* Q3 Revenue and occupancy numbers expected to take a hit
* Operating expenses to play key role in driving up Q3 FFO
* Lease incentives to continue to attract traffic
By Biswarup Gooptu
BANGALORE, Oct 30 (Reuters) - Depressed tenant demand and anaemic consumer spending are expected to weigh on U.S. storage REITs when they start reporting quarterly results this week.
Analysts expect companies such as Public Storage (PSA.N), Extra Space Storage Inc (EXR.N), U-Store-It Trust YSI.N and Sovran Self Storage SSS.N to beat consensus estimates, largely driven by stringent cost control measures.
However, key metrics such as occupancy and revenue are expected to take a hit as the REITs head into a lean leasing season.
The ongoing recession -- the worst in several decades -- has sucked out demand for storage services as people view such expenses as discretionary.
Third-quarter occupancy numbers for these self-storage REITs are expected to drop by about 300 basis points year-over-year, in spite of increased discounts and incentives to attract customers. BMO Capital analyst Paul Adornato said the latest quarter was probably the last opportunity for the storage REITs to buff up their occupancy numbers for the year.
"We still expect a deterioration in the fundamentals even if the economy starts to stabilize, because ultimately, storage is a discretionary spending item," the analyst said.
The offerings, however, have put added pressure on the companies' top lines in an already difficult economic environment.
Depending on the market, analysts expect new rental rates to be down 7 percent to 15 percent on average for the third quarter, negatively impacting revenue by 5 percent.
Investors will also keep an eye on net move outs reported by the storage REITs during the quarter, with August and September historically seen as periods when customers tend to vacate storage premises.
"The big number to be focussing on here is the net move outs. You want to see if that continues to stabilize or not, and if it does, it's a very good thing for the sector," Oppenheimer's Samit Parikh noted.
To compensate for the drop in revenue, the REITs have kept their operating expenses down, which analysts say is unsustainable.
Robert W. Baird analyst Paula Poskon said the REITs could not continue to make up their earnings on the bottom line by cutting down on their expenses to offset weaker revenue in the long run.
"There's a certain amount of infrastructure that you need to manage effectively... I don't think you're going to see a spike in expenses, but year-over-year comparisons are going to get tougher," she noted.
In August, Extra Space Chief Operating Officer Karl Haas admitted that the current level of expense control would be increasingly hard to achieve going forward, and the company would need to arrive on a better pricing strategy for incoming tenants.
The gradual recovery of the U.S. housing market could act as stimulant for the storage sector, with home prices in August rising for the fourth straight month.
While sales of new homes unexpectedly tumbled in September, a housing market recovery seems to be gaining a foothold.
"If we continue to see home sales pick up, the effect on underlying demand, specifically within the net move outs and occupancy levels, will increase. It's a catalyst forward for the entire industry," Oppenheimer's Parikh said.
Fifteen analysts expect Public Storage to post third-quarter FFO of $1.25 a share, while 12 analysts expect rival storage REIT Extra Space Storage to report FFO of 22 cents a share for the same period.
Sovran Self Storage and U-Store-It Trust are expected to post quarterly FFO of 66 cents and 17 cents a share, respectively, for the third quarter.
FFO is a key performance measure for the REITs, because it excludes the profit-reducing effect of depreciation.
The benchmark MSCI U.S. REIT Index .RMZ has gained more than 19 percent over the last three months. The shares of the largest publicly traded storage REIT, Public Storage, underperformed the index, gaining 5.3 percent during the same time, while U-Store-It Trust gained almost 27 percent. (Reporting by Biswarup Gooptu in Bangalore; Editing by Anil D'Silva)