Behind the Business: 3 Questions for ProLogis

Shareholders don't just own stocks. We invest in businesses. Every share we buy purchases a stake in a company -- a sliver of a living, breathing enterprise run by a management team that ultimately determines the fate of the money we invest.

That's why The Motley Fool regularly contacts public companies and executives on our community's behalf, asking them the questions shareholders would find relevant. Because while quantitative measures are important, it's also crucial for investors to assess the less tangible aspects of the businesses they own (or are thinking of owning).

We recently surveyed select companies to gain insights into their business. Today we highlight ProLogis (NYSE: PLD  ) :

Headquarters	Denver
Market Cap	$6.6 billion
Industry	Real estate investment trust
Related Companies	AMB Property (NYSE: AMB  ) , First Industrial Realty (NYSE: FR  ) , PS Business Parks (NYSE: PSB  ) , Developers Diversified Realty (NYSE: DDR  )

Following are ProLogis' answers to our email query about the business.

What steps have you taken to navigate your business through the economic turmoil of the past 12 months?
In the face of the seminal events of the last year, we moved quickly to implement an action plan, and over the last 12 months have proven our ability to execute in this tough environment. Our primary goals under this plan included de-leveraging our balance sheet by $2 billion by the end of 2009 and de-risking the company by reducing the size of our development portfolio, through both asset sales and a halt in new development. In addition, we undertook a comprehensive effort to retain capital by reducing spending and lowering our cash dividend.

Over the last 12 months, we have created $6.6 billion of liquidity through asset sales, contributions of properties to our investment management funds, and issuances of debt and equity. Proceeds from these activities were used to refinance, repay, and repurchase debt as well as to fund the remaining costs associated with properties under development. In all, we have reduced debt by close to $3.1 billion -- far exceeding our de-leveraging goal. We reduced the risk in our development portfolio through the lease-up of more than 17.8 million square feet of space and substantially reduced our general and administrative expenses by roughly one-third to better align spending with our current business activity level.

We are a stronger company today, but market conditions are still tough, even though we are seeing early signs of stabilization. Given the market drivers that support demand for distribution space over the long-term remain intact, the steps we are taking today will put us in a stronger position for when the time is right to invest.

What are the top two or three metrics to which your business pays the closest attention?
There are a number of market drivers supporting demand for global distribution space. Year-to-date results for the U.S. industrial markets are not surprising: Occupancies have declined, rents are down, and absorption is negative. Absorption, or net take-up, of bulk industrial space in the top 31 markets in the United States in 2009 is expected to be 180 million square feet less than in 2007. This is a staggering decrease, but statistics show the United States has never experienced a full year of negative bulk industrial space absorption in the past 25 years. It is expected that 2009 will be the year in which this does occur, but it's very unlikely that trend will continue for an extended period of time due to the strong correlation between real U.S. GDP growth, which resumed in the third quarter, and growth in occupied warehouse space.

This strong correlation is one of the factors that keeps industrial facilities well leased compared with sectors such as office or retail. Over the last 25 years, average occupancies in the top 31 U.S. industrial markets only twice dipped below 89%. One of the keys to this high occupancy is a short construction cycle. With a six-month turnaround from ground-breaking to move-in, developers of bulk distribution facilities can react quickly to market conditions and adjust supply. Builders have done just that in 2009 with projected starts in the U.S. expected to be less than 15 million square feet, the vast majority of which will be pre-leased.

In Europe, fundamentals are holding up better. To date, net absorption has remained positive in Southern and Central Europe, and market rents have been more resistant to downward pressure than in the United States. Some of this resilience could be due to European economies entering the downturn later, or a result of the longer, more challenging entitlement process that acts as a natural constraint on new construction.

Over the longer term, we believe Europe will benefit from the ongoing evolution of its supply chain. The advent of the EU in 1992 brought with it demand for larger, regional distribution centers that had not previously existed. The smaller facilities that did exist were no longer adequate for large-scale distribution, and the need to upgrade those facilities will be a key driver that supports demand for distribution facilities over the longer term. This, coupled with the return of consumer spending and continued migration of manufacturing jobs to the east, increasing the buying power of citizens there, should support demand over the longer term.

Japan has proven adept at dealing with flat or slightly negative economic growth. While we have seen activity slow, rents and occupancies are not under as much pressure as elsewhere in the world. We expect that Japan will continue the distribution network reconfiguration that was underway prior to the global recession. Companies also continue to shift to leasing, rather than owning, their real estate. This trend, coupled with functional obsolescence, as buildings that were adequate during the postwar boom are replaced with more efficient facilities, will also continue to be major drivers of demand.

In most markets around the world, population growth will continue to play a role in demand complemented by consumers' desire for greater selection, which results in product proliferation. As manufacturers strive to meet those demands to retain market share, their supply chains grow and become more complicated -- creating demand for modern industrial space.

There are other factors that support the long-term attractiveness of the bulk industrial property sector. Only about 15% of distribution facility leases expire each year; considering high average tenant retention of 60-65%, this translates into only 4-5% in annual lease turnover. And when buildings do change customers, the relatively small amount of interior finish means lower costs to prepare the space for new tenants, as well as low ongoing capital maintenance costs. Furthermore, most industrial properties have triple-net leases, which means that the majority of increases in taxes, utilities and insurance are passed on to the customer. All of these factors combined contribute to a higher level of certainty and consistency of cash flow compared with other property sectors.

In addition, we anticipate the eventual return of rising rental rates. We believe it is not only demand that will drive lease rates higher; it is also development reluctance. In response to soft market conditions, developers are on the sidelines today. When demand returns, there will be a sizable gap between current market rents and the rents needed to generate a development profit. Either construction costs will need to decline, or rents will need to rise before developers will again take development risk. While these factors do not magically create growth in a down economy, they represent long-term trends that will drive demand.

Now that the first decade of the new century is drawing to a close, we'd like to take a moment to reflect on what lies ahead. What excites you most about your business?
Industrial real estate is built on the global demand drivers we outlined above. It can respond to market conditions surprisingly quickly. It is straightforward, comprehensible and relatively predictable. A recovering economy, which we believe will take hold more firmly in 2010, will translate into increased demand for the state-of-the-art facilities that are ProLogis' hallmark. Our global platform, premiere land position, strong customer relationships, and strengthened balance sheet will allow us to capitalize on these opportunities as they emerge.

ProLogis is rated three stars (out of a possible five) by our Motley Fool CAPS community. Do you agree with our community's bullish assessment? Click here to rate the stock and cast your opinion.