Prologis (PLD 0.07%) continues to benefit from robust demand for warehouse space worldwide. Persistent supply chain issues have companies changing their inventory management practices, which is one of many factors driving demand for warehouses. These strong market conditions are evident in the first-quarter 2022 results for the real estate investment trust (REIT).
In-demand real estate
Prologis reported another excellent quarter. The industrial REIT delivered $1.09 per share of core funds from operations, up 12.4% from the prior-year period. A big driver was the robust underlying performance of its legacy portfolio, evidenced by strong occupancy levels and surging rental rates:
Occupancy remained high, holding flat with the fourth quarter of 2021. While that's a shift from the growing occupancy over the last few quarters, chief financial officer Tim Arndt noted on the quarterly conference call that it was "counter to the typical first-quarter decline" the company historically sees this time of year.
Its tenant retention rate also remained high because of that strong occupancy level, enabling Prologis to capture much higher rental rates as leases expired. Arndt said on the call that the "rent change on rollover was 37% on a net effective basis and was led by the U.S. at 42%. Notably, our Southern California and New York, New Jersey portfolios realized 86% and 67% rent change during the quarter, respectively." That helped drive record growth of 8.7% in same-store net operating income (NOI) in the quarter.
Enormous growth potential
Because Prologis typically signs long-term leases with customers, a significant portion of its current contracts are well below market rates. Arndt said that the current mark-to-market on its leases (the difference between the existing rate and the current market rate) is now 47%. And he added that "given our market rent forecast and expected rent change, the lease mark-to-market could exceed 50% by year-end."
Arndt said that "this equates to $1.6 billion of annual NOI as leases roll to market, or over $2-per-share of earnings that will drop to the bottom line even with no additional rent growth." With the company currently generating $3.5 billion of NOI, this estimate implies 46% income upside potential without any more market improvement or new investments.
However, Prologis has a long history of making value-enhancing investments:
Arndt said that the company started more than $1 billion of new developments in the first quarter across 32 projects in 16 markets that it expects will create $400 million in shareholder value. Meanwhile, its land bank now stands at $28 billion, enough to potentially build 200 million square feet of new warehouse space.
The REIT has ample financial flexibility to fund new investments. Arndt said on the call: "The balance sheet remains in excellent shape, our debt-to-market cap is very low at 14%. We have nearly $7 billion of liquidity and over $18 billion of investment capacity across Prologis and our open-ended funds." Because of that, Prologis can continue taking advantage of the strong market conditions to make value-enhancing investments in developing additional warehouse space.
An extremely well-positioned REIT
Prologis' global warehouse portfolio is benefiting from nearly unstoppable demand. Because of that, more existing tenants are renewing their leases despite surging rental rates, keeping occupancy levels high. These strong market conditions also enable Prologis to continue developing new properties to create additional value for shareholders.
With enormous embedded rent-growth potential, a top-notch balance sheet, and a vast land bank, Prologis appears poised to continue growing briskly for the next several years.