Prologis Sees Market For Logistics Space Turn Corner From Pandemic

The world's leading logistics real estate investment trust (REIT), Prologis Inc PLD, said demand for logistics real estate has held up well through COVID-19, accelerating further during June. Lease proposals are up 21% over the recent 30-day period given the scarcity of logistics space.

The San Francisco-based company reported better-than-expected second-quarter 2020 financial results Tuesday, with core funds from operations (FFO) coming in at $1.11 per share, 12 cents better than the consensus estimate and 34 cents higher year-over-year.

Earnings call reaffirms tightness in logistics real estate markets

On its earnings call with analysts, management said rent collection has been "excellent," with the company collecting 98% of June rents and 92.1% of July payments thus far. Deferred rents stood at 195 basis points in June and 70 basis points so far in July. France and the U.K. have been the most delinquent, but management asserts most of those late payments are from financially healthy companies that have taken the advice of their respective governments not to pay rents during the pandemic.

Management believes it will collect all cash on future rents except for what it has already recorded as bad debt, approximately 60 to 90 basis points. Historically, the company's bad debt expense hovers around 20 basis points and hits the 56-basis point level during the 2008-2009 financial crisis.

Rent amounts are expected to remain level in the second half of the year. Management still sees market rents in the U.S. on the favorable trajectory they were on prior to the downturn, albeit on pause currently. They believe high levels of occupancy and utilization entering this downturn place the logistics real estate market on firmer footing than in past recessions.

Further, they believe supply chains will carry as much as 5% to 10% in incremental inventory or "safety stock" in the future to avoid supply crunches like the ones seen in the early part of the outbreak.

Looking across the Prologis portfolio, 60% of its customers are expanding while some are shrinking. Verticals seeing the most strength are home improvement, including appliances, and food and grocery. Management said that while Amazon Inc AMZN has been busy building out its distribution footprint, market leasing activity has been "more broad-based than just Amazon."

The company's book of business is more diversified now as e-commerce accounts for 24% of new leases after climbing as high as 40% during the peak of the shutdown mandates.

On the potential for retail conversion — converting big-box retail properties into logistics warehouses — negatively impacting the tight supply dynamic, management expects conversions to occur but notes the process isn't easy. Most retail spaces have strict reciprocal easement rules and rezoning is a requirement. The conversion from retail to industrial is tough as retail locations are based in densely populated areas and local homeowners don't want the heavy-truck traffic in their neighborhood.

Asked why they haven't sold more of the properties that were acquired in recent deals as planned, management said they are in no rush to sell as the company is "underleveraged." However, they did highlight one transaction.

They are selling the Platform Portfolio, 22 warehouses in the U.K. that were acquired in the $13 billion acquisition of Liberty Property Trust. The properties are stand-alone facilities, outside of Prologis' core portfolio that consists primarily of assets in logistics and industrial parks. Management said they are receiving two to three times more letters of interest than originally expected. The initial guide price has been reported to total 435 million pounds (the U.S. $555 million).

Guidance raise

Prologis raised its 2020 guidance for core FFO to $3.70 to $3.75 per share, compared to the prior range of $3.55 to $3.65 and ahead of the consensus estimate of $3.59.

The company increased its outlook from the first quarter for development starts to a range of $800 million to $1.2 billion, still roughly half the initial 2020 guide. It also increased expected building acquisitions to a range of $500 million to $600 million and added in $250 million in new spec projects as they are much more confident in building spec now than they were in April.

The company's first-quarter guidance assumed no new capital deployment other than the projects already under contract.

Second-quarter results

Consolidated revenue increased 60% year-over-year to $1.27 billion, with rental revenue increasing 35% to $944 million. A more than threefold increase in strategic capital revenue and previous portfolio acquisitions were the key drivers. Lease starts increased 14% to 42 million square feet, customer retention climbed 150 basis points to 80.9%, but the occupancy rate slid 110 basis points to 95.7%. Asia saw a 320-basis point decline year-over-year in occupancy, down 210 basis points from the first quarter.

The 34-cents-per-share increase in core FFO was in part due to a 23-cents-per-share increase in net promote income, returns paid by third-party investors for performance exceeding expectations. No net promotion income was recorded in the prior-year period.

Prologis' key performance indicators

Prologis ended the second quarter with $4.05 billion in available credit and $549 million in cash. Including open-ended funds and liquidity of $3.3 billion in its co-investment ventures, Prologis has more than $13 billion in investment capacity. The company's investment funds have raised more than $2.2 billion in equity this year.

The company's debt-to-market capitalization ratio was 20%.

Shares of PLD are up 4% compared to the S&P 500 and FTSE NAREIT Composite, which are up less than 1% on the day.

Prologis' industrial real estate portfolio exceeds $90 billion in gross book value and total expected investment. The company's nearly one billion square feet of owned and managed properties spans 19 countries, serving 5,500 customers. Many of its warehouses in the U.S. service ports on both coasts, regional distribution hubs, and rail and intermodal facilities.

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