Most people starting out on their passive income journey focus on an investment's current yield. They want to earn as much income as possible from their investment. However, that can cause them to miss out on the even greater income upside from an investment that can grow its income stream over time.
One excellent example of the upside potential of an income grower is Extra Space Storage (EXR 0.21%). The real estate investment trust (REIT) focused on self-storage has delivered tremendous dividend growth over the past decade, turning a $1,000 investment into a more than $200 annual income stream.
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An amazing decade of dividend growth
Ten years ago, Extra Space Storage made quarterly dividend payments of $0.20 per share. At its share price at the time, it offered a dividend yield of around 2.8%. Put another way, a $1,000 investment in the self-storage REIT would have initially generated about $28.50 in annual passive income.
While that's a relatively attractive passive income stream, it might not have been high enough for investors focused on maximizing their income yield. Because of that, they might have passed on Extra Space Storage for a stock offering a higher dividend yield. That could have caused them to miss out on an even greater income upside, given how much the REIT has increased its dividend over time.
Extra Space has boosted its dividend by 650% over the past decade. It now pays out $1.50 per share each quarter. That's an eye-popping 21.4% yield on its share price from 10 years ago. It implies a $1,000 investment would now produce over $200 of annual dividend income, and that's assuming investors didn't reinvest dividends into buying more shares. Meanwhile, add in stock price appreciation, and Extra Space's total return is approaching 800%.
The key to Extra Space Storage's dividend growth success
Extra Space Storage has benefited from multiple growth drivers over the past decade. Demand for self-storage space has steadily increased. That benefited the REIT's existing properties, allowing it to steadily increase its rental rates. Meanwhile, it has kept costs in check, enabling it to deliver strong net operating income growth. That has provided a good foundation for dividend growth.
On top of that, the REIT has benefited from several external growth drivers. It started its third-party management platform in 2008, which has grown into the largest in the industry as it added new properties to the program. It also made a needle-moving deal in 2015, acquiring SmartShop Self Storage for $1.4 billion. The REIT also launched a bridge loan program in 2019 to provide developers with capital as they work to stabilize recently built self-storage facilities, many of which Extra Space has acquired upon stabilization. These moves have helped more than double its store count over the past decade, helping drive strong earnings growth.
Extra Space has funded this growth while maintaining solid financial metrics. Despite growing its dividend by 50% over the past year, Extra Space will only pay out about 73% of its projected funds from operations this year. That's enabling it to retain a meaningful portion of its cash flow to reinvest in continued growth. In addition, the REIT maintains a solid investment-grade balance sheet, providing additional debt capacity to fund new investments. This strong financial profile has enabled the REIT to grow its cash flow per share so that it can continue increasing the dividend.
Focusing on growth can pay big dividends over the long term
Passive income seekers can't afford to overlook an investment's income-growth potential. What might not look like an appealing income steam at first glance can grow into a gusher of passive income over time if the underlying asset has the potential of expanding its earnings at a healthy rate. Because of that, it's more important to focus on an investment's income growth potential than its current yield, since it could grow into a much larger income stream over the long term.
