Like most real estate investment trusts (REITs), logistics giant Prologis (NYSE: PLD) cut its guidance earlier this year as the COVID-19 outbreak started shutting down the economy. The industrial REIT revised its outlook for earnings, occupancy, and growth due to the pandemic's uncertain impact.
However, a few short months later, the company revised its outlook again -- this time for the better. While there's still some caution in its most recent forecast, this quick reversal shows just how strong market conditions are in the logistics sector compared to other real estate subgroups.
The round trip back to optimistic
When Prologis initially unveiled its 2020 guidance in January, it was coming off "another strong year with annual growth in core FFO of approximately 10%, excluding promotes," according to CFO Thomas Olinger. However, as good as last year was, the CFO stated that he felt "even better about our outlook given the acceleration in operating metrics from our substantial embedded rent upside."
That initial forecast had the company projecting that core FFO would range between $3.67 and $3.75 per share, which would be up 12% from the prior year at the midpoint. Driving that optimistic view was the company's belief that occupancy would end the year between 96% and 97%, cash same-store NOI would grow by 4.25% to 5.25%, and it would start $2 billion to $2.4 billion of development projects.
However, by the time the company reported its first-quarter results in late April, it adjusted its outlook to reflect the likelihood of reduced demand due to the economic slowdown. At the time, the CFO stated: "While the full economic impact of the pandemic is difficult to quantify, we have analyzed numerous scenarios and have adjusted our guidance to account for a broad range of outcomes. Accordingly, we have assumed reduced demand into the third quarter and anticipate that the operating environment will begin to recover toward the end of the year."
As a result, Prologis cut its guidance for core FFO to $3.55 to $3.65 per share, occupancy to 94.5% to 96%, and NOI growth to 1.75% to 3.25%. The company also dramatically reduced its development start plans to between $500 million and $800 million, mainly focused on build-to-suit projects.
While Prologis initially expected tepid demand through the third quarter, that hasn't been the case. By the time the company reported its second-quarter results in July, it noted that "demand is broad-based across a variety of categories -- a trend we saw accelerate in June," according to CEO Hamid Moghadam.
Because of that, the company bumped up its guidance for the year. It now sees core FFO coming in at $3.70 to $3.75 per share, which is above its initial forecast at the midpoint. Meanwhile, it now expects occupancy and NOI growth between 95% and 96% and 2.5% and 3.5%, respectively. It also boosted its development plans to between $800 million and $1.2 billion in starts.
Customers need more space
While Prologis is still somewhat cautious because of the uncertain impact of COVID-19 on the economy, two factors are driving its renewed optimism.
First, existing customers continue to pay their rent like clockwork, giving increasing visibility to its cash flows. Meanwhile, Olinger also noted that the company's dialogue with its customers "gives us a more positive outlook for the back half of the year." That's because many of them are finding they will need more logistics space as consumers increasingly do their shopping online.
According to an estimate by eMarketer, e-commerce sales are on track to grow from 14.5% of total retail sales this year to 18.1% by 2024, when they should top $1 trillion. With e-commerce companies typically needing 1.2 million square feet of distribution space for every $1 billion in sales, per a projection by Prologis, demand for industrial real estate in the U.S. alone could grow by 1 billion square feet by 2025, says commercial real estate services firm JLL (NYSE: JLL).
To put that into perspective, that's bigger than Prologis' current portfolio, which currently owns or manages 963 million square feet of space worldwide. In other words, the sector has lots of growth ahead.
Quickly shifting from a small headwind to a massive tailwind
Prologis initially thought this year's economic downturn due to the COVID-19 pandemic would negatively impact demand for industrial real estate. Instead, it has accelerated the growth of e-commerce by forcing more people to do their shopping online. Therefore, the company is increasingly optimistic about what it sees ahead, which makes it a great REIT to buy these days.