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Investors Are Moving Into Storage Units

Returns from real-estate companies Public Storage and Extra Space Storage have stood out this year.

You read it right!  Companies such as Public Storage PSA -1.91% and Extra Space Storage Inc., EXR -0.99% which operate facilities where people pay to stash their stuff, are among a breed of property-owning entities called real-estate investment trusts, or REITs. These companies distribute nearly all of their profits to shareholders, which makes them appealing to investors looking to generate income when many debt or cash instruments pay out little.

The Federal Reserve chopped its benchmark interest rate twice in the third quarter to cushion the U.S. economy from a global slowdown. Meanwhile, yields on short-term debt rose above those of longer-term issues several times during the period, an unusual occurrence that often has presaged recessions.

Both developments bode well for real-estate stocks. “When rates go down, REITs tend to outperform,” said Raymond James analyst Jonathan Hughes.

Different segments of REITs don’t move in lockstep, of course. For example, favorable conditions this year haven’t prevented those that own regional malls from losing 3.15% through Friday. Besides storage facilities and shopping malls, there are REITs that specialize in office towers, timberlands, apartment complexes, cell towers, nursing homes and the warehouses that enable e-commerce.

Amid a shaky marketplace, investors are eyeing the yield curve for signs of economic stability. History shows that when the yield curve inverts, a recession may soon follow. Photo Composite: Stephanie Swart for The Wall Street Journal.

After the financial crisis, REITs emerged to manage tens of thousands of foreclosed suburban houses that were turned into rentals. Most REITs make money collecting rent at property they own. A few lend against property.

They are all required to distribute at least 90% of their taxable income to shareholders. Like utility stocks, investors tend to treat REITs as shelter in slowdowns, when investors move money from the highflying stocks, like technology companies, that they ride during economic expansions. Though many investors treat them as proxies for bonds, REITs are typically riskier than debt securities. REITs, like the broader stock market, lost money as a group last year.

The FTSE Nareit All Equity REITs Index, which tracks the performance of 164 companies, is up 28.2% in 2019 through Thursday, including dividends. That compares with a 19.9% total return for the S&P 500 and an 8.5% return for the Bloomberg Barclays U.S. Aggregate bond index, which tracks a mix of corporate, government and mortgage-backed bonds.

Stored ValueShares of companies that operate self-storage facilities have outperformed the broader market. Self storage hasn’t been the hottest-performing REIT sector this year; that would be data centers and manufactured homes, which through Friday had returned 47.8% and 43.4% respectively, including dividends.

But storage’s total return of 25.6% has trounced the broader market and shares of the segment’s biggest players, Public Storage and Extra Space, have proven particularly good bets on otherwise bad days for stocks.

Extra Space and Public Storage are up 32.3% and 24.3%, this year on a total return basis.

On days this year when the S&P 500 fell by at least 1%, storage stocks averaged returns of 0.3%, according to an analysis by real-estate research firm Green Street Advisors.

That doesn’t sound like much, but they were one of only two segments of REITs not to lose value on down days in the market. The other, manufactured housing, held flat. The worst performers during bad days were REITs that own hotels, offices and malls.

Dave Bragg, managing director at Green Street, said the results of that analysis support a time-tested way to pick REIT stocks: Choose those that can maintain the quality of their properties cheaply, like owners of trailer parks and storage units, over those, such as hotel and office buildings, that have to spend a lot to keep their customers happy.

“A terrific real-estate investing strategy is to prioritize low-capital-expenditure sectors,” Mr. Bragg said. “It’s the most important thing and it tends to get underestimated.”

That isn’t to say that investing in self storage and other cheap-to-maintain real estate is a sure thing. Self-storage stocks have been on a decadelong bull run for which many investors have been anticipating an end. The companies got a boost during the foreclosure crisis, when many Americans downsized and moved in with each other.

Some analysts have warned that the shares, particularly Public Storage, have gotten somewhat pricey given forecasts for slower growth.

“The risk-off trade and low interest rates are giving Public Storage shares an additional valuation boost, which may not last,” analysts with SunTrust Robinson Humphrey wrote in a note to clients in September.

Public Storage, which owns about 2,500 facilities and has a stock-market value of $43 billion, has returned 355% over the past 10 years, including dividends. Extra Space, the next-biggest player, is up 1,439% on a total-return basis. The S&P 500 return including dividends is 245% over that span.

That performance inspired developers to build more storage space, which has threatened to swamp the market and limit rent growth.

Public Storage executives estimate $4 billion worth of new facilities will come online industrywide this year, about equal to last year’s added supply and about four times the billion dollar’s worth of new space that hit the market in a typical year during the decade leading up to 2016.

Mr. Hughes of Raymond James said that the storage space in the development pipeline equates to about 9% of current supply. That is way above the 1% to 2% of existing supply that is typically under development in other commercial real estate segments.

So far, though, the big operators have weathered the flood of competition with sophisticated advertising and pricing strategies that adjust asking rents on an hourly basis.

“If you’re looking for somewhere to put your money,“ Mr. Hughes said, ”storage is hard to beat.”