When Wall Street gets a story in its head, the facts on the ground at individual companies often stop mattering. Basically, the baby goes out with the bathwater. That appears to be the case today with Prologis (PLD 0.69%), the largest publicly traded warehouse landlord. That's too bad, because investors willing to do a little digging will find that management is very clear about the future remaining quite bright.
The problem
People started working from home and social distancing when the world was dealing with the coronavirus pandemic in 2020. That resulted in a boost in online shopping and increased the demand for warehouse space. Adding to the issue were supply chain problems that required companies to hold extra inventory. Investors loved the story and pushed up the share prices of real estate investment trusts (REITs) like Prologis that own warehouses.
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Then the world started to open back up again. There wasn't as much need for warehouse space, highlighted by Amazon announcing that it was pulling back on its warehouse expansion plans. Suddenly investors were worried that there was now too much warehouse space and the warehouse REITs that were market darlings suddenly became market pariahs.
But if you look at the results that Prologis has been seeing in its portfolio, the fear seems misplaced. For example, occupancy in the first quarter was 98%. That's a huge number that speaks to strong demand. Adding to that is the fact that leases that were being rolled over in the quarter witnessed average rent increases of 68.8%.
Once again, that's an almost shockingly large number, but in line with recent quarterly trends (rents rose 50% in the fourth quarter of 2022 and over 38% in the third). In fact, rent hikes are still going up. If the warehouse industry were weakening, you'd expect rents to be going down.
More good news to come
While it probably isn't reasonable to expect 60%+ rent rollovers every quarter, Prologis is still telling investors that there's more good news ahead. That's because leases are signed over time and roll over at different points. This isn't a one-time event or even a one-year event. Old leases signed when rental rates were lower will be rolling over and increasing to market rents for a while. Prologis is very clear on this point.
According to the company, "If all leases were to reset to market today, rents would be 68% higher." That's an indication of the size of the opportunity that lies ahead, assuming that rents flatline at current levels. This makes it all the more interesting that the company also said that "As leases continue to roll to market, our portfolio would see 8%-10% net effective same-store NOI for several years." So the rent increases in the portfolio will play out over years and lead to very strong growth.
It might help to put a number on this. According to Prologis, its current net operating income is around $5.2 billion a year. If it were to mark up all of its rents to current lease rates, it would add $2.7 billion to that total, bringing operating income up to $7.9 billion. The company believes that this will lead to as much as $3 in additional funds from operations (FFO) per share. While that won't happen in one year, it is a pretty good target for investors to watch over the next several years.
The story is still good
Investors have soured on warehouses and Prologis. But the story here is just as good as it was a couple of years ago, when investors seemed to love the REIT and its warehouse peers. The best part, however, is that as FFO continues to rise, so should the dividend. And that could easily keep the double-digit dividend increases of recent years going. If you are a dividend growth investor, Prologis and its 2.8% dividend yield are worth a deep dive.
