Shares of warehouse landlord Prologis (PLD -1.69%) have been falling of late because of a big acquisition effort and news that Amazon is subleasing some locations. Neither of these things are as bad as they sound when you step back from the picture a little bit. In fact, if the first quarter is any indication, this industry giant is in an "unprecedented" situation and that's not likely to change anytime soon.
The 800-pound gorilla
If you are looking to buy a real estate investment trust (REIT) with a logistics focus, Prologis is easily the biggest name in the space. It has a portfolio that covers 1 billion square feet across 4,675 buildings. It is globally diversified as well, with roughly 81% of its net operating income from North America, 5% from South America, 11% from Europe, and 3% from Asia. It is, essentially, in most of the key distribution hubs that exist across the world.
Image source: Getty Images.
This is one of the key reasons Prologis is viewed as a bellwether for the warehouse sector. And warehouses have been very, very hot over the last couple of years. That's partly because the pandemic shifted purchasing patterns, increasing the amount of online shopping. That required more warehouse space to move goods. Essentially, the so-called "retail apocalypse" was sped up. The impact on Prologis' business was huge.
During Prologis' first-quarter 2022 earnings conference call, CEO Hamid Moghadam explained:
... we are in unprecedented territory, I mean industrial rents historically. While some people actually used to say industrial rents are never going to go up. But industrial rents do go up and -- but they've never grown at these levels, but we've never had market conditions like we have now.
The numbers are huge, and likely to continue
What does "unprecedented" actually mean? In the first quarter, the REIT was able to increase rents on new leases by 37%. In just the U.S., the number was an incredible 41.5%. The wording here is important, though, because new leases are the key to the story. Same-store net operating income only rose 8.7% in the quarter. That's a nice number, but it is way lower than the 37% new-lease figure noted above. And that's the long-term opportunity here.
Prologis signs long-term leases for the assets it owns. So the bulk of its portfolio isn't up for a new lease in any given year, just a small portion of the total. The existing assets, however, are likely to have below-market lease rates because the deals were signed years ago. As leases roll over, the rental rate gets increased to the current level with the existing tenant, or Prologis finds a new tenant willing to pay the current market rate. Although management is very clear that rent rates can't continue to grow like they have in recent years, the rent increases that have taken shape are unlikely to retreat materially. So there should be a built-in boost from leases that roll over for many years into the future.
CFO Timothy Arndt, for example, noted on the first-quarter call: "Our lease mark-to-market of 47% provides substantial embedded earnings growth for years to come even without any further increase in market rents. The long-term growth outlook for our business and balance sheet has never been stronger." That's a pretty positive outlook that is likely to remain in place even if Amazon subleases space or if demand for warehouse space cools off some.
Focus on the underlying strength
When Prologis next reports earnings, investors shouldn't focus so much on what Amazon is doing or the REIT's effort to buy a peer. The big story is rental growth, and that's baked into the cake, to some degree, as expiring leases roll over to current rates. Indeed, don't get caught up in the headlines; for Prologis, the important numbers are a little bit deeper in the news flow.
