Wall Street is salivating over Public Storage Inc.'s $2.5 billion unsolicited offer to buy Shurgard Storage Centers Inc., anticipating a 70-basis-point rise in net operating income yield, even before tens of millions of dollars in cost cuts materialize.

There's just one problem: Shurgard's board of directors has flat-out rejected the bid, which, at the time it was made, was $53.40 a share and represented a 14% premium over Shurgard's share price at the end of July.

To the delight of the capital markets, however, Glenfield, Calif.-based Public Storage has fortified its effort to acquire Seattle-based Shurgard. In mid-August, Public Storage hired Goldman Sachs & Co. as a financial advisor to help make the proposed transaction a reality.

But Public Storage may have to increase its offer by 10% to 15% before Shurgard investors will force management to negotiate, predicts Jay Leupp, an analyst with RBC Capital Markets, who follows both companies. Another obstacle: Previous hostile takeover attempts among real estate investment trusts have crapped out.

Still, Public Storage has a good shot at pulling off such a deal, says Michael Mueller, an analyst with J.P. Morgan. “Public Storage has nothing to lose in going after this transaction, and if it works out, it will be good for their stock,” he says. “They see a company that has arguably stumbled, and a portfolio that they think they can operate better.”

Indeed, Shurgard is striving to cut expenses, boost occupancy and rebuild credibility after an accounting scandal two years ago. Among other reasons for rebuffing Public Storage, Shurgard says the offer doesn't fairly value its 640 operations in the U.S. and Europe.

But Public Storage made the overture after the two REITs failed to hammer out a deal on friendlier terms in July. (Public Storage and Shurgard reportedly have been in on-again, off-again merger discussions since 2000.)

Now, Shurgard sure has the characteristics of a company in play: The REIT's share price shot to a 52-week high of $55.20 after Public Storage made its offer. In mid-August, Shurgard was trading around $54 a share, even though it reported a net loss of $693,000 for the second quarter of 2005, compared to a $20.8 million profit in the same quarter last year.

Public Storage, meanwhile, was added to Standard & Poor's 500 Index in mid-August and reported net income of $108.3 million in the second quarter, a 17.2% hike over the same period in 2004.

“I think a deal makes great sense for shareholders of Public Storage and Shurgard,” says Craig Silvers, portfolio manager for Bricks & Mortar Capital, a Los Angeles-based real estate hedge fund that owns an undisclosed number of shares in each REIT. “Absent this offer, Shurgard wouldn't be trading above $50 a share.”

A Public Storage-Shurgard combination would follow some $3 billion worth of friendly mergers in the self-storage sector over the last couple of months.

Why does self-storage appeal to investors? The popular 1990s adage that “the one with the most stuff wins” has a bit to do with it. Consumers have more material goods, but need to stash away those belongings more often due to divorce, death, relocation and other events.

Self-storage properties generate decent returns and are cheap to develop and operate, Silvers says. The National Association of Real Estate Investment Trusts reports that self-storage equity REITs generated total returns of 19.33% through July 29 of this year, while the entire equity REIT index reported total returns of 14%.

Moreover, Silvers adds, self-storage companies have made their properties palatable by concentrating on architectural embellishments, such as faux windows to better blend into neighborhoods. That has helped fuel their proliferation in densely populated markets. “Self-storage has become a need,” he says, “and cities have become more accepting of these nicer buildings over the years.”

VITAL SIGNS OF SELF-STORAGE HEAVYWEIGHTS

Public Storage Inc. (NYSE: PSA)

Headquarters: Glendale, Calif.

Portfolio: 1,480 facilities in the U.S.

Market Cap: $8.5 billion

2004 Revenues: $788 million

2Q/2005 EPS: 47 cents

Occupancy: 92.4%

Shurgard Storage Centers Inc. (NYSE: SHU)

Headquarters: Seattle

Portfolio: 640 facilities in the U.S. and Europe

Market Cap: $2.5 billion

2004 Revenues: $425.7 million

2Q/2005 EPS: 8-cent loss

Occupancy: 86% (U.S. properties); 78% (European properties)