Warehouses have been among the hottest properties in the real estate sector in recent years. Companies have had a voracious appetite for warehouse space, fueled by growing e-commerce sales and supply chain challenges. That has driven vacancies down to record lows while powering prodigious rent growth.
Prologis (PLD 1.86%) has been a key beneficiary of this upswing. The industrial REIT has grown at a torrid pace by capturing higher rents and expanding its portfolio. The company sees more growth ahead despite its expectations that we'll experience a modest recession this year.
NYSE: PLD
Key Data Points
The demand tailwinds remain strong
Prologis CFO Tim Arndt laid out the company's outlook for 2023 on its fourth-quarter conference call. He noted that the company "had outstanding results" (in that period) despite challenging headwinds from the capital markets and the overall economic backdrop. After discussing those numbers, he turned his attention to what was ahead.
The CFO stated: "With regard to our markets and leasing activity, the bottom line is that conditions remain healthy, and there is little we see across our results or proprietary metrics that point to a meaningful slowdown. We see a normalization of demand" from the pandemic-driven boom it has experienced in recent years.
When discussing the 2023 outlook, he continued: "While our macro forecast assumes a moderate recession, which may put headwinds on demand, our business is driven by secular forces and long-term planning by our customers that should limit the impact, unless such a downturn becomes significant and protracted."
The company does expect vacancies in its markets to rise as new warehouse developments come online. However, it anticipates occupancy to remain strong as supplies stay relatively constrained against continued healthy demand growth. Arndt said, "Putting this sentiment together with our outlook on supply and demand, our '23 rent forecast calls for approximately 10% growth in the U.S. and 9% globally."
While that's down from the 28% rent growth the company experienced last year, it's still well above the historical average. Further, the CFO noted that it's conservative on forecasting rent growth and sees this as a comfortable starting point amid the current macroeconomic backdrop.
Adding to its already sizable gap
Prologis doesn't need rents to grow this year. Due to the long-term nature of its leases, the company hasn't yet captured the full benefit of the significant rent surge coming out of the pandemic. The REIT estimates that the gap between the average rental rate on its existing leases and market rents (known as the mark-to-market) was 62% at the end of the third quarter. That represents $2.4 billion of incremental net operating income (NOI) potential as those leases expire and it captures market rates. Because of that, the company estimates it can grow its same-store NOI by 8% to 10% per year for several years without further rent growth.
However, with rents projected to rise by 9% despite the threat of a recession, that gap will widen further. The CFO stated, "We believe our lease mark-to-market will be sustained or even increase over '23, and end the year between 65% and 70%, and providing visibility to an incremental $2.9 billion of NOI after the more than $300 million that will become realized over the course of this year." That positions the company for strong NOI growth in the coming years.
This year, the company anticipates that its cash same-store NOI will grow by 8.5% to 9.5%. Add in the growth from development projects and acquisitions, and Prologis sees its FFO per share rising by about 9.5% in 2023. That's a strong growth rate for a REIT.
The company could continue delivering a leading growth rate in the coming years, given its embedded NOI growth from mark-to-market rents and vast land bank to support additional developments.
Recession-resistant growth
While demand for warehouse space has normalized from its pandemic-driven boom, it remains robust. Because of that, Prologis expects rents to continue rising this year despite a recession and increased supplies. That adds to its long-term growth potential. These factors make it a great growth stock to buy amid the macroeconomic worries, since a recession won't have much impact on its expansion.
