained open to all customer activity. We consider the safety of our employees and customers as our first priority, and have accordingly taken significant steps to ensure safety while keeping our services available to the public. These steps include initiating our touchless eRental(R) leasing platform, touchless mobile app allowing customer access to our properties, enforcing social distancing requirements in our property offices and grounds, and providing protective equipment, including face coverings, gloves, and plastic barriers.

Our corporate offices as well as our call centers migrated to a "work from home" environment during the COVID Pandemic. We expect our corporate employees to return to the corporate office assuming the risk of the COVID Pandemic continues to recede. However, we expect that our call centers will remain in a "work from home"

environment due to certain favorable aspects of a distributed call center team. We believe these changes have not resulted in any significant negative impacts to our operations or decision making.

It is possible that stricter government restrictions, including stay at home orders, could be instituted or reinstituted in response to increases in infections, the aggregate effect of the COVID Pandemic and seasonal influenza infections, or if additional pandemics occur. We cannot estimate the extent of the COVID Pandemic's future negative impacts.

The negative impacts of the COVID Pandemic are described more fully below, as well as throughout our MD&A which follows.

Our self-storage operations generate most of our net income. Our earnings growth is most impacted by the level of organic growth in our Same Store Facilities' revenues. Accordingly, a significant portion of management's time is devoted to maximizing cash flows from our existing self-storage facilities.

During the years ended December 31, 2020 and 2019, revenues generated by our Same Store Facilities decreased by 1.0% and increased by 1.5%, respectively, as compared to the previous year. Revenue growth in each year was impacted by increased competition from newly developed facilities. The decrease in revenue in the year ended December 31, 2020 included the negative impact caused by the COVID Pandemic including restrictions on rate increases to tenants imposed by local government due to "States of Emergency." Our trends in revenue have improved in the last half of 2020, with revenues from our Same Store Facilities increasing 0.8% during the three months ended December 31, 2020 as compared to the three months ended December 31, 2019. At December 31, 2020, as compared to December 31, 2019, occupancies for our Same Store Facilities was 2.7% higher, while the contract rent per occupied foot was essentially flat, suggesting continued revenue growth into early 2021.

See "Self-storage Operations - Same Store Operations" for further information with respect to our same-store operations, including potential downside risks to our expectations.

In addition to managing our existing facilities for organic growth, we have grown and plan to continue to grow through the acquisition and development of new facilities and expanding our existing self-storage facilities. In the three years ended December 31, 2020, we acquired a total of 131 facilities with 9.9 million net rentable square feet from third parties for approximately $1.4 billion, and we opened newly developed and expanded self-storage space for a total cost of $866.1 million, adding approximately 7.9 million net rentable square feet.

In order to enhance the competitive position of certain of our facilities relative to local competitors (including newly developed "fifth generation" facilities), we have embarked on a multi-year program to rebrand our properties, in order to develop more pronounced, attractive, and clearly identifiable color schemes and signage, as well as to upgrade the configuration and layout of the offices and other customer zones to improve the customer experience. The timing and scope of the program will evolve as the work is executed and we evaluate its impact. The cost of this program is included in "capital expenditures to maintain our real estate facilities" on our statements of cash flow, and the program is discussed more fully in "Liquidity and Capital Resources - Capital Expenditure Requirements" below.

See "Liquidity and Capital Resources" for further information regarding our capital requirements and anticipated sources of capital to fund such requirements.

Results of Operations

Operating results for 2020 and 2019

In 2020, net income allocable to our common shareholders was $1,098.3 million or $6.29 per diluted common share, compared to $1,272.8 million or $7.29 per diluted common share in 2019 representing a decrease of $174.4 million or $1.00 per diluted common share. The decrease is due primarily to (i) a $105.8 million decrease due to the impact of foreign currency exchange gains and losses associated with our Euro denominated debt, (ii) a $40.3 million increase in depreciation and amortization expense, (iii) a $21.1 million increase in general and administrative expense, (iv) a $15.6 million decrease due to the impact of allocations to preferred shareholders with respect to redemption of preferred shares, and (v) a $8.0 million decrease in self-storage net operating income.

The $8.0 million decrease in self-storage net operating income is a result of a $41.7 million decrease in our Same Store Facilities (as defined below), offset partially by a $33.7 million increase in our non-Same Store Facilities (as defined below). Revenues for the Same Store Facilities decreased 1.0% or $23.7 million in 2020 as compared to 2019, due primarily to reduced late charges and administrative fees. Cost of operations for the Same Store Facilities increased by 2.7% or $18.1 million in 2020 as compared to 2019, due primarily to a 22.5% ($11.0 million) increase in marketing expenses, a 3.1% ($7.4 million) increase in property tax expense, and a 2.5% ($3.1 million) increase in on-site property manager payroll expense. The increase in net operating income of $33.7 million for the non-Same Store Facilities is due primarily to the impact of facilities acquired in 2020 and 2019 and the fill-up of recently developed and expanded facilities.

Operating results for 2019 and 2018

In 2019, net income allocable to our common shareholders was $1,272.8 million or $7.29 per diluted common share, compared to $1,488.9 million or $8.54 per diluted common share in 2018 representing a decrease of $216.1 million or $1.25 per diluted common share. The decrease is due primarily to (i) $183.1 million in aggregate gains due to Shurgard's initial public offering and the sale of our facility in West London to Shurgard in October 2018, (ii) our $37.7 million equity share of gains recorded by PS Business Parks during 2018, (iii) a $10.3 million decrease due to the impact of foreign currency exchange gains associated with our euro denominated debt and (iv) a $32.7 million allocation to our preferred shareholders associated with our preferred share redemption activities in 2019. These impacts were offset partially by a $34.3 million increase in self-storage net operating income (described below) and a reduction in general and administrative expense attributable to $30.7 million in incremental share-based compensation expense in 2018 for the planned retirement of our former CEO and CFO.

The $34.3 million increase in self-storage net operating income is a result of a $9.9 million increase in our Same Store Facilities and $24.4 million increase in our non-Same Store Facilities. Revenues for the Same Store Facilities increased 1.5% or $36.7 million in 2019 as compared to 2018, due primarily to higher realized annual rent per occupied square foot. Cost of operations for the Same Store Facilities increased by 4.2% or $26.9 million in 2019 as compared to 2018, due primarily to a 47.1% ($15.7 million) increase in marketing expenses and increased property taxes. The increase in net operating income of $24.4 million for the non-Same Store Facilities is due primarily to the impact of facilities acquired in 2019 and 2018 and the fill-up of recently developed and expanded facilities.

Funds from Operations and Core Funds from Operations

Funds from Operations ("FFO") and FFO per share are non-GAAP measures defined by the National Association of Real Estate Investment Trusts and are considered helpful measures of REIT performance by REITs and many REIT analysts. FFO represents net income before depreciation and amortization, which is excluded because it is based upon historical costs and assumes that building values diminish ratably over time, while we believe that real estate values fluctuate due to market conditions. FFO also excludes gains or losses on sale of real estate assets and real estate impairment charges, which are also based upon historical costs and are impacted by historical depreciation. FFO and FFO per share are not a substitute for net income or earnings per share. FFO is not a substitute for net cash flow in evaluating our liquidity or ability to pay dividends, because it excludes investing and financing

activities presented on our statements of cash flows. In addition, other REITs may compute these measures differently, so comparisons among REITs may not be helpful.

For the year ended December 31, 2020, FFO was $9.75 per diluted common share, as compared to $10.58 and $10.45 per diluted common share for the years ended December 31, 2019 and 2018, respectively, representing a decrease in 2020 of 7.8%, or $0.83 per diluted common share, as compared to 2019. The following tables reconcile diluted earnings per share to FFO per share and set forth the computation of FFO per share:







                                                                     Year Ended December 31,
                                                                2020             2019          2018
                                                          (Amounts in thousands, except per share data)
        Reconciliation of Diluted Earnings per Share to
        FFO per Share:
        Diluted Earnings per Share                        $            6.29   $      7.29   $      8.54
        Eliminate amounts per share excluded from FFO:
        Depreciation and amortization                                  3.53          3.32          3.21
        Gains on sale of real estate investments and
        Shurgard IPO, including our equity share
        from investments                                             (0.07)        (0.03)        (1.30)
        FFO per share                                     $            9.75   $     10.58   $     10.45
        Computation of FFO per Share:
        Net income allocable to common shareholders       $       1,098,335   $ 1,272,767   $ 1,488,900
        Eliminate items excluded from FFO:
        Depreciation and amortization                               549,975       511,413       483,646
        Depreciation from unconsolidated
        real estate investments                                      70,681        71,725        79,868
        Depreciation allocated to noncontrolling
        interests and restricted share unitholders                  (3,850)       (4,208)       (3,646)
        Gains on sale of real estate investments and
        Shurgard IPO, including our equity share
        from investments and other                                 (12,791)       (5,896)     (227,332)
        FFO allocable to common shares                    $       1,702,350   $ 1,845,801   $ 1,821,436
        Diluted weighted average common shares                      174,642       174,530       174,297
        FFO per share                                     $            9.75   $     10.58   $     10.45
        


We also present "Core FFO per share," a non-GAAP measure that represents FFO per share excluding the impact of (i) foreign currency exchange gains and losses,

The following table reconciles FFO per share to Core FFO per share:







                                                                    Year Ended December 31,            Year Ended December 31,
                                                                                      Percentage                         Percentage
                                                                  2020       2019       Change       2019       2018       Change
        FFO per share                                           $   9.75   $  10.58       (7.8)%   $  10.58   $  10.45         1.2%
        Eliminate the per share impact of items
        excluded from Core FFO, including
        our equity share from investments:
        Foreign currency exchange loss (gain)                       0.56     (0.04)                  (0.04)     (0.10)
        Application of EITF D-42                                    0.28       0.21                    0.21          -
        Shurgard - IPO costs and casualty loss                         -          -                       -       0.03
        (Forfeiture)/Acceleration of share-
        based compensation expense due
        to the departure of senior executives                          -     (0.01)                  (0.01)       0.18
        Other items                                                 0.02       0.01                    0.01          -
        Core FFO per share                                      $  10.61   $  10.75       (1.3)%   $  10.75   $  10.56         1.8%
        


Analysis of Net Income by Reportable Segment

The following discussion and analysis is presented and organized in accordance with Note 11 to our December 31, 2020 financial statements, "Segment Information." Accordingly, refer to the table presented in Note 11 in order to reconcile such amounts to our total net income and for further information on our reportable segments.

Self-Storage Operations

Our self-storage operations are analyzed in four groups: (i) the 2,221 facilities that we have owned and operated on a stabilized basis since January 1, 2018 (the "Same Store Facilities"), (ii) 131 facilities we acquired after December 31, 2017 (the "Acquired facilities"), (iii) 148 facilities that have been newly developed or expanded, or that had commenced expansion by December 31, 2020 (the "Newly developed and expanded facilities") and (iv) 48 other facilities, which are otherwise not stabilized with respect to occupancies or rental rates since January 1, 2018 (the "Other non-same store facilities"). See Note 11 to our December 31, 2020 financial statements "Segment Information," for a reconciliation of the amounts in the tables below to our total net income.







        --------------------------------------------------------------------------------
        Self-Storage Operations
        Summary                             Year Ended December 31,                    Year Ended December 31,
                                                                  Percentage                                 Percentage
                                        2020           2019         Change         2019           2018         Change
                                                     (Dollar amounts and square footage in thousands)
        Revenues:
        Same Store facilities       $ 2,436,546    $ 2,460,229        (1.0)%   $ 2,460,229    $ 2,423,485          1.5%
        Acquired facilities              59,818         28,733        108.2%        28,733          5,167        456.1%
        Newly developed and
        expanded facilities             180,764        151,043         19.7%       151,043        122,602         23.2%
        Other non-same store
        facilities                       44,502         44,547        (0.1)%        44,547         46,353        (3.9)%
                                      2,721,630      2,684,552          1.4%     2,684,552      2,597,607          3.3%
        Cost of operations (a):
        Same Store facilities           687,828        669,763          2.7%       669,763        642,870          4.2%
        Acquired facilities              27,627         12,456        121.8%        12,456          2,197        467.0%
        Newly developed and
        expanded facilities              75,642         64,312         17.6%        64,312         48,858         31.6%
        Other non-same store
        facilities                       16,446         15,885          3.5%        15,885         15,814          0.4%
                                        807,543        762,416          5.9%       762,416        709,739          7.4%
        Net operating income (b):
        Same Store facilities         1,748,718      1,790,466        (2.3)%     1,790,466      1,780,615          0.6%
        Acquired facilities              32,191         16,277         97.8%        16,277          2,970        448.0%
        Newly developed and
        expanded facilities             105,122         86,731         21.2%        86,731         73,744         17.6%
        Other non-same store
        facilities                       28,056         28,662        (2.1)%        28,662         30,539        (6.1)%
        Total net operating income    1,914,087      1,922,136        (0.4)%     1,922,136      1,887,868          1.8%
        Depreciation and
        amortization expense:
        Same Store facilities          (422,461)      (409,270)         3.2%      (409,270)      (408,972)         0.1%
        Acquired facilities             (40,986)       (24,355)        68.3%       (24,355)        (5,940)       310.0%
        Newly developed and
        expanded facilities             (61,643)       (53,844)        14.5%       (53,844)       (45,454)        18.5%
        Other non-same store
        facilities                      (28,167)       (25,449)        10.7%       (25,449)       (23,280)         9.3%
        Total depreciation and
        amortization expense           (553,257)      (512,918)         7.9%      (512,918)      (483,646)         6.1%
        Net income (loss):
        Same Store facilities         1,326,257      1,381,196        (4.0)%     1,381,196      1,371,643          0.7%
        Acquired facilities              (8,795)        (8,078)         8.9%        (8,078)        (2,970)       172.0%
        Newly developed and
        expanded facilities              43,479         32,887         32.2%        32,887         28,290         16.2%
        Other non-same store
        facilities                         (111)         3,213      (103.5)%         3,213          7,259       (55.7)%
        Total net income            $ 1,360,830    $ 1,409,218        (3.4)%   $ 1,409,218    $ 1,404,222          0.4%
        Number of facilities at
        period end:
        Same Store facilities             2,221          2,221             -         2,221          2,221             -
        Acquired facilities                 131             69         89.9%            69             25        176.0%
        Newly developed and
        expanded facilities                 148            145          2.1%           145            134          8.2%
        Other non-same store
        facilities                           48             48          0.0%            48             49        (2.0)%
                                          2,548          2,483          2.6%         2,483          2,429          2.2%
        Net rentable square footage
        at period end:
        Same Store facilities           143,721        143,721             -       143,721        143,721             -
        Acquired facilities               9,882          4,762        107.5%         4,762          1,629        192.3%
        Newly developed and
        expanded facilities              17,716         16,649          6.4%        16,649         12,840         29.7%
        Other non-same store
        facilities                        3,732          3,776        (1.2)%         3,776          3,857        (2.1)%
                                        175,051        168,908          3.6%       168,908        162,047          4.2%
        


(b)Net operating income or "NOI" is a non-GAAP financial measure that excludes the impact of depreciation and amortization expense, which is based upon historical real estate costs and assumes that building values diminish ratably over time, while we believe that real estate values fluctuate due to market conditions. We utilize NOI in determining current property values, evaluating property performance, and in evaluating property operating trends. Direct net operating income (a subtotal within NOI) is also a non-GAAP financial measure that excludes the impact of supervisory payroll, centralized management costs and stock based compensation in addition to depreciation and amortization . . .

Feb 24, 2021

COMTEX_381672616/2041/2021-02-24T17:20:21

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