Earnings season is now underway, and we're starting to hear from some of the largest real estate investment trusts (REITs). Industrial real estate has been on fire recently, and top industrial REIT Prologis (NYSE: PLD) reported its latest results. To put it mildly, the numbers were extremely impressive. In this article, we'll take a closer look at the key numbers and what we're watching going forward.
Prologis' third-quarter rent growth stole the show
First, the headline numbers. Core FFO (funds from operations) is essentially the REIT equivalent of "earnings," and Prologis reported $1.04 per share for the third quarter, a 16% year-over-year increase.
However, unlike many other REITs that report large FFO jumps, the 16% increase isn't primarily due to a surge in acquisitions, nor is it because of the comparison with the pandemic-burdened third quarter of 2020. In fact, Prologis was a major beneficiary of the surge in e-commerce we saw last year.
By far, the most impressive part of Prologis' earnings report is its rent growth. Its cash rent grew by nearly 13% year over year, and same-store net operating income (the income generated by properties Prologis owned last year) increased by 6.7%. This shows just how strong demand is for industrial real estate and how it is translating into pricing power for industrial REITs like Prologis. This is record-high rent growth for the company. What's more, Prologis believes that current market rents are 22% more than tenants are currently paying, so as leases expire, this record level of rent growth should continue.
As CEO Hamid Moghadam said in the company's earnings release, "With vacancies at unprecedented lows, space in our markets is effectively sold out." And he's right. Occupancy is up by 60 basis points from the second quarter, and 98% of the portfolio's square footage was leased at the end of September.
Industrial real estate is in demand, and Prologis is capitalizing on it
Prologis is aggressively deploying capital to take advantage, with over $1.4 billion in development starts in the third quarter alone, in addition to $373 million spent on acquisitions. For the full year, Prologis anticipates spending at least $3.5 billion on development starts and approximately $2 billion on acquisitions, an aggressive rate of growth even for a REIT with a $105 billion market cap.
This could be a major value driver for investors -- after all, Prologis can borrow money very cheaply (it recently issued $1.3 billion of debt at 2.1%) and it expects a 5.8% yield on new development and a margin (value relative to cost) in excess of 36%. It doesn't take any complex mathematics to see why the company would want to build new properties quickly.
It's also worth noting that Prologis' debt load is very low, as a debt-to-capitalization ratio of less than 17% is less than half of what most other REITs use. The company has $5.5 billion of cash on hand that it could invest, as well as enough borrowing capacity to bring its total liquidity to $15 billion.
The Millionacres bottom line
According to a report by Cushman & Wakefield, demand for industrial real estate outpaced new supply by about 120 million square feet through the first nine months of 2021. New supply through the first three quarters was 246.6 million square feet, while the market absorbed 365.9 million. And the latter figure was nearly double the absorption through the first nine months of last year.
In short, industrial real estate demand is incredibly strong right now. Industrial REITs have an amazing opportunity to create value right now, and with tremendous liquidity and access to cheap capital, Prologis is in a strong position to benefit.