This year has been tough on real estate investment trusts (REITs). Rising interest rates, high inflation, and the cooling of the real estate market have made investors wary of REITs' near-term prospects.
Even the highest quality REITs have been affected. Prologis (PLD 0.69%), the world's largest REIT by market capitalization, is down 33% year to date despite the company having an incredibly strong year.
I see a lot of growth ahead for the stock in 2023, which is why I'm using the last few days of the year to buy more shares of this market leader while prices are down. Here's why you might want to as well.
Prologis is dominating a trillion-dollar market
Prologis isn't just the largest REIT by market capitalization, it's also the largest industrial operator in the world. The company has interest in or ownership of nearly 5,000 industrial buildings (covering the equivalent of roughly 1.2 billion square feet) on four continents. To say it's the dominant force in this industry is an understatement. Its properties house and facilitate around 3% of the world's gross domestic product (GDP).
The industrial REIT has a diverse tenant base across a wide range of industries, including third-party logistics, e-commerce, manufacturing, warehousing, and transportation. This provides a hedge against slowdowns in any one sector and helps it maintain healthy growth regardless of what a specific market or industry is doing.
A lot of Prologis' share price volatility this past year is a result of a growing concern about market saturation for industrial real estate. Amazon and FedEx, two of Prologis's tenants, have indicated plans to reduce their industrial footprint. Investors took this as a sign of a weakening economy and bad news for Prologis. Yet demand has never been stronger for the REIT's properties.
In the third quarter of 2022, Prologis saw its net effective rent -- the rent collected after concessions -- grow nearly 60% year over year, and its occupancy remains healthy at 97.7%. A lack of high-quality industrial space has led to record leasing demand and rapid rental growth in the U.S. and European markets, a momentum I see continuing.
This industrial giant is built to last
E-commerce is a large driver of long-term industrial demand. Some experts predict e-commerce growth will be around 11% yearly from 2021 to 2030. The supply chain challenges and the explosion of online shopping in 2020 and 2021 led a lot of manufacturers and suppliers to increase inventory and improve distribution speed, which helped accelerate that trend. But e-commerce isn't the only industry fueling long-term growth for Prologis.
Of the executed leases in the third quarter, 83% were outside of the e-commerce industry. It's also not relying on any single tenant to sustain its growth. Amazon didn't execute any new leases with the company in the third quarter, yet Prologis still had a record quarter for earnings.
The company also knows this unprecedented industrial growth won't last forever. The market will return to more normalized levels at some point, and Prologis remains ready to profit despite that.
Even if the company sees no increase in rent growth year over year, the number of renewing leases it has over the next five years would still provide an estimated 8% to 10% increase in net operating income simply due to higher lease rates compared to previous leases executed five to 10 years ago. And it has a fantastic financial profile with credit ratings of A, low debt ratios, and plenty of cash to help it keep growing.
It's a strong dividend payer with favorable pricing
Prologis has raised its dividend payouts for eight years in a row, amounting to a total dividend increase of 119% during that period. Today its yield is about 2.8%, which is more than 1 percentage point higher than the average for the S&P 500. And it has more than enough funds from operations (FFO) per share -- a metric that works similarly to earnings per share -- to cover its dividend payouts in the future.
The stock is also trading at a favorable price of 22 times its projected full-year FFO. This is on the higher side of valuations for REITs, but considering it's a premium REIT and the number is much lower than its historical range, it's a fair valuation.
The company's fundamentals haven't changed despite its lower pricing. While negative headlines and a slowing economy could push this stock down further in 2023, I believe it should continue to perform wonderfully for years to come. That is precisely why I'm using today's lower valuation as an opportunity to reinvest in this high-quality stock.
