Industrial real estate has had a very positive few years. The sector has grown by leaps and bounds as the rise of e-commerce has led to a greater and greater need for logistics and warehouse space. At the center of it all is Prologis (NYSE: PLD), the largest real estate investment trust (REIT) focused on industrial properties. It's not surprising that Prologis had a successful 2020, but their year-end earnings show not just a big year in the rearview mirror but also positive signs of growth in the future.
The biggest gets bigger
Prologis had net earnings of $0.38 per diluted share in the fourth quarter compared to $0.61 for the same period in 2019. However, core FFO per diluted share was $0.95 for the quarter compared to $0.84 for the same period in 2019. Overall, for 2020, core FFO per diluted share was $3.80 compared to $3.31 the previous year.
Prologis completed $17 billion in mergers and acquisitions in 2020. At the same time, it saw an increase in leases so rapid that it leased over 1 million square feet of space per business day in the fourth quarter. Much of the new leasing activity came from consumer products as well as food and beverage. E-commerce alone represented nearly 20% of new leases. Short-term leasing was up by 58% as retail customers sought increased flexibility.
All that demand led to an increase in pricing, up 3.2% for the year, a strong result during a pandemic. Prologis expects rents to increase by 5% in 2021.
Prologis also benefits from the increased value of its global footprint. It estimated that the value of its real estate rose by $7 billion in the fourth quarter alone. Europe was heavily impacted by COVID-19, but Prologis saw rents start to tick up in the U.K. and Europe toward the end of 2020. The continued fallout from Brexit is actually good news for Prologis, leading to a need for companies to hold higher inventory and have larger warehouses.
Pandemic trends could stick around
Online shopping in the U.S. during the holiday season was up 32.2% from 2019. While e-commerce may dip as people return to retail shopping and start to shift their discretionary income back to travel and experiences, the longtail trend of people shopping online isn't going anywhere. While Amazon (NASDAQ: AMZN) is a major customer, Prologis isn't just banking on the e-commerce giant. "While we'll see plenty of Amazon, I am really encouraged by the other uses," said Michael S. Curless, Chief Customer Officer, on the earnings call. "We just signed a big lease with Kraft (NASDAQ: KHC) about a month ago, and working with a ton of brand names next year we'll be happy to talk more about."
The global disruption of COVID-19 showed just how weak many supply chains are. Space utilization of Prologis facilities actually dropped as customers ran out of stock. As companies slowly begin to restock, they may have an eye toward keeping inventory levels high. The lack of inventory may have led to a reduced need for square footage in the short term but will lead to an increase over time as companies plan ahead.
Prologis estimates an incremental demand of 200 million square feet or more for e-commerce alone. With containerized imports slowly rising, it's likely that even a small increase in inventory will lead to a bigger demand for capacity over time.
Prologis isn't slowing down in 2021 but is anticipating between $2.3 billion and $2.7 billion in new development. The company expects year-over-year growth of more than 10%, and it expects to generate over $1 billion in free cash flow.
Is it possible to be too big?
Prologis had a solid fourth quarter, and its future looks bright as the economic tailwinds for industrial real estate continue. With a market capitalization of over $70 billion, Prologis is the giant in its space. Trillions of dollars in goods pass through Prologis facilities each year, making it not just a top REIT but also a player in the world economy as a whole.
However, as my colleague Matt DiLallo recently mentioned, that size may mean that it doesn't have the growth potential of some of its rivals. Prologis is primed for steady expansion, but when you're already at the top, there may be only so far you can go.