Demand for industrial real estate is hotter than ever, according to giant industrial real estate investment trust (REIT) Prologis (NYSE: PLD). The company's CEO Hamid Moghadam stated in its recent second-quarter earnings report that "demand for logistics space is robust and diverse, and operating conditions remain the healthiest in our 38-year history."
Because of that, he continued, "vacancies in our markets are at all-time lows, contributing to record rent growth." That helped Prologis report exceptional second-quarter results while allowing it to raise its full-year outlook yet again.
On its second-quarter conference call, the company provided a bit more context on what's driving this demand. Here's a closer look at those catalysts and what the company sees ahead for the industrial real estate sector.
Intense demand from all sides
Prologis' CFO Tom Olinger discussed the current market environment on the REIT's second-quarter call, noting that "In the second quarter, lease signings were 64 million square feet, and lease proposals were 84 million square feet; both remain above average and were driven by new and development leasing. Likewise, the Prologis IBI Customer Activity Index reached a new high in the second quarter, an early indicator of strong future demand."
The CFO also noted that their leasing mix is broad. While the company is seeing the greatest demand for spaces above 100,000 square feet, activity is picking up for smaller spaces, with the REIT signing its highest volume of leases in that segment in three years.
Demand is coming from all customer segments, though "e-commerce continues to lead the way, representing 30% of new lease signings in the second quarter," according to Olinger. He noted that "while Amazon remains steady at 6% of total new leasing, we have seen many more e-commerce players come to the table."
The company signed 168 e-commerce leases during the first half of this year, up from 51 in the same period in 2020. In addition to e-commerce, companies are beginning to restock their inventory levels, which the CFO believes will create more demand going forward.
Running low on room
Prologis doesn't expect demand to cool off anytime soon. Because of that, market conditions should remain strong as new supplies are barely keeping up with demand. In the U.S., Prologis sees customers absorbing 360 million square feet of space this year, up 20% from its prior forecast. Meanwhile, it expects new deliveries to come in 8% higher than its previous forecast, though at 325 million square feet, that's below projected demand.
As such, the company expects the industry's historic low vacancy rate of 4.5% to carry into 2022, which should drive continued rent growth. Olinger stated that "customers continue to compete for space and are making decisions faster," which is contributing to strong rental growth rates.
Prologis also noted that it's getting harder to build new warehouse space due to several issues. Olinger pointed out that "significant barriers exist in our markets and include a lack of buyable land, increasingly difficult and expensive permitting and entitlement processes, and rapidly escalating replacement cost" due to inflation on building materials, land values, and wages.
However, Prologis does have a leg up on the competition because of the company's extensive land position -- which can support $18 billion of future developments -- that enabled it to boost its 2021 development start forecast by 10.3% to a range of $3.05 billion to $3.35 billion. Meanwhile, it expects to stabilize $2.2 billion to $2.4 billion of developments this year, up 9.5% from its prior guidance range, thanks to strong demand for space.
Increasingly valuable real estate
With intense demand for warehouse space pushing occupancy to historic levels, rental rates are rising fast. That's making industrial real estate increasingly valuable, with Olinger noting that Prologis' asset values rose 8% in the second quarter alone.
And that number should keep rising, given that existing rates on many leases are well below market values, giving it room to continue growing income at its legacy properties as those leases expire. Those factors make industrial REITs look like attractive investment options.