3 advantages that could completely change your opinion of Prologis
When companies get big, like Prologis (PLD 2.24%), one of the largest real estate investment trusts (REITs) by market capitalization, there comes a time when many investors stop viewing their stocks as an opportunity for growth. Growth, after all, can be difficult when you already have the majority of market share.
Prologis shares are down 21% year-to-date largely for this reason: growing concern about the company’s ability to continue expanding in a changing economic environment. But before you dismiss Prologis as just a slow-but-steady way to a slightly above-average dividend yield, consider these three benefits that could change your opinion of the REIT.
1. Its growth in rents
Prologis has seen incredible year-on-year rental growth over the past few years. After the onset of the global recession, demand for industrial space – especially warehouses and distribution and logistics centers like Prologis owns and leases – skyrocketed.
Limited supply, which still weighs on the global market today, pushed global rental growth from less than 5% in 2019 to 20%. The net change in Prologis effective rent in the second quarter of 2022, which corresponds to the mixed rate of new leases and renewals, was 45.6% year-on-year. Taking into account an increase in operating expenses, its net operating income increased by 8.2%. That’s fantastic growth without even taking into account that the company is simultaneously expanding its portfolio very quickly.
16.4% of leases in its current portfolio are due to expire in the remainder of 2022 and 2023, giving the company even more leverage to increase rental income. And it has 10,700 acres of land ready for future development and $1.6 billion in active developments underway in 2022.
Rent growth obviously won’t stay near 50% forever. But it will definitely help the business grow in the meantime. With around 83% of its legacy leases set to expire after 2023, there are still many years of upside to come. And the limited supply for the foreseeable future will continue to weigh on the market and force rents to rise rapidly.
2. Limited space
The current supply of available industrial space, assuming no new developments are delivered, would last only 18 months. The historical average for the United States is 36 months of supply, which means the current supply is half the average. E-commerce, although slightly down after an initial boom due to the pandemic, is expected to grow steadily. Omnichannel e-commerce, which aims to create a seamless shopping experience offering things like online purchase and in-store pickup, curbside delivery, and online shopping, is very likely to increase. Which will directly increase the demand for industrial space with it.
The barriers to entry into the Prologis market are also increasing. Inflation-adjusted costs for new developments increased by 25% compared to last year. Higher costs coupled with higher interest rates and costly barriers to entry limit competition in the space and allow big companies like Prologis – who have the experience, knowledge and money – to d get more contracts.
3. Its access to capital
Prologis is seated on $5.2 billion in cash and cash equivalents, including its credit facilities, and has extremely low costs to access capital. Its latest debt issuance of $5.1 billion was at an average interest rate of 1.4%, which is lower than that of the US Treasury and gives the company a major advantage when it comes to expand its portfolio while making a profit.
Its low debt-to-equity ratio of 4.2 times earnings before interest, tax, depreciation and amortization (EBITDA) and a low payout ratio of 56% mean it won’t run out of money anytime soon.
The company is financing major acquisitions this year, including the purchase of Duke Real Estate, another industrial REIT, for $26 billion, which will completely change its financial situation. But Prologis has maintained an incredible track record over its more than 20 years of operation, and I don’t see that changing anytime soon.
This is not its first attempt to acquire bigger companies to increase its market capitalization. Last year, Prologis made an offer to acquire a European last-mile delivery company owned by The Blackstone Group, although the deal never went through. So, acquisitions funded by its strong liquidity is a theme that I think the company will repeat in the future.
Over the past decade, the REIT has delivered an annualized return of nearly 18%. It pays a dividend of around 2%. Its price-to-funds-from-operations (FFO) ratio, a metric that works similarly to earnings per share (EPS), is slightly high by REIT standards at 30 times. But for the growth that I think the company is capable of achieving, today’s price is still long-term value.