Prologis Sets Rent Growth Records, CEO Remains Optimistic Amid Geopolitical Turmoil

Prologis reported slightly dented third-quarter earnings Tuesday following several quarters of strong returns, an indicator of the impact rising interest rates and a gushing pipeline of new supply have had on the industrial real estate market.

Still, the global REIT beat analyst estimates and turned in record rent growth along with nearly full occupancy at its properties. Company executives on an earnings call Tuesday discussed various threats to the economy and the industrial sector. 

In the face of geopolitical concerns, specifically the latest war between Israel and Hamas, Prologis CEO Hamid Moghadam indicated he wasn't concerned about the potential impact to his company's bottom line.

“The nightmare scenario would be that, you know, a couple of tankers get sunk in the Persian Gulf at the narrow end and oil goes to $200 a barrel,” Moghadam said. “The bets are off. But boy, if we see that scenario, I can't think of a better business to want to be in. I hate to see that scenario happen, but actually, on a relative basis, it should be good for our business.”

Moghadam went on to say that industrial inventory would escalate in importance in such a scenario, leading suppliers to switch from a just-in-time mindset to just-in-case, similar to what the global logistics market experienced during the early days of the pandemic. 

“I hate to say it would be good because it's an awful situation that's going there, and before this is all over, a lot of innocent people are going to get killed, and I don't want to see this happen,” Moghadam said. “But I don't think the impact on the business on a relative basis is going to be terrible.”

Moghadam said he is more concerned about upcoming actions by the Federal Reserve's Federal Open Market Committee, which could announce another interest rate hike at its November meeting. An increase would be the 12th such action the committee has taken to slow inflation since early 2022.

The increases have brought the base interest rate to between 5.25% and 5.5%, a drastic jump in a short period that has slammed the brakes on many real estate deals.

Prologis' short-term cost for development funding is 6%, Chief Financial Officer Tim Arndt said on the call. As the company ramps up development, interest expenses weigh on core funds from operations, which ticked down to $1.30 in Q3 from $1.73 for the same period in 2022.

The San Francisco-based industrial giant reported a net effective year-over-year rent rise of 84%, an all-time high. On a cash basis, the annual growth in rent was 54.2%, also an all-time high. Revenues from rents have spiked for Prologis. In the first nine months of 2023, rental revenue came in at about $5B, up from $3.3B in the same period last year.

Prologis executives also mentioned the company's recent forays into data center development during the earnings call but declined to give too many specifics, saying that the company would have more information about its data centers at an investor meeting in December.

Still, they said that data centers represent a strong new avenue of growth for the company.

“If you can get the power, the demand is there, and it's been boosted by AI and a bunch of other things,” Moghadam said. “So we see a rush of the large players — and they're all big-credit players — into the business, and they can't get enough of this stuff to keep up with demand.

“The margins embedded in the data center development are orders of magnitude higher, certainly on the basis of market value on their industrial use or purchase price on their industrial use.”

Data centers accounted for a “pretty significant volume” of Prologis' build-to-suits, while logistics built-to-suit activity was in line with the company's expectations, Moghadam said.

In addition to record rent growth, Prologis turned in a relatively strong Q3, though cooled from last year.

Prologis' net earnings per share came in at 80 cents for the quarter, down from $1.36 for Q3 2022. 

Arndt characterized industrial markets as strong but off their peak from the last two years, as demand declines and an overhang of supply that broke ground during the boom years continues to come online.

But the supply-demand imbalances will be temporary as development slows into next year, Arndt said.

“While rising, vacancy remains historically very low in the U.S., Mexico and Europe, market vacancy increased approximately 70 basis points during the quarter in the U.S., driven by low absorption as well as recently delivered but unleased completions,” Arndt said. 

The company predicted that for the U.S., completions will outpace net absorption by 150M SF to 200M SF over the next three quarters, according to Arndt. Then, during the three quarters after that, the trend will reverse, with demand exceeding supply by 75M SF to 125M SF.

The company will continue to see rent growth globally over the coming year, albeit at a slower pace while the pipeline is absorbed, Arndt said.

Occupancy at Prologis properties came in at 97.1% for the quarter, down from 97.5% the previous quarter, with 46.4M SF leased in Q3.

“Whatever the precise path, we expect that as vacancy normalizes over the long term, our portfolio will outperform the market due to both its location and quality, as well as the strength of our relationships and operating platform,” Arndt said.