| Extra Space Storage Inc |
| Item 1A Risk Factors An investment in our securities involves various risks |
| All investors should carefully consider the following risk factors in conjunction with the other information contained in this Annual Report before trading in our securities |
| If any of the events set forth in the following risks actually occur, our business, operating results, prospects and financial condition could be harmed |
| Our performance is subject to risks associated with real estate investments |
| We are a real estate company that derives our income from operation of our properties |
| There are a number of factors that may adversely affect the income that our properties generate, including the following: Risks Related to Our Properties and Operations If we are unable to promptly re-let our units or if the rates upon such re-letting are significantly lower than expected, then our business and results of operations would be adversely affected |
| Virtually all of our leases are on a month-to-month basis |
| In addition, lower than expected rental rates upon re-letting could impede our growth |
| 5 _________________________________________________________________ We face increasing competition for the acquisition of self-storage properties and other assets, which may impede our ability to make future acquisitions or may increase the cost of these acquisitions |
| We compete with many other entities engaged in real estate investment activities for acquisitions of self-storage properties and other assets, including national, regional and local operators and developers of self-storage properties |
| These competitors may drive up the price we must pay for self-storage properties or other assets we seek to acquire or may succeed in acquiring those properties or assets themselves |
| In addition, our potential acquisition targets may find our competitors to be more attractive suitors because they may have greater resources, may be willing to pay more or may have a more compatible operating philosophy |
| In addition, the number of entities and the amount of funds competing for suitable investment properties may increase |
| This competition will result in increased demand for these assets and therefore increased prices paid for them |
| Because of an increased interest in single-property acquisitions among tax-motivated individual purchasers, we may pay higher prices if we purchase single properties in comparison with portfolio acquisitions |
| If we pay higher prices for self-storage properties or other assets, our profitability will be reduced |
| Our investments in development and redevelopment projects may not yield anticipated returns, which would harm our operating results and reduce the amount of funds available for distributions |
| A key component of our growth strategy is exploring new asset development and redevelopment opportunities through strategic joint ventures |
| To the extent that we engage in these development and redevelopment activities, they will be subject to the following risks normally associated with these projects: • we may be unable to obtain financing for these projects on favorable terms or at all; • we may not complete development projects on schedule or within budgeted amounts; • we may encounter delays or refusals in obtaining all necessary zoning, land use, building, occupancy and other required governmental permits and authorizations; and • occupancy rates and rents at newly developed or redeveloped properties may fluctuate depending on a number of factors, including market and economic conditions, and may result in our investment not being profitable |
| In deciding whether to develop or redevelop a particular property, we make certain assumptions regarding the expected future performance of that property |
| We may underestimate the costs necessary to bring the property up to the standards established for its intended market position or may be unable to increase occupancy at a newly acquired property as quickly as expected or at all |
| Any substantial unanticipated delays or expenses could adversely affect the investment returns from these development or redevelopment projects and harm our operating results, liquidity and financial condition, which could result in a decline in the value of our securities |
| We may in the future develop self-storage properties in geographic regions where we do not currently have a significant presence and where we do not possess the same level of familiarity with development, which could adversely affect our ability to develop such properties successfully or at all or to achieve expected performance |
| We rely to a large extent on the investments of our joint venture partners for funding our development and redevelopment projects |
| If our reputation in the self-storage industry changes or the number of investors considering us an attractive strategic partner is otherwise reduced, our ability to develop or redevelop properties could be affected, which would limit our growth |
| We may not be successful in identifying and consummating suitable acquisitions that meet our criteria, which may impede our growth and negatively affect our stock price |
| Our ability to expand through acquisitions is integral to our business strategy and requires us to identify suitable acquisition candidates or investment opportunities that meet our criteria and are 6 _________________________________________________________________ compatible with our growth strategy |
| We may not be successful in identifying suitable properties or other assets that meet our acquisition criteria or in consummating acquisitions or investments on satisfactory terms or at all |
| Failure to identify or consummate acquisitions will slow our growth, which could in turn adversely affect our stock price |
| Our ability to acquire properties on favorable terms and successfully integrate and operate them may be constrained by the following significant risks: • competition from local investors and other real estate investors with significant capital, including other publicly-traded REITs and institutional investment funds; • competition from other potential acquirers may significantly increase the purchase price which could reduce our profitability; • satisfactory completion of due diligence investigations and other customary closing conditions; • failure to finance an acquisition on favorable terms or at all; • we may spend more than the time and amounts budgeted to make necessary improvements or renovations to acquired properties; and • we may acquire properties subject to liabilities without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of undisclosed environmental contamination, claims by persons dealing with the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties |
| In addition, strategic decisions by us, such as acquisitions, may adversely affect the price of our common stock |
| We may not be successful in integrating and operating acquired properties |
| We expect to make future acquisitions of self-storage properties |
| If we acquire any self-storage properties, we will be required to integrate them into our existing portfolio |
| The acquired properties may turn out to be less compatible with our growth strategy than originally anticipated, may cause disruptions in our operations or may divert managementapstas attention away from day-to-day operations, which could impair our results of operations as a whole |
| We depend upon our on-site personnel to maximize tenant satisfaction at each of our properties, and any difficulties we encounter in hiring, training and maintaining skilled field personnel may harm our operating performance |
| We have 1cmam628 field personnel as of February 28, 2006 in the management and operation of our properties |
| The general professionalism of our site managers and staff are contributing factors to a siteapstas ability to successfully secure rentals |
| We also rely upon our field personnel to maintain clean and secure self-storage properties |
| If we are unable to successfully recruit, train and retain qualified field personnel, the quality of service we strive to provide at our properties could be adversely affected which could lead to decreased occupancy levels and reduced operating performance |
| Other self-storage operators may employ STORE or a technology similar to STORE, which could enhance their ability to compete with us |
| We rely on STORE to support all aspects of our business operations and to help us implement new development and acquisition opportunities and strategies |
| If other self-storage companies obtain a license to use STORE, or employ or develop a technology similar to STORE, their ability to compete with us could be enhanced |
| 7 _________________________________________________________________ Uninsured losses or losses in excess of our insurance coverage could adversely affect our financial condition and our cash flow |
| We maintain comprehensive liability, fire, flood, earthquake, wind (as deemed necessary or as required by our lenders), extended coverage and rental loss insurance with respect to our properties with policy specifications, limits and deductibles customarily carried for similar properties |
| Certain types of losses, however, may be either uninsurable or not economically insurable, such as losses due to earthquakes, hurricanes, tornadoes, riots, acts of war or terrorism |
| Should an uninsured loss occur, we could lose both our investment in and anticipated profits and cash flow from a property |
| In addition, if any such loss is insured, we may be required to pay a significant deductible on any claim for recovery of such a loss prior to our insurer being obligated to reimburse us for the loss, or the amount of the loss may exceed our coverage for the loss |
| As a result, our operating results may be adversely affected |
| Increases in taxes and regulatory compliance costs may reduce our income |
| Costs resulting from changes in real estate tax laws generally are not passed through to tenants directly and will affect us |
| Increases in income, property or other taxes generally are not passed through to tenants under leases and may reduce our net income, FFO, cash flow, financial condition, ability to pay or refinance our debt obligations, ability to make distributions to stockholders, and the trading price of our common stock |
| Similarly, changes in laws increasing the potential liability for environmental conditions existing on properties or increasing the restrictions on discharges or other conditions may result in significant unanticipated expenditures, which could similarly adversely affect our business and results of operations |
| We did not always obtain independent appraisals of our properties, and thus the consideration paid for these properties may exceed the value that may be indicated by third-party appraisals |
| We do not always obtained third-party appraisals of the properties in connection with our acquisitions of properties and the consideration being paid by us in exchange for those properties may exceed the value as determined by third-party appraisals |
| In such cases, the terms of any agreements and the valuation methods used to determine the value of the properties were determined by our senior management team |
| Environmental compliance costs and liabilities associated with operating our properties may affect our results of operations |
| Under various US federal, state and local laws, ordinances and regulations, owners and operators of real estate may be liable for the costs of investigating and remediating certain hazardous substances or other regulated materials on or in such property |
| Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such substances or materials |
| The presence of such substances or materials, or the failure to properly remediate such substances, may adversely affect the ownerapstas or operatorapstas ability to lease, sell or rent such property or to borrow using such property as collateral |
| Persons who arrange for the disposal or treatment of hazardous substances or other regulated materials may be liable for the costs of removal or remediation of such substances at a disposal or treatment facility, whether or not such facility is owned or operated by such person |
| Certain environmental laws impose liability for release of asbestos-containing materials into the air and third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials |
| Certain environmental laws also impose liability, without regard to knowledge or fault, for removal or remediation of hazardous substances or other regulated materials upon owners and operators of contaminated property even after they no longer own or operate the property |
| Certain environmental laws impose compliance obligations on owners and operators of real property with respect to the management of hazardous materials and other regulated substances |
| For example, environmental laws govern the management of asbestos-containing materials and lead-based paint |
| Failure to comply with these laws can result in penalties or other sanctions |
| No assurances can be given that existing environmental studies with respect to any of our properties reveal all environmental liabilities, that any prior owner or operator of our properties did not create any material environmental condition not known to us, or that a material environmental condition does not otherwise exist as to any one or more of our properties |
| There also exists the risk that material environmental conditions, liabilities or compliance concerns may have arisen after the review was completed or may arise in the future |
| Finally, future laws, ordinances or regulations and future interpretations of existing laws, ordinances or regulations may impose additional material environmental liability |
| Adverse economic or other conditions in the markets in which we do business could negatively affect our occupancy levels and rental rates and therefore our operating results |
| Our operating results are dependent upon our ability to maximize occupancy levels and rental rates in our self-storage properties |
| Adverse economic or other conditions in the markets in which we operate may lower our occupancy levels and limit our ability to increase rents or require us to offer rental discounts |
| If our properties fail to generate revenues sufficient to meet our cash requirements, including operating and other expenses, debt service and capital expenditures, our net income, funds from operations ( "e FFO "e ), cash flow, financial condition, ability to make distributions to stockholders and common stock trading price could be adversely affected |
| The following factors, among others, may adversely affect the operating performance of our properties: • the national economic climate and the local or regional economic climate in the markets in which we operate, which may be adversely impacted by, among other factors, industry slowdowns, relocation of businesses and changing demographics; • periods of economic slowdown or recession, rising interest rates or declining demand for self-storage or the public perception that any of these events may occur could result in a general decline in rental rates or an increase in tenant defaults; • local or regional real estate market conditions such as the oversupply of self-storage or a reduction in demand for self-storage in a particular area; • perceptions by prospective users of our self-storage properties of the safety, convenience and attractiveness of our properties and the neighborhoods in which they are located; • increased operating costs, including need for capital improvements, insurance premiums, real estate • taxes and utilities; • changes in supply of or demand for similar or competing properties in an area; • the impact of environmental protection laws; • earthquakes, hurricanes and other natural disasters, terrorist acts, civil disturbances or acts of war which may result in uninsured or underinsured losses; and • changes in tax, real estate and zoning laws |
| Risks Related to Our Organization and Structure Our business could be harmed if key personnel with long-standing business relationships in the self-storage industry terminate their employment with us |
| Our success depends, to a significant extent, on the continued services of our Chairman and Chief Executive Officer and the other members of our executive management team |
| Our executive 9 _________________________________________________________________ management team has substantial experience in the self-storage industry |
| In addition, our ability to continue to develop properties depends on the significant relationships our executive management team has developed with our institutional joint venture partners such as affiliates of Prudential Financial, Inc |
| There is no guarantee that any of them will remain employed by us |
| We do not maintain key person life insurance on any of our officers |
| The loss of services of one or more members of our executive management team, particularly our Chairman and Chief Executive Officer, could harm our business and our prospects |
| We may change our investment and financing strategies and enter into new lines of business without stockholder consent, which may subject us to different risks |
| We may change our investment and financing strategies and enter into new lines of business without stockholder consent, which may subject us to different risks |
| We may change our investment and financing strategies and enter into new lines of business at any time without the consent of our stockholders, which could result in our making investments and engaging in business activities that are different from, and possibly riskier than, the investments and businesses described in this document |
| A change in our investment strategy or our entry into new lines of business may increase our exposure to other risks or real estate market fluctuations |
| If other self-storage companies convert to an UPREIT structure or if tax laws change, we may no longer have an advantage in competing for potential acquisitions |
| Because we are structured as an UPREIT, we are a more attractive acquirer of property to tax-motivated sellers than our competitors that are not structured as UPREITs |
| However, if other self-storage companies restructure their holdings to become UPREITs, this competitive advantage will disappear |
| In addition, new legislation may be enacted or new interpretations of existing legislation may be issued by the Internal Revenue Service ( "e IRS "e ), or the US Treasury Department that could affect the attractiveness of our UPREIT structure so that it may no longer assist us in competing for acquisitions |
| Tax indemnification obligations may require the operating partnership to maintain certain debt levels |
| In connection with the formation transactions, we agreed to make available to each of Kenneth M Woolley, our Chairman and Chief Executive Officer, Richard S Tanner, our Senior Vice President, Development, and other third parties, the following tax protections: for nine years, with a three-year extension if the applicable party continues to own at least 50prca of the OP units received by it in the formation transactions at the expiration of the initial nine-year period, the opportunity to (1) guarantee debt or (2) enter into a special loss allocation and deficit restoration obligation, in an aggregate amount, with respect to the foregoing contributors, of at least equal to dlra60dtta0 million |
| We agreed to these provisions in order to assist these contributors in preserving their tax position after their contributions |
| These obligations may require us to maintain certain indebtedness than we would not otherwise require for our business |
| Our joint venture investments could be adversely affected by our lack of sole decision-making authority |
| As of December 31, 2005, we held interests in 354 properties through joint ventures |
| All of these arrangements could be adversely affected by our lack of sole decision-making authority, our reliance on co-venturers &apos financial conditions and disputes between us and our co-venturers |
| We expect to continue our joint venture strategy by entering into more joint ventures for the purpose of developing new self-storage properties and acquiring existing properties |
| In such event, we would not be in a position to exercise sole decision-making authority regarding the property, partnership, joint venture or other entity |
| The decision-making authority regarding the properties we currently hold through joint ventures is either vested exclusively with our joint venture partners, is subject to a majority vote of the joint 10 _________________________________________________________________ venture partners or equally shared by us and the joint venture partners |
| In addition, investments in partnerships, joint ventures or other entities may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners or co-venturers might become bankrupt or fail to fund their share of required capital contributions |
| Partners or co-venturers may have economic or other business interests or goals which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives |
| Such investments may also have the potential risk of impasses on decisions, such as a sale, because neither we nor the partner or co-venturer would have full control over the partnership or joint venture |
| Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their time and efforts on our business |
| Consequently, actions by or disputes with partners or co-venturers might result in subjecting properties owned by the partnership or joint venture to additional risk |
| In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers, which could harm our financial condition |
| Kenneth M Woolley, our Chairman and Chief Executive Officer, Spencer F Kirk, one of our directors, Richard S Tanner, Senior Vice President, Development, Kent W Christensen, Senior Vice President, Chief Financial Officer, and Charles L Allen, Senior Vice President, Senior Legal Counsel, members of our senior management team, have outside business interests which could divert their time and attention away from us, which could harm our business |
| Kenneth M Woolley, our Chairman and Chief Executive Officer, as well as one of our directors and certain other members of our senior management team, have outside business interests |
| These business interests include the ownership of a self-storage property located in Pico Rivera, California, which as of December 31, 2005 was in lease-up, and the ownership of Extra Space Development LLC Other than this property and Extra Space Development, LLC, the members of our senior management are not currently engaged in any other self-storage activities outside the company |
| Woolleyapstas employment agreement includes an exception to his non-competition covenant pursuant to which he is permitted to devote a portion of his time to the management and operations of RMI Development, LLC, a multi-family business in which he has a majority ownership |
| Woolleyapstas employment agreement requires that he devote substantially his full business time and attention to us, this agreement also permits him to devote time to his outside business interests |
| These outside business interests could interfere with his ability to devote time to our business and affairs and as a result, our business could be harmed |
| Conflicts of interest could arise as a result of our relationship with our operating partnership |
| Conflicts of interest could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other |
| Our directors and officers have duties to our company under applicable Maryland law in connection with their management of our company |
| At the same time, we, through our wholly owned subsidiary, have fiduciary duties, as a general partner, to our operating partnership and to the limited partners under Delaware law in connection with the management of our operating partnership |
| Our duties, through our wholly owned subsidiary, as a general partner to our operating partnership and its partners may come into conflict with the duties of our directors and officers to our company |
| The partnership agreement of our operating partnership does not require us to resolve such conflicts in favor of either our company or the limited partners in our operating partnership |
| Unless otherwise provided for in the relevant partnership agreement, Delaware law generally requires a general partner of a Delaware limited partnership to adhere to fiduciary duty standards under which it owes its limited partners the highest duties of good faith, fairness, and loyalty and which generally prohibit such general partner from taking any action or engaging in any transaction as to which it has a conflict of interest |
| 11 _________________________________________________________________ Additionally, the partnership agreement expressly limits our liability by providing that neither we, our direct wholly owned Massachusetts business trust subsidiary, as the general partner of the operating partnership, nor any of our or their trustees, directors or officers, will be liable or accountable in damages to our operating partnership, the limited partners or assignees for errors in judgment, mistakes of fact or law or for any act or omission if we, or such trustee, director or officer, acted in good faith |
| In addition, our operating partnership is required to indemnify us, our affiliates and each of our respective trustees, officers, directors, employees and agents to the fullest extent permitted by applicable law against any and all losses, claims, damages, liabilities (whether joint or several), expenses (including, without limitation, attorneys &apos fees and other legal fees and expenses), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the operating partnership, provided that our operating partnership will not indemnify for (1) willful misconduct or a knowing violation of the law, (2) any transaction for which such person received an improper personal benefit in violation or breach of any provision of the partnership agreement, or (3) in the case of a criminal proceeding, the person had reasonable cause to believe the act or omission was unlawful |
| The provisions of Delaware law that allow the common law fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict our fiduciary duties that would be in effect under common law were it not for the partnership agreement |
| Our managementapstas ownership of contingent conversion shares, or CCSs, and contingent conversion units, or CCUs, may cause them to devote a disproportionate amount of time to the performance of the 14 wholly owned early-stage lease-up properties, which could cause our overall operating performance to suffer |
| In connection with our IPO, we issued to certain contributors, which included certain members of our senior management, CCSs and/or a combination of OP units and CCUs |
| The terms of the CCSs and CCUs provide that they will convert into our common stock and OP units, respectively, only if the relevant 14 lease-up properties identified at the time of the initial public offering achieve specified performance thresholds prior to December 31, 2008 |
| As a result, our directors and officers who own CCSs and CCUs may have an incentive to devote a disproportionately large amount of their time and attention to these properties in comparison with our remaining properties, which could harm our operating results |
| We may pursue less vigorous enforcement of terms of contribution and other agreements because of conflicts of interest with certain of our officers |
| Kenneth M Woolley, our Chairman and Chief Executive Officer, Spencer F Kirk, who serves as director, Kent W Christensen, Senior Vice President, Chief Financial Officer, Charles L Allen, Senior Vice President, Senior Legal Counsel, and Richard S Tanner, Senior Vice President, Development had direct or indirect ownership interests in certain properties that were contributed to our operating partnership in the formation transactions |
| Following the completion of the formation transactions, we, under the agreements relating to the contribution of such interests, became entitled to indemnification and damages in the event of breaches of representations or warranties made by the contributors |
| In addition, Kenneth M Woolleyapstas employment agreement includes an exception to his non-competition covenant pursuant to which he is permitted to devote time to the management and operations of RMI Development, LLC, a multi-family business |
| None of these contribution and non-competition agreements was negotiated on an armapstas-length basis |
| We may choose not to enforce, or to enforce less vigorously, our rights under these contribution and non-competition agreements because of our desire to maintain our ongoing relationships with the individuals party to these agreements |
| 12 _________________________________________________________________ Certain provisions of Maryland law and our organizational documents, including the stock ownership limit imposed by our charter, may inhibit market activity in our stock and could prevent or delay a change in control transaction |
| Our charter, subject to certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than 7dtta0prca (by value or by number of shares, whichever is more restrictive) of our outstanding common stock or 7dtta0prca (by value or by number of shares, whichever is more restrictive) of our outstanding capital stock |
| Our board of directors, in its sole discretion, may exempt a proposed transferee from the ownership limit |
| However, our board of directors may not grant an exemption from the ownership limit to any proposed transferee whose ownership could jeopardize our qualification as a REIT These restrictions on ownership will not apply if our board of directors determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT The ownership limit may delay or impede a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders |
| Different ownership limits apply to the family of Kenneth M Woolley, certain of his affiliates, family members and estates and trusts formed for the benefit of the foregoing and Spencer F Kirk, certain of his affiliates, family members and estates and trusts formed for the benefit of the foregoing and certain designated investment entities (as defined in our charter) |
| Our board of directors has the power to issue additional shares of our stock in a manner that may not be in the best interest of our stockholders |
| Our charter authorizes our board of directors to issue additional authorized but unissued shares of common stock or preferred stock and to increase the aggregate number of authorized shares or the number of shares of any class or series without stockholder approval |
| In addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares |
| Our board of directors could issue additional shares of our common stock or establish a series of preferred stock that could have the effect of delaying, deferring or preventing a change in control or other transaction that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders |
| Our rights and the rights of our stockholders to take action against our directors and officers are limited |
| Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances |
| In addition, our charter eliminates our directors &apos and officers &apos liability to us and our stockholders for money damages except for liability resulting from actual receipt of an improper benefit in money, property or services or active and deliberate dishonesty established by a final judgment and which is material to the cause of action |
| Our bylaws require us to indemnify our directors and officers for liability resulting from actions taken by them in those capacities to the maximum extent permitted by Maryland law |
| As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law |
| In addition, we may be obligated to fund the defense costs incurred by our directors and officers |
| To the extent our distributions represent a return of capital for US federal income tax purposes, our stockholders could recognize an increased capital gain upon a subsequent sale of common stock |
| Distributions in excess of our current and accumulated earnings and profits and not treated by us as a dividend will not be taxable to a US stockholder under current US federal income tax law to the extent those distributions do not exceed the stockholderapstas adjusted tax basis in his, her, or its common stock, but instead will constitute a return of capital and will reduce such adjusted basis |
| If distributions 13 _________________________________________________________________ result in a reduction of a stockholderapstas adjusted basis in such holderapstas common stock, subsequent sales of such holderapstas common stock will result in recognition of an increased capital gain or realized capital loss due to the reduction in such adjusted basis |
| Risks Related to the Real Estate Industry Our primary business involves the ownership, operation and development of self-storage properties |
| Our current strategy is to own, operate and develop only self-storage properties |
| Consequently, we are subject to risks inherent in investments in a single industry |
| Because investments in real estate are inherently illiquid, this strategy makes it difficult for us to diversify our investment portfolio and to limit our risk when economic conditions change |
| Decreases in market rents, negative tax, real estate and zoning law changes and changes in environmental protection laws may also increase our costs, lower the value of our investments and decrease our income, which would adversely affect our business, financial condition and operating results |
| Any negative perceptions of the self-storage industry generally may result in a decline in our stock price |
| To the extent that the investing public has a negative perception of the self-storage industry, the value of our common stock may be negatively impacted, which could result in our common stock trading below the inherent value of our assets |
| Costs associated with complying with the Americans with Disabilities Act of 1990 may result in unanticipated expenses |
| Under the ADA, all places of public accommodation are required to meet certain federal requirements related to access and use by disabled persons |
| These requirements became effective in 1992 |
| A number of additional US federal, state and local laws may also require modifications to our properties, or restrict certain further renovations of the properties, with respect to access thereto by disabled persons |
| Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any non-complying feature, which could result in substantial capital expenditures |
| We have not conducted an audit or investigation of all of our properties to determine our compliance and we cannot predict the ultimate cost of compliance with the ADA or other legislation |
| If one or more of our properties is not in compliance with the ADA or other legislation, then we would be required to incur additional costs to bring the facility into compliance |
| If we incur substantial costs to comply with the ADA or other legislation, our financial condition, results of operations, cash flow, per share trading price of our common stock and our ability to satisfy our debt service obligations and to make distributions to our stockholders could be adversely affected |
| Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties |
| Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited |
| The real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control |
| We cannot predict whether we will be able to sell any property for the price or on the terms set by us or whether any price or other terms offered by a prospective purchaser would be acceptable to us |
| We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property |
| We may be required to expend funds to correct defects or to make improvements before a property can be sold |
| We cannot assure you that we will have funds available to correct those defects or 14 _________________________________________________________________ to make those improvements |
| In acquiring a property, we may agree to transfer restrictions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property |
| These transfer restrictions would impede our ability to sell a property even if we deem it necessary or appropriate |
| Any investments in unimproved real property may take significantly longer to yield income-producing returns, if at all, and may result in additional costs to us to comply with re-zoning restrictions or environmental regulations |
| We have invested in the past, and may invest in the future, in unimproved real property |
| Unimproved properties generally take longer to yield income-producing returns based on the typical time required for development |
| Any development of unimproved property may also expose us to the risks and uncertainties associated with re-zoning the land for a higher use or development and environmental concerns of governmental entities and/or community groups |
| Any unsuccessful investments or delays in realizing an income-producing return or increased costs to develop unimproved real estate could restrict our ability to earn our targeted rate of return on an investment or adversely affect our ability to pay operating expenses which would harm our financial condition and operating results |
| Risks Related to Our Debt Financings Required payments of principal and interest on borrowings may leave us with insufficient cash to operate our properties or to pay the distributions currently contemplated or necessary to maintain our qualification as a REIT and may expose us to the risk of default under our debt obligations |
| As of December 31, 2005, we had approximately dlra866dtta8 million of outstanding indebtedness |
| We expect to incur additional debt in connection with future acquisitions |
| We may borrow under our line of credit or borrow new funds to acquire these future properties |
| Additionally, we do not anticipate that our internally generated cash flow will be adequate to repay our existing indebtedness upon maturity and, therefore, we expect to repay our indebtedness through refinancings and equity and/or debt offerings |
| Further, we may need to borrow funds to make distributions required to maintain our qualification as a REIT or to meet our expected distributions |
| If we are required to utilize our line of credit for purposes other than acquisition activity, this will reduce the amount available for acquisitions and could slow our growth |
| Therefore, our level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following: • our cash flow may be insufficient to meet our required principal and interest payments; • we may be unable to borrow additional funds as needed or on favorable terms, including to make acquisitions or distributions required to maintain our qualification as a REIT; • we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness; • because a portion of our debt bears interest at variable rates, an increase in interest rates could materially increase our interest expense; • we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms; • after debt service, the amount available for distributions to our stockholders is reduced; • our debt level could place us at a competitive disadvantage compared to our competitors with less debt; • we may experience increased vulnerability to economic and industry downturns, reducing our ability to respond to changing business and economic conditions; • we may default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and receive an assignment of rents and leases; 15 _________________________________________________________________ • we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations; and • our default under any one of our mortgage loans with cross-default or cross-collateralization provisions could result in a default on other indebtedness or result in the foreclosures of other properties |
| We could become highly leveraged in the future because our organizational documents contain no limitation on the amount of debt we may incur |
| Our organizational documents contain no limitations on the amount of indebtedness that we or our operating partnership may incur |
| We could alter the balance between our total outstanding indebtedness and the value of our portfolio at any time |
| If we become more highly leveraged, then the resulting increase in debt service could adversely affect our ability to make payments on our outstanding indebtedness and to pay our anticipated distributions and/or the distributions required to maintain our REIT qualification, and could harm our financial condition |
| Increases in interest rates may increase our interest expense and adversely affect our cash flow and our ability to service our indebtedness and make distributions to our stockholders |
| As of December 31, 2005 we had approximately dlra866dtta8 million of debt outstanding, of which approximately dlra94dtta2 million, or 10dtta9prca will be subject to variable interest rates (including dlra61dtta8 million on which we had a reverse interest rate swap) |
| This variable rate debt had a weighted average interest rate of approximately 5dtta7prca per annum |
| Increases in interest rates on this variable rate debt would increase our interest expense, which could harm our cash flow and our ability to pay distributions |
| For example, if market rates of interest on this variable rate debt increased by 100 basis points, the increase in interest expense would decrease future earnings and cash flows by approximately dlra1dtta0 million annually |
| Failure to hedge effectively against interest rate changes may adversely affect our results of operations |
| In certain cases we may seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements |
| Hedging involves risks, such as the risk that the counterparty may fail to honor its obligations under an arrangement |
| Failure to hedge effectively against interest rate changes may adversely affect our financial condition, results of operations and ability to make distributions to our stockholders |
| Risks Related to Qualification and Operation as a REIT To maintain our qualification as a REIT, we may be forced to borrow funds on a short-term basis during unfavorable market conditions |
| To qualify as a REIT, we generally must distribute to our stockholders at least 90prca of our net taxable income each year, excluding net capital gains, and we are subject to regular corporate income taxes to the extent that we distribute less than 100prca of our net taxable income each year |
| In addition, we are subject to a 4prca nondeductible excise tax on the amount, if any, by which distributions made by us in any calendar year are less than the sum of 85prca of our ordinary income, 95prca of our capital gain net income and 100prca of our undistributed income from prior years |
| In order to maintain our REIT qualification and avoid the payment of income and excise taxes, we may need to borrow funds on a short-term basis, or possibly long-term, to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings |
| These borrowing needs could result from a difference in timing between the actual receipt of cash and inclusion of income for US federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt amortization payments |
| 16 _________________________________________________________________ Dividends payable by REITs generally do not qualify for reduced tax rates |
| The maximum US federal income tax rate for dividends paid by domestic corporations to individual US stockholders is 15prca (through 2008) |
| Dividends paid by REITs, however, are generally not eligible for the reduced rates |
| The more favorable rates applicable to regular corporate dividends could cause stockholders who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock |
| In addition, the relative attractiveness of real estate in general may be adversely affected by the favorable tax treatment given to corporate dividends, which could negatively affect the value of our properties |
| Possible legislative or other actions affecting REITs could adversely affect our stockholders |
| The rules dealing with US federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the US Treasury Department |
| Changes to tax laws (which changes may have retroactive application) could adversely affect our stockholders |
| It cannot be predicted whether, when, in what forms, or with what effective dates, the tax laws applicable to us or our stockholders will be changed |
| The power of our board of directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders |
| Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interests to continue to qualify as a REIT If we cease to qualify as a REIT, we would become subject to US federal income tax on our taxable income and would no longer be required to distribute most of our net taxable income to our stockholders, which may have adverse consequences on the total return to our stockholders |
| Our failure to qualify as a REIT would have significant adverse consequences to us and the value of our stock |
| We operate in a manner that allows us to qualify as a REIT for US federal income tax purposes under the Internal Revenue Code |
| If we fail to qualify as a REIT or lose our qualification as a REIT at any time, we will face serious tax consequences that would substantially reduce the funds available for distribution to you for each of the years involved because: • we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to US federal income tax at regular corporate rates; • we also could be subject to the US federal alternative minimum tax and possibly increased state and local taxes; and • unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following a year during which we were disqualified |
| In addition, if we fail to qualify as a REIT, we will not be required to make distributions to stockholders, and all distributions to stockholders will be subject to tax as regular corporate dividends to the extent of our current and accumulated earnings and profits |
| This means that our US individual stockholders would be taxed on our dividends at capital gains rates, and our US corporate stockholders would be entitled to the dividends received deduction with respect to such dividends, subject, in each case, to applicable limitations under the Internal Revenue Code |
| As a result of all these factors, our failure to qualify as a REIT also could impair our ability to expand our business and raise capital, and could adversely affect the value of our common stock |
| 17 _________________________________________________________________ Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which there are only limited judicial and administrative interpretations |
| The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Internal Revenue Code is greater in the case of a REIT that, like us, holds its assets through a partnership |
| The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the composition of our assets and sources of our gross income |
| Our ability to satisfy the asset tests depends upon our analysis of the fair market value of our assets, some of which are not susceptible to precise determination, and for which we will not obtain any independent appraisals |
| Also, we must make distributions to stockholders aggregating annually at least 90prca of our net taxable income, excluding capital gains |
| In addition, legislation, new regulations, administrative interpretations or court decisions may adversely affect our investors, our ability to qualify as a REIT for US federal income tax purposes or the desirability of an investment in a REIT relative to other investments |
| Even though we qualify as a REIT for US federal income tax purposes, we will be required to pay some US federal, state and local taxes on our income and property |
| Extra Space Management, Inc |
| manages self-storage properties for our joint venture properties and properties owned by third parties |
| We, jointly with Extra Space Management, Inc, elected to treat Extra Space Management, Inc |
| as a "e taxable REIT subsidiary "e of our Company for US federal income tax purposes |
| A taxable REIT subsidiary is a fully taxable corporation, and may be limited in its ability to deduct interest payments made to us |
| In addition, we will be subject to a 100prca penalty tax on certain amounts if the economic arrangements among our tenants, our taxable REIT subsidiary and us are not comparable to similar arrangements among unrelated parties or if we receive payments for inventory or property held for sale to customers in the ordinary course of business |
| To the extent that we are or our taxable REIT subsidiary is required to pay US federal, state or local taxes, we will have less cash available for distribution to stockholders |
| Complying with REIT requirements may cause us to forego otherwise attractive opportunities |
| To qualify as a REIT for US federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock |
| In order to meet these tests, we may be required to forego attractive business or investment opportunities |
| Thus, compliance with the REIT requirements may adversely affect our ability to operate solely to maximize profits |