Shares of real estate investment trust (REIT) Prologis (PLD 0.27%) have fallen over 30% so far in 2022. That type of drop might suggest that the warehouse landlord is facing material difficulties, but that's not the case. Here's why Prologis will be a bigger and better company a year from now no matter what Wall Street thinks of its stock.
Irrationally up and down
Part of the reason why Prologis' stock has fallen so much in 2022 is because it rose so much in 2020 and 2021. The story behind the uptrend is fairly easy to understand. When the COVID-19 pandemic hit in early 2020, people were forced to socially distance, and online sales drastically increased. That meant there was a huge need for warehouse space, which is exactly what Prologis provides.
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Wall Street has a tendency to take a trend and extend it way too far into the future. Thus, Prologis seemed to have huge growth potential over the long term. That thesis, however, came to a screeching halt in 2022 when Amazon.com announced that it had overspent on warehouse space. Suddenly, investors were concerned that there was too much warehouse capacity, and they started to sell Prologis.
Which story is correct? The answer is probably somewhere in the middle.
Demand remains robust
Prologis, for example, hasn't seen demand for its space fall off. The REIT's occupancy stood at 97.7% in the third quarter of 2022. That's extremely strong, though management suggested that the full-year figure could fall to 97.25% at the low end of its guidance. Even the low end of guidance is still a great number. So, clearly, demand remains robust, though perhaps occupancy isn't going to increase in the near term.
And yet, Prologis was able to increase its rent on renewal leases by a huge 59.7% year over year in the quarter. Although this figure, too, could fall, the key takeaway is that the REIT is seeing leases end with tenants eager to resign at current, much higher, lease rates. Tenants simply aren't leaving to look for lower leases or building new warehouses. That's a function of the impact inflation is having on construction costs and the highly desirable locations Prologis has in key international transportation hubs, among other things. But this clearly suggests that Prologis' business is not falling off a cliff. Far from it; it remains very robust.
One area where Prologis is getting materially more cautious is on the construction front. Management believes it has a $37 billion pipeline of investment projects on land it currently owns. In good times, it could simply build a warehouse and then find a tenant, which is known as building on spec. Today, however, it has decided that it needs to be more prudent, "aiming to be very selective in new projects" and focusing more on construction with tenants that are already lined up.
That hints of a construction slowdown over the near term, not a complete stop. It's also just a prudent response to market conditions, which should be reassuring for investors. Over the long term, assuming the world continues to become more interconnected, the company's massive investment pipeline still offers huge built-in growth opportunities.
Prologis' growth isn't over yet
When you dig in a little bit, Wall Street isn't wrong to be worried about a slowdown in Prologis' growth over the near term. But the REIT is still likely to grow over the next year or more, with strong occupancy trends supporting rent growth and additional construction, even if the pipeline is smaller. Investors overreacted on the upside, but they may also be overreacting on the downside here. Prologis remains soundly in growth mode today.
