Public Storage - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

[X]Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2018

or

[   ]Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ____________ to ____________.

Commission File Number:  001-33519

PUBLIC STORAGE
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (818) 244-8080.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.

[X]  Yes  [   ]  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

[X]  Yes  [   ]  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [   ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

[   ]  Yes  [X]  No

Indicate the number of the registrant’s outstanding common shares of beneficial interest, as of October 29, 2018:

Common Shares of beneficial interest, $.10 par value per share – 174,364,490 shares

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PUBLIC STORAGE



INDEX







 



 

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PUBLIC STORAGE

BALANCE SHEETS

(Amounts in thousands, except share data)



 

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PUBLIC STORAGE

STATEMENTS OF INCOME

(Amounts in thousands, except per share amounts)

(Unaudited)





 

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PUBLIC STORAGE

STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

(Unaudited)





 



 

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 PUBLIC STORAGE

STATEMENT OF EQUITY

(Amounts in thousands, except share and per share amounts)

(Unaudited)





 



 

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PUBLIC STORAGE

STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)



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PUBLIC STORAGE

STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)







 



 

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1.Description of the Business

Public Storage (referred to herein as “the Company,” “we,” “us,” or “our”), a Maryland real estate investment trust (“REIT”), was organized in 1980.  Our principal business activities include the ownership and operation of self-storage facilities which offer storage spaces for lease, generally on a month-to-month basis, for personal and business use, ancillary activities such as merchandise sales and tenant reinsurance to the tenants at our self-storage facilities, as well as the acquisition and development of additional self-storage space. 

At September 30, 2018, we have direct and indirect equity interests in 2,418 self-storage facilities (with approximately 161 million net rentable square feet) located in 38 states in the United States (“U.S.”) operating under the “Public Storage” name.  We also own one self-storage facility in London, England and we have a 49% interest in Shurgard Self Storage SA (“Shurgard Europe”), which owns 227 self-storage facilities (with approximately 12 million net rentable square feet) located in seven Western European countries, all operating under the “Shurgard” name.  We also have direct and indirect equity interests in approximately 29 million net rentable square feet of commercial space located in seven states in the U.S. primarily owned and operated by PS Business Parks, Inc. (“PSB”) under the “PS Business Parks” name.  At September 30, 2018, we have an approximate 42% common equity interest in PSB.

See Note 13 ‘Subsequent Events” for further information on an initial global offering of Shurgard Europe’s shares.

Disclosures of the number and square footage of facilities, as well as the number and coverage of tenant reinsurance policies (Note 12) are unaudited and outside the scope of our independent registered public accounting firm’s review of our financial statements in accordance with the standards of the Public Company Accounting Oversight Board (U.S.).

2.Summary of Significant Accounting Policies

Basis of Presentation

We have prepared the accompanying interim financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) as set forth in the Accounting Standards Codification of the Financial Accounting Standards Board (“FASB”), and in conformity with the rules and regulations of the Securities and Exchange Commission (“SEC”).  In our opinion, the interim financial statements presented herein reflect all adjustments, of a normal recurring nature, that are necessary to fairly present the interim financial statements.  Because they do not include all of the disclosures required by GAAP for complete annual financial statements, these interim financial statements should be read together with the audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Consolidation and Equity Method of Accounting

We consider entities to be Variable Interest Entities (“VIEs”) when they have insufficient equity to finance their activities without additional subordinated financial support provided by other parties, or the equity holders as a group do not have a controlling financial interest.  We consolidate VIEs when we have (i) the power to direct the activities most significantly impacting economic performance, and (ii) either the obligation to absorb losses or the right to receive benefits from the VIE.  We have no involvement with any material VIEs.  We consolidate all other entities when we control them through voting shares or contractual rights.  The entities we consolidate, for the period in which the reference applies, are referred to collectively as the “Subsidiaries,” and we eliminate intercompany transactions and balances. 

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We account for our investments in entities that we do not consolidate but have significant influence over using the equity method of accounting.  These entities, for the periods in which the reference applies, are referred to collectively as the “Unconsolidated Real Estate Entities”, eliminating intra-entity profits and losses and amortizing any differences between the cost of our investment and the underlying equity in net assets against equity in earnings as if the Unconsolidated Real Estate Entity were a consolidated subsidiary.  Equity in earnings of unconsolidated real estate entities represents our pro-rata share of the earnings of the Unconsolidated Real Estate Entities. 

When we begin consolidating an entity, we reflect our preexisting equity interest at book value.  All changes in consolidation status are reflected prospectively.

Collectively, at September 30, 2018, the Company and the Subsidiaries own 2,418 self-storage facilities in the U.S., one self-storage facility in London, England and three commercial facilities in the U.S.  At September 30, 2018, the Unconsolidated Real Estate Entities are comprised of PSB and Shurgard Europe.

Use of Estimates

The financial statements and accompanying notes reflect our estimates and assumptions.  Actual results could differ from those estimates and assumptions.

Income Taxes

We have elected to be treated as a REIT, as defined in the Internal Revenue Code of 1986, as amended (the “Code”).  As a REIT, we do not incur federal income tax if we distribute 100% of our REIT taxable income each year, and if we meet certain organizational and operational rules.  We believe we have met these REIT requirements for all periods presented herein.  Accordingly, we have recorded no federal income tax expense related to our REIT taxable income.

Our merchandise and tenant reinsurance operations are subject to corporate income tax and such taxes are included in ancillary cost of operations.  We also incur income and other taxes in certain states, which are included in general and administrative expense. 

We recognize tax benefits of uncertain income tax positions that are subject to audit only if we believe it is more likely than not that the position would ultimately be sustained assuming the relevant taxing authorities had full knowledge of the relevant facts and circumstances of our positions.  As of September 30, 2018, we had no tax benefits that were not recognized.

Real Estate Facilities

Real estate facilities are recorded at cost.  We capitalize all costs incurred to acquire, develop, construct, renovate and improve facilities, including interest and property taxes incurred during the construction period.  We allocate the net acquisition cost of acquired real estate facilities to the underlying land, buildings, and identified intangible assets based upon their respective individual estimated fair values. 

Costs associated with dispositions of real estate, as well as repairs and maintenance costs, are expensed as incurred.  We depreciate buildings and improvements on a straight-line basis over estimated useful lives ranging generally between 5 to 25 years.

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Other Assets

Other assets primarily consist of rents receivable from our tenants, prepaid expenses and restricted cash.

Accrued and Other Liabilities

Accrued and other liabilities consist primarily of rents prepaid by our tenants, trade payables, property tax accruals, accrued payroll, accrued tenant reinsurance losses, and contingent loss accruals when probable and estimable.  We believe the fair value of our accrued and other liabilities approximates book value, due to the short period until repayment.  We disclose the nature of significant unaccrued losses that are reasonably possible of occurring and, if estimable, a range of exposure.

Cash Equivalents, Marketable Securities and Other Financial Instruments

Cash equivalents represent highly liquid financial instruments such as money market funds with daily liquidity or short-term commercial paper or treasury securities maturing within three months of acquisition.  Cash and equivalents which are restricted from general corporate use are included in other assets.  We believe that the book value of all such financial instruments for all periods presented approximates fair value, due to the short period to maturity.

Fair Value

As used herein, the term “fair value” is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  Our estimates of fair value involve considerable judgment and are not necessarily indicative of the amounts that could be realized in current market exchanges.

We estimate the fair value of our cash and equivalents, marketable securities, other assets, debt, and other liabilities by discounting the related future cash flows at a rate based upon quoted interest rates for securities that have similar characteristics such as credit quality and time to maturity.  Such quoted interest rates are referred to generally as “Level 2” inputs.

Currency and Credit Risk

Financial instruments that are exposed to credit risk consist primarily of cash and equivalents, certain portions of other assets including rents receivable from our tenants and restricted cash.  Cash equivalents we invest in are either money market funds with a rating of at least AAA by Standard & Poor’s, commercial paper that is rated A1 by Standard & Poor’s or deposits with highly rated commercial banks.

At September 30, 2018, due primarily to our investment in Shurgard Europe (Note 4) and our notes payable denominated in Euros (Note 6), our operating results and financial position are affected by fluctuations in currency exchange rates between the Euro, and to a lesser extent, other European currencies, against the U.S. Dollar. 

Goodwill and Other Intangible Assets

Intangible assets are comprised of goodwill, the “Shurgard” trade name, acquired customers in place, and leasehold interests in land.

Goodwill totaled $174.6 million at September 30, 2018 and December 31, 2017.  The “Shurgard” trade name, which is used by Shurgard Europe pursuant to a fee-based licensing agreement, has a book value of

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$18.8 million at September 30, 2018 and December 31, 2017.  Goodwill and the “Shurgard” trade name have indefinite lives and are not amortized.

Acquired customers in place and leasehold interests in land are finite-lived assets and are amortized relative to the benefit of the customers in place or the benefit to land lease expense to each period.  At September 30, 2018, these intangibles had a net book value of $15.9 million ($21.5 million at December 31, 2017).  Accumulated amortization totaled $29.0 million at September 30, 2018 ($31.0 million at December 31, 2017), and amortization expense of $12.7 million and $11.9 million was recorded in the nine months ended September 30, 2018 and 2017, respectively.  The estimated future amortization expense for our finite-lived intangible assets at September 30, 2018 is approximately $3.3 million in the remainder of 2018, $6.3 million in 2019 and $6.3 million thereafter.  During the nine months ended September 30, 2018, intangibles increased $7.1 million in connection with the acquisition of self-storage facilities (Note 3). 

Evaluation of Asset Impairment

We evaluate our real estate and finite-lived intangible assets for impairment each quarter.  If there are indicators of impairment and we determine that the asset is not recoverable from future undiscounted cash flows to be received through the asset’s remaining life (or, if earlier, the expected disposal date), we record an impairment charge to the extent the carrying amount exceeds the asset’s estimated fair value or net proceeds from expected disposal. 

We evaluate our investments in unconsolidated real estate entities for impairment on a quarterly basis.  We record an impairment charge to the extent the carrying amount exceeds estimated fair value, when we believe any such shortfall is other than temporary.  

We evaluate goodwill for impairment annually and whenever relevant events, circumstances and other related factors indicate that fair value of the related reporting unit may be less than the carrying amount.  If we determine that the fair value of the reporting unit exceeds the aggregate carrying amount, no impairment charge is recorded.  Otherwise, we record an impairment charge to the extent the carrying amount of the goodwill exceeds the amount that would be allocated to goodwill if the reporting unit were acquired for estimated fair value.  

We evaluate other indefinite-lived intangible assets, such as the “Shurgard” trade name for impairment at least annually and whenever relevant events, circumstances and other related factors indicate that the fair value is less than the carrying amount.  When we conclude that it is likely that the asset is not impaired, we do not record an impairment charge and no further analysis is performed.  Otherwise, we record an impairment charge to the extent the carrying amount exceeds the asset’s estimated fair value. 

No impairments were recorded in any of our evaluations for any period presented herein.

Casualty Loss

We record casualty losses for a) the book value of assets destroyed and b) incremental repair, clean-up, and other costs associated with the casualty.  Insurance proceeds are recorded as a reduction in casualty loss when all uncertainties of collection are satisfied.  During the three and nine months ended September 30, 2017, we incurred casualty losses totaling $7.8 million, comprised of $3.3 million in book value of assets damaged and $4.5 million in repairs and maintenance incurred in connection with Hurricanes Harvey and Irma. 

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Revenue and Expense Recognition

Revenues from self-storage facilities, which are primarily composed of rental income earned pursuant to month-to-month leases, as well as associated late charges and administrative fees, are recognized as earned.  Promotional discounts reduce rental income over the promotional period, which is generally one month.  Ancillary revenues and interest and other income are recognized when earned.  

We accrue for property tax expense based upon actual amounts billed and, in some circumstances, estimates when bills or assessments have not been received from the taxing authorities.  If these estimates are incorrect, the timing and amount of expense recognition could be incorrect.  Cost of operations (including advertising expenditures), general and administrative expense, and interest expense are expensed as incurred. 

Foreign Currency Exchange Translation

The local currency (primarily the Euro) is the functional currency for our interests in foreign operations.  The related balance sheet amounts are translated into U.S. Dollars at the exchange rates at the respective financial statement date, while amounts on our statements of income are translated at the average exchange rates during the respective period.  When financial instruments denominated in a currency other than the U.S. Dollar are expected to be settled in cash in the foreseeable future, the impact of changes in the U.S. Dollar equivalent are reflected in current earnings.  The Euro was translated at exchange rates of approximately 1.160 U.S. Dollars per Euro at September 30, 2018 (1.198 at December 31, 2017), and average exchange rates of 1.162 and 1.175 for the three months ended September 30, 2018 and 2017, respectively, and average exchange rates of 1.194 and 1.113 for the nine months ended September 30, 2018 and 2017, respectively.  Cumulative translation adjustments, to the extent not included in cumulative net income, are included in equity as a component of accumulated other comprehensive income (loss).

Comprehensive Income

Total comprehensive income represents net income, adjusted for changes in other comprehensive income (loss) for the applicable period.  The aggregate foreign currency exchange gains and losses reflected on our statements of comprehensive income are comprised primarily of foreign currency exchange gains and losses on our investment in Shurgard Europe and our unsecured notes denominated in Euros.

Recent Accounting Pronouncements and Guidance

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which requires revenue to be based upon the consideration expected from customers for promised goods or services.  In February 2017, the FASB issued ASU 2017-05, Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets, which provides guidance with respect to the sale of real estate facilities.  The new standards permit either the retrospective or cumulative effects transition method.  We adopted the new standards effective January 1, 2018 utilizing the modified retrospective transition method applied to open contracts.  The new standards did not have a material impact on our results of operations or financial condition, primarily because most of our revenue is from rental revenue from self-storage facilities, and included in self-storage facilities revenue on our statements of income, which the new standards do not address, and because we do not provide any material products and services to our customers or sell material amounts of our real estate facilities.  The remainder of our revenues are composed of elements that are either covered by the new standards but not impacted, or are not covered by the new standards.

In February 2016, the FASB issued ASU 2016-02, Leases, which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting.  The new standard, effective on January 1, 2019, requires a

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modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief effective January 1, 2019 with a cumulative effect through December 31, 2018 recorded through retained earnings.  The Company is currently assessing the impact of the guidance on our financial statements.  However, we do not believe this standard will have a material impact on our results of operations or financial condition, because substantially all of our lease revenues are derived from month-to-month self-storage leases, and we do not have material amounts of lease expense.    

In May 2017, the FASB issued ASU 2017-09, Stock Compensation: Scope of Modification Accounting, to increase clarity and consistency of practice and reduce cost and complexity when modifying the terms of share-based awards.  We prospectively adopted this guidance effective January 1, 2018, with no material impact on our financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash, which primarily requires the statement of cash flows to explain not only the change in cash and equivalents, but also the change in restricted cash.  The standard is effective on January 1, 2018, with early adoption permitted and requires the use of the retrospective transition method. The Company early adopted the new guidance during the fourth quarter of 2017 and, accordingly, net cash flows from investing activities decreased by $4,162,000 for the nine months ended September 30, 2017 as compared to the current presentation on the statement of cash flows.

Net Income per Common Share

Net income is allocated to (i) noncontrolling interests based upon their share of the net income of the Subsidiaries, (ii) preferred shareholders, to the extent redemption cost exceeds the related original net issuance proceeds (an “EITF D-42 allocation”), and (iii) the remaining net income is allocated to each of our equity securities based upon the dividends declared or accumulated during the period, combined with participation rights in undistributed earnings. 

Basic and diluted net income per common share are each calculated based upon net income allocable to common shareholders presented on the face of our income statement, divided by (i) in the case of basic net income per common share, weighted average common shares, and (ii) in the case of diluted income per share, weighted average common shares adjusted for the impact, if dilutive, of stock options outstanding (Note 10).  The following table reconciles from basic to diluted common shares outstanding (amounts in thousands):





3.Real Estate Facilities



Activity in real estate facilities during the nine months ended September 30, 2018 is as follows:

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During the nine months ended September 30, 2018, we acquired 16 self-storage facilities (1.0 million net rentable square feet), for a total cost of $107.8 million in cash, of which $7.1 million was allocated to intangible assets.  We completed development and redevelopment activities costing $278.1 million during the nine months ended September 30, 2018, adding 2.4 million net rentable square feet of self-storage space.  Construction in process at September 30, 2018 consists of projects to develop new self-storage facilities and redevelop existing self-storage facilities, which will build 5.4 million net rentable square feet of storage space at an aggregate estimated cost of approximately $596.4 million.  During the nine months ended September 30, 2018, we sold portions of real estate facilities in connection with eminent domain proceedings for $3.4 million in cash proceeds and recorded a related gain on sale of real estate of approximately $1.8 million.

4.Investments in Unconsolidated Real Estate Entities

The following table sets forth our investments in, and equity in earnings of, the Unconsolidated Real Estate Entities (amounts in thousands):

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During the nine months ended September 30, 2018 and 2017, we received cash distributions from our investments in the Unconsolidated Real Estate Entities totaling $186.3 million and $39.9 million, respectively.  For the nine months ended September 30, 2018, $91.9 million of the distributions received exceeded the retained earnings of the Unconsolidated Real Estate Entities and are presented as an investing activity on our statement of cash flows.    At September 30, 2018, the cost of our investment in the Unconsolidated Real Estate Entities exceeds our pro rata share of the underlying equity by approximately $66.8 million ($67.3 million at December 31, 2017).  This differential is being amortized as a reduction to equity in earnings of the Unconsolidated Real Estate Entities based upon allocations to the underlying net assets.  Such amortization was approximately $1.1 million and $1.0 million during the nine months ended September 30, 2018 and 2017, respectively.  

Investment in PSB

PSB is a REIT traded on the New York Stock Exchange.  We have an approximate 42% common equity interest in PSB as of September 30, 2018 and December 31, 2017, comprised of our ownership of 7,158,354 shares of PSB’s common stock and 7,305,355 limited partnership units (“LP Units”) in an operating partnership controlled by PSB.  The LP Units are convertible at our option, subject to certain conditions, on a one-for-one basis into PSB common stock.  Based upon the closing price at September 30, 2018 ($127.09 per share of PSB common stock), the shares and units we owned had a market value of approximately $1.8 billion.  At September 30, 2018, the adjusted tax basis of our investment in PSB approximates book value.    

The following table sets forth selected financial information of PSB. The amounts represent all of PSB’s balances and not our pro-rata share.

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Investment in Shurgard Europe

For all periods presented, we owned 31,268,459 shares of Shurgard Europe representing 49% of the shares outstanding and our joint venture partner owned the remaining shares.  See Note 13 “Subsequent Events” for further information on an initial global offering of Shurgard Europe’s common shares. Our equity in earnings of Shurgard Europe is comprised of our 49% share of Shurgard Europe’s net income and 49% of the trademark license fees that Shurgard Europe pays to us for the use of the “Shurgard” trademark.  The remaining 51% of the license fees are classified as interest and other income on our income statement. 

During the three months ended September 30, 2018, Shurgard Europe paid a cash dividend to its shareholders, of which our equity share was $145.4 million. 

Changes in foreign currency exchange rates decreased our investment in Shurgard Europe by approximately $9.0 million and increased it by $19.6 million in the nine months ended September 30, 2018 and 2017, respectively. 

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The following table sets forth selected consolidated financial information of Shurgard Europe based upon all of Shurgard Europe’s balances for all periods, rather than our pro rata share.  Our equity earnings in Shurgard Europe are based upon our acquired book basis under GAAP, while Shurgard’s separate financial statements are presented in accordance with International Financial Reporting Standards (“IFRS”).  For Shurgard Europe, the primary difference between IFRS and GAAP is the use of fair value accounting for its real estate under IFRS, while GAAP presents real estate at historical cost.  Net income is affected by the corresponding periodic changes in the fair value of real estate under IFRS, as compared to the recognition of periodic depreciation expense under GAAP, combined with the related net impact upon deferred income tax expense. 





See Note 13 “Subsequent Events” for further information on an initial global offering of Shurgard Europe’s common shares. 

5.Credit Facility

We have a revolving credit agreement (the “Credit Facility”) with a $500 million borrowing limit, which expires on March 31, 2020.  Amounts drawn on the Credit Facility bear annual interest at rates ranging from LIBOR plus 0.850% to LIBOR plus 1.450% depending upon the ratio of our Total Indebtedness to Gross Asset Value (as defined in the Credit Facility) (LIBOR plus 0.850% at September 30, 2018).  We are also required to

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pay a quarterly facility fee ranging from 0.080% per annum to 0.250% per annum depending upon the ratio of our Total Indebtedness to our Gross Asset Value (0.080% per annum at September 30, 2018).  At September 30, 2018 and October 30,  2018, we had no outstanding borrowings under this Credit Facility.  We had undrawn standby letters of credit, which reduce our borrowing capacity, totaling $16.1 million at September 30, 2018 and December 31, 2017.  The Credit Facility has various customary restrictive covenants, all of which we were in compliance with at September 30, 2018.

6.Notes Payable

Our notes payable at September 30, 2018 and December 31, 2017  are set forth in the table below:

U.S. Dollar Denominated Unsecured Debt

On September 18, 2017, we issued, in a public offering, two tranches each totaling $500.0 million of U.S. Dollar denominated unsecured notes (the “U.S. Dollar Notes”).  In connection with the offering, we incurred a total of $7.9 million in costs, which is reflected as a reduction in the principal amount and amortized, using the effective interest method, over the term of each respective note.  Interest on the U.S. Dollar Notes is payable semi-annually on March 15 and September 15 of each year, commencing March 15, 2018. 

The U.S. Dollar Notes have various financial covenants, all of which we were in compliance with at September 30, 2018.  Included in these covenants are a) a maximum Debt to Total Assets of 65%  (4.3% at September 30, 2018) and b) a minimum ratio of Adjusted EBITDA to Interest Expense of 1.5x  (66.8x for the twelve months ended September 30, 2018)  as well as covenants limiting the amount we can encumber our properties with mortgage debt. 

Euro Denominated Unsecured Debt

Our euro denominated unsecured notes (the “Euro Notes”) are payable to institutional investors.  The Euro Notes consist of two tranches, (i) €242.0 million issued on November 3, 2015 for $264.3 million in net

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proceeds upon converting the Euros to U.S. Dollars and (ii) €100.0 million issued on April 12, 2016 for $113.6 million in net proceeds upon converting the Euros to U.S. Dollars.  Interest is payable semi-annually.  The Euro Notes have various customary financial covenants, all of which we were in compliance with at September 30, 2018. 

We reflect changes in the U.S. Dollar equivalent of the amount payable, as a result of changes in foreign exchange rates as “foreign currency exchange gain (loss)” on our income statement (gains of $2.6 million and $12.7 million for the three and nine months ended September 30, 2018, respectively, as compared to losses of $13.4 million and $44.5 million for the same periods in 2017, respectively).

Mortgage Debt

Our non-recourse mortgage debt was assumed in connection with property acquisitions, and recorded at fair value with any premium or discount to the stated note balance amortized using the effective interest method. 

At September 30, 2018, the related contractual interest rates are fixed, ranging between 2.9% and 7.1%, and mature between November 2018 and September 2028.

At September 30, 2018, approximate principal maturities of our Notes Payable are as follows (amounts in thousands):

Cash paid for interest totaled $27.3 million and $7.6 million for the nine months ended September 30, 2018 and 2017, respectively.  Interest capitalized as real estate totaled $3.5 million and $3.1 million for the nine months ended September 30, 2018 and 2017, respectively.

7.Noncontrolling Interests

At September 30, 2018, the noncontrolling interests represent (i) third-party equity interests in subsidiaries owning 16 operating self-storage facilities and six self-storage facilities that are under construction and (ii) 231,978 partnership units held by third-parties in a subsidiary that are convertible on a one-for-one basis (subject to certain limitations) into common shares of the Company at the option of the unitholder (collectively, the “Noncontrolling Interests”).  At September 30, 2018, the Noncontrolling Interests cannot require us to redeem their interests, other than pursuant to a liquidation of the subsidiary.  During the nine months ended September 30, 2018 and 2017, we allocated a total of $4.5 million and $4.7 million, respectively, of income to these interests; and we paid $5.3 million and $5.5 million, respectively, in distributions to these interests. 

During the nine months ended September 30, 2017, we acquired Noncontrolling Interests for $14.4 million  (none for the nine months ended September 30, 2018), in cash, of which $7.7 million was allocated

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to Paid-in capital and $6.7 million as a reduction to Noncontrolling Interests.  During the nine months ended September 30, 2018 and 2017, Noncontrolling Interests contributed  $1.3 million and $1.1 million, respectively,  to our subsidiaries.    

8.Shareholders’ Equity



Preferred Shares

At September 30, 2018 and December 31, 2017, we had the following series of Cumulative Preferred Shares (“Preferred Shares”) outstanding:





The holders of our Preferred Shares have general preference rights with respect to liquidation, quarterly distributions and any accumulated unpaid distributions.  Except under certain conditions and as noted below, holders of the Preferred Shares will not be entitled to vote on most matters.  In the event of a cumulative arrearage equal to six quarterly dividends, holders of all outstanding series of preferred shares (voting as a single class without regard to series) will have the right to elect two additional members to serve on our board of trustees (our “Board”) until the arrearage has been cured.  At September 30, 2018, there were no dividends in arrears.

Except under certain conditions relating to the Company’s qualification as a REIT, the Preferred Shares are not redeemable prior to the dates indicated on the table above.  On or after the respective dates, each of the series of Preferred Shares is redeemable at our option, in whole or in part, at $25.00 per depositary share, plus accrued and unpaid dividends.  Holders of the Preferred Shares cannot require us to redeem such shares.

Upon issuance of our Preferred Shares, we classify the liquidation value as preferred equity on our balance sheet with any issuance costs recorded as a reduction to Paid-in capital.

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On June 2, 2017, we issued 11.2 million depositary shares, each representing 1/1,000 of a share of our 5.150% Series F Preferred Shares, at an issuance price of $25.00 per depositary share, for a total of $280.0 million in gross proceeds, and we incurred $8.9 million in issuance costs. 

On August 9, 2017, we issued 12.0 million depositary shares, each representing 1/1,000 of a share of our 5.050% Series G Preferred Shares, at an issuance price of $25.00 per depositary share, for a total of $300.0 million in gross proceeds, and we incurred $9.9 million in issuance costs. 

In June 2017, we called for redemption of, and on July 26, 2017, we redeemed our 5.900% Series S Preferred Shares, at par.  We recorded a $14.6 million allocation of income from our common shareholders to the holders of our Preferred Shares in the nine months ended September 30, 2017 in connection with this redemption.

In August 2017, we called for redemption of, and on September 28, 2017, we redeemed our 5.750% Series T Preferred Shares, at par.  We recorded a $14.7 million allocation of income from our common shareholders to the holders of our Preferred Shares in the three and nine months ended September 30, 2017 in connection with this redemption.

Dividends

Common share dividends, including amounts paid to our restricted share unitholders, totaled $349.2 million ($2.00 per share) and $348.6 million ($2.00 per share) for the three months ended September 30, 2018 and 2017, respectively, and $1.0 billion ($6.00 per share) and $1.0 billion  ($6.00 per share) for the nine months ended September 30, 2018 and 2017, respectively.  Preferred share dividends totaled $54.1 million and $61.1 million for the three months ended September 30, 2018 and 2017, respectively, and $162.2 million and $182.5 million for the nine months ended September 30, 2018 and 2017, respectively.

9.Related Party Transactions

B. Wayne Hughes, our former Chairman and his family, including his daughter Tamara Hughes Gustavson and his son B. Wayne Hughes, Jr., who are both members of our Board, collectively own approximately 14.3% of our common shares outstanding at September 30, 2018.

At September 30, 2018, B. Wayne Hughes and Tamara Hughes Gustavson together owned and controlled  58 self-storage facilities in Canada.  These facilities operate under the “Public Storage” tradename, which we license to the owners of these facilities for use in Canada on a royalty-free, non-exclusive basis.  We have no ownership interest in these facilities and we do not own or operate any facilities in Canada.  If we chose to acquire or develop our own facilities in Canada, we would have to share the use of the “Public Storage” name in Canada.  We have a right of first refusal, subject to limitations, to acquire the stock or assets of the corporation engaged in the operation of these facilities if their owners agree to sell them.  Our subsidiaries reinsure risks relating to loss of goods stored by customers in these facilities, and have received approximately $980,000 and $752,000 for the nine months ended September 30, 2018 and 2017, respectively.  Our right to continue receiving these premiums may be qualified.

10.Share-Based Compensation

Under various share-based compensation plans and under terms established by our Board or a committee thereof, we grant non-qualified options to purchase the Company’s common shares, as well as restricted share units (“RSUs”), to trustees, officers, and key employees.  

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Stock options and RSUs are considered “granted” and “outstanding” as the terms are used herein, when (i) the Company and the recipient reach a mutual understanding of the key terms of the award, (ii) the award has been authorized, (iii) the recipient is affected by changes in the market price of our stock, and (iv) it is probable that any performance conditions will be met.  

We amortize the grant-date fair value of awards as compensation expense over the service period, which begins on the grant date and ends on the vesting date.  For awards that are earned solely upon the passage of time and continued service, the entire cost of the award is amortized on a straight-line basis over the service period.  For awards with performance conditions, the individual cost of each vesting is amortized separately over each individual service period (the “accelerated attribution” method).

In amortizing share-based compensation expense, we do not estimate future forfeitures in advance.  Instead, we reverse previously amortized share-based compensation expense with respect to grants that are forfeited in the period the employee terminates employment. 

In February 2018, we announced that our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) are retiring from their executive roles at the end of 2018 and will then serve only as Trustees of the Company.  Pursuant to our share-based compensation plans, their unvested grants will continue to vest over the original vesting periods as long as they remain Trustees.  For financial reporting, the service periods for previous stock option and RSU grants for these executives have changed from (i) the grants’ vesting periods to (ii) the end of 2018 when they will retire.  Accordingly, all remaining share-based compensation expense for these two executives will now be amortized by the end of 2018. 

See also “net income per common share” in Note 2 for further discussion regarding the impact of RSUs and stock options on our net income per common share and income allocated to common shareholders.

Stock Options

Stock options vest ratably over a three to five-year period, expire ten years after the grant date, and the exercise price is equal to the closing trading price of our common shares on the grant date.  Employees cannot require the Company to settle their award in cash.  We use the Black-Scholes option valuation model to estimate the fair value of our stock options. 

Outstanding stock option grants are included on a one-for-one basis in our diluted weighted average shares, to the extent dilutive, after applying the treasury stock method (based upon the average common share price during the period) to assumed exercise proceeds and measured but unrecognized compensation.

For the three and nine months ended September 30, 2018, we recorded $4.0 million and $10.9 million, respectively, in compensation expense related to stock options, as compared to $2.3 million and $5.1 million, for the same periods in 2017.  Amounts for the three and nine months ended September 30, 2018 include $1.8 million and $5.3 million, respectively, in connection with the acceleration of amortization of grants to our CEO and CFO noted above.  Amounts for the nine months ended September 30, 2017 reflect a reduction in compensation expense of $0.8 million related to stock options forfeited during the periods.

During the nine months ended September 30, 2018,  200,000 stock options were granted, 136,805 options were exercised and 8,000 options were forfeited.  A total of 2,464,112 stock options were outstanding at September 30, 2018  (2,408,917 at December 31, 2017) and have an average exercise price of $199.64.

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Restricted Share Units

RSUs generally vest ratably over a five to eight-year period from the grant date.  The grantee receives dividends for each outstanding RSU equal to the per-share dividends received by our common shareholders.  We expense any dividends previously paid upon forfeiture of the related RSU.  Upon vesting, the grantee receives common shares equal to the number of vested RSUs, less common shares withheld in exchange for tax deposits made by the Company to satisfy the grantee’s statutory tax liabilities arising from the vesting. 

The fair value of our RSUs is determined based upon the applicable closing trading price of our common shares.

During the nine months ended September 30, 2018,  63,395 RSUs were granted, 50,975 RSUs were forfeited and 121,191 RSUs vested.  This vesting resulted in the issuance of 69,470 common shares.  In addition, tax deposits totaling $10.9 million ($12.4 million for the same period in 2017) were made on behalf of employees in exchange for 51,721 common shares withheld upon vesting.  A total of 690,358 RSUs were outstanding at September 30, 2018  (799,129 at December 31, 2017). 

A total of $14.7 million and $41.9 million in RSU expense was recorded for the three and nine months ended September 30, 2018,  respectively, which includes approximately $0.1 million and $1.0 million in employer taxes incurred upon vesting, as compared to $10.7 million and $21.1 million for the same periods in 2017, which includes approximately $0.1 million and $0.7 million, respectively, in employer taxes incurred upon vesting.    Amounts for the three and nine months ended September 30, 2018 include $5.3 million and $17.3 million, respectively, in connection with the acceleration of amortization on grants to our CEO and CFO as discussed above.  Amounts for the nine months ended September 30, 2017 reflect a reduction in compensation expense of $4.6 million related RSUs forfeited during the period.

11.Segment Information

Our reportable segments reflect the significant components of our operations where discrete financial information is evaluated separately by our chief operating decision maker (“CODM”).  We organize our segments based primarily upon the nature of the underlying products and services, as well as the drivers of profitability growth.  The net income for each reportable segment included in the tables below are in conformity with GAAP and our significant accounting policies as denoted in Note 2.  The amounts not attributable to reportable segments are aggregated under “other items not allocated to segments.” 

Following is a description of and basis for presentation for each of our reportable segments.

Self-Storage Operations

The Self-Storage Operations segment reflects the rental operations from all self-storage facilities we own.  Our CODM reviews the net operating income (“NOI”) of this segment, which represents the related revenues less cost of operations (prior to depreciation expense), in assessing performance and making resource allocation decisions.  The presentation in the tables below sets forth the NOI of this segment, as well as the depreciation expense for this segment, which while reviewed by our CODM and included in net income, is not considered by the CODM in assessing performance and decision making.  For all periods presented, substantially all of our real estate facilities, goodwill and other intangible assets, other assets, and accrued and other liabilities are associated with the Self-Storage Operations segment.

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Ancillary Operations

The Ancillary Operations segment reflects the sale of merchandise and reinsurance of policies against losses to goods stored by our self-storage tenants, activities which are incidental to our primary self-storage rental activities.  Our CODM reviews the NOI of these operations in assessing performance and making resource allocation decisions. 

Investment in PSB

This segment represents our 42% equity interest in PSB, a publicly-traded REIT that owns, operates, acquires and develops commercial properties, primarily multi-tenant flex, office, and industrial space.  PSB has a separate management team that makes its financing, capital allocation, and other significant decisions.  In making resource allocation decisions with respect to our investment in PSB, the CODM reviews PSB’s net income, which is detailed in PSB’s periodic filings with the SEC, and is included in Note 4.  The segment presentation in the tables below includes our equity earnings from PSB. 

Investment in Shurgard Europe

This segment represents our 49% equity interest in Shurgard Europe, which owns and operates self-storage facilities located in seven countries in Western Europe.  Shurgard Europe has a separate management team reporting to our CODM and our joint venture partner.  In making resource allocation decisions with respect to our investment in Shurgard Europe, the CODM reviews Shurgard Europe’s net income, which is detailed in Note 4.  The segment presentation below includes our equity earnings from Shurgard Europe.

Presentation of Segment Information

The following tables reconcile NOI (as applicable) and net income of each segment to our consolidated net income (amounts in thousands):

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12.Commitments and Contingencies

Contingent Losses

We are a party to various legal proceedings and subject to various claims and complaints; however, we believe that the likelihood of these contingencies resulting in a material loss to the Company, either individually or in the aggregate, is remote.

Insurance and Loss Exposure

We carry property, earthquake, general liability, employee medical insurance and workers compensation coverage through internationally recognized insurance carriers, subject to deductibles.  Our deductible for general liability is $2.0 million per occurrence.  Our annual deductibles for property losses are $25.0 million for first occurrence with an aggregate of $35.0 million for multiple occurrences and $5.0 million per occurrence thereafter.  Insurance carriers’ aggregate limits on these policies of $75.0 million for property losses and $102.0 million for general liability losses are higher than estimates of maximum probable losses that could occur from individual catastrophic events determined in recent engineering and actuarial studies; however, in case of multiple catastrophic events, these limits could be exceeded.

We reinsure a program that provides insurance to our customers from an independent third-party insurer.  This program covers customer claims for losses to goods stored at our facilities as a result of specific named perils (earthquakes are not covered by this program), up to a maximum limit of $5,000 per storage unit.  We reinsure all risks in this program, but purchase insurance to cover this exposure for a limit of $15.0 million for losses in excess of $5.0 million per occurrence. We are subject to licensing requirements and regulations in several states.  Customers participate in the program at their option.  At September 30, 2018, there were approximately 924,000 certificates held by our self-storage customers, representing aggregate coverage of approximately $2.9 billion.

Construction Commitments

We have construction commitments representing future expected payments for construction under contract totaling $209.2  million at September 30, 2018.  We expect to pay approximately $36.6 million in the remainder of 2018, $146.7 million in 2019 and $25.9 million in 2020 for these construction commitments.



13.Subsequent Events

Subsequent to September 30, 2018, we acquired or were under contract to acquire (subject to customary closing conditions) nine self-storage facilities, with 585,000 net rentable square feet, for $79.7 million. 



On October 15, 2018, Shurgard Europe completed an initial global offering (the “Offering”) of its common shares, and its shares commenced trading on Euronext Brussels under the “SHUR” symbol.  In the Offering, Shurgard Europe issued 21.7 million of its shares to third parties at a price of €23 per share, for €500 million in gross proceeds.  There is a potential “green shoe” for an additional €75 million in gross proceeds at €23 per share.  Our equity interest, comprised of a direct and indirect pro-rata ownership interest in 31.3 million shares, decreased from 49% to 36.6% as a result of the Offering  (35.2% if the “green shoe” option is exercised).  While we did not sell any of our shares in the Offering, we will record a gain on disposition in the three months ending December 31, 2018, as if we had sold a proportionate share of our investment in Shurgard Europe. 

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On October 18, 2018, we sold our property in West London to Shurgard Europe for $42.1 million.  We will record a gain on disposition  in the three months ending December 31, 2018.