When companies become big, like Prologis (PLD 0.72%), one of the largest real estate investment trusts (REITs) by market capitalization, there's a point at which many investors stop looking at their stocks as a growth opportunity. Growth, after all, can be challenging when you already have the majority of the market share.
Shares of Prologis are down 21% year to date, largely for this reason: increasing concern over the company's ability to keep expanding in a changing economic environment. But before you dismiss Prologis as simply a slow but steady way to earn a slightly better-than-average dividend return, consider these three advantages that could change your opinion about the REIT.
1. Its rent growth
Prologis has experienced incredible year-over-year rent growth over the past few years. After the onset of the global recession, demand for industrial space -- particularly warehouses and distribution and logistics centers like Prologis owns and leases -- went through the roof.
Limited supply, which still strains the global market today, has pushed global rent growth from under 5% in 2019 to 20%. Prologis' net effective rent change in the second quarter of 2022, which is the blended rate of new and renewing leases, was 45.6% year over year. Accounting for an increase in operating costs, its net operating income rose by 8.2%. This is fantastic growth without even taking into consideration that the company is simultaneously and very rapidly expanding its portfolio.
16.4% of leases on its current portfolio are set to expire in the remainder of 2022 and 2023, which gives the company even more upside to grow its rental revenue. 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 sustain itself at nearly 50% forever. But it will certainly help the company grow in the meantime. With roughly 83% of its legacy leases are set to expire post-2023, there are still many years of upside to come. And limited supply in the foreseeable future will continue to strain the market and force rents to grow rapidly.
2. A limited supply of space
The current supply of available industrial space, assuming no new developments are delivered, would only last 18 months. The historical average for the United States is 36 months of supply, meaning today's supply is half the average. E-commerce, while down slightly after an initial boom due to the pandemic, is expected to grow continuously. Omnichannel e-commerce, which aims to create a seamless shopping experience offering things like buying online and picking up in-store, curbside delivery, and online shopping, is very likely to increase. Which will directly increase demand for industrial space with it.
Barriers to entry in Prologis' market are also increasing. Inflation-adjusted costs for new developments are up 25% over the last year. Higher costs coupled with higher interest rates and the expensive barriers of entry limit competition in the space and allow large companies like Prologis -- which have the experience, knowledge, and money -- to gain more deals.
3. Its access to capital
Prologis is sitting on $5.2 billion in cash and cash equivalents, including its credit facilities, and has extremely low costs for accessing capital. Its latest issuance of debt of $5.1 billion was at an average interest rate of 1.4% which is lower than the U.S. Treasury and gives the company a major upper hand when it comes to expanding its portfolio and still turning a profit
Its low debt ratio of 4.2 times its earnings before interest, taxes, depreciation, and amortization (EBITDA) and a low payout ratio of 56% mean it's not at risk of running out of money anytime soon.
The company is funding some big acquisitions this year -- including the purchase of Duke Realty, another industrial REIT, for $26 billion -- which will completely change its financial position. But Prologis has maintained an incredible balance sheet for its 20-plus years of operation, and I don't see that changing anytime soon.
This isn't its first attempt to acquire larger companies to boost 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 I think the company will repeat well into the future.
Over the last decade, the REIT has provided a nearly 18% annualized return. It pays a dividend yielding roughly 2%. Its price-to-funds-from-operations (FFO), a metric that works similar 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 a value for the long haul.
