The industrial sector seems to be on fire. Despite tough economic circumstances in 2020, industrial real estate demand, rents, and profitability have risen. All this makes Prologis (NYSE: PLD), one of the largest real estate investment trusts (REITs) by market cap and the leading industrial REIT with global reach, an appealing way to participate in this growing sector.
As long-term trends seem to be shifting in favor of industrial real estate, it seems this sector is well-positioned for a strong run over the next decade. But does this giant REIT have room to grow with it? Here's where Prologis could be in five years.
Where Prologis is now
Prologis owns or has interest in approximately 976 million square feet of industrial space used for business-to-business retail or online fulfillment in 19 countries on 4 continents. The company leases its 4,679 buildings to roughly 5,500 different tenants, including big names like Amazon (NASDAQ: AMZN), Home Depot (NYSE: HD), and FedEx (NYSE: FDX). Their portfolio as of Q3 2020 was 95.6% occupied, with 81% of their net operating income (NOI) being earned in the U.S., followed by 11% in Europe, 5% in the other Americas, and 3% in Asia.
Increased demand for online shopping and e-commerce pushed rents sky-high in 2020, resulting in a 30.7% net effective rent change in the U.S. alone, a 25.9% net effective rent change for third quarter 2020 for the company, and 98.2% rental collection, not including those in some form or forbearance or lease deferrals, which makes up less than 1% of rental collections. At the start of 2021, Prologis has a high credit rating by Moody/S&P of A3/A-, has $5.2 billion in cash or cash equivalents, and a relatively comfortable debt-to-EBITDA ratio of 4.3 times.
Growth prospects over the next five years
Currently, in-place rents are 12% lower than market rents, meaning Prologis in the short term has an opportunity for significant incremental rent increases for existing tenants while still adding planned and completed developments at market rent to their portfolio. Prologis predicts 285 to 570 million square feet of aggregate demand in the U.S. over the next two to three years based on current trends.
Additionally, retooling current supply chains to improve efficiency could lead to another 140 to 185 million square feet of demand. As of Q3 2020, the company had $392 million in development starts, a number that will likely continue to grow over the next few years to help keep pace with growing supply and demand.
In addition to redeveloping, retooling, and new development, the company plans to build out and expand their current land bank, which is structured to strategically hold land in high-density markets near consumer hubs that can be used or sold for future developments.
There is clear demand for industrial space, particularly subsectors that serve the e-commerce markets in which Prologis operates like logistics, distribution, or manufacturing warehouses. Eventually, the supply will balance out with demand, but I believe we won't see the tipping point into oversupply for another 7 to 10 years, similar to trends we saw in the storage sector. Those that don't already dominate market share (something Prologis has on their side) will likely be the first to feel the pinch.
I expect to see the company grow significantly in their funds from operations (FFO), net operating income, and revenues over the next two to three years, with income flattening out to more stabilized levels around years four to five as the market recovers from the global pandemic.
The Millionacres bottom line
I believe Prologis should be able to maintain consistent growth over the next five years, with dividend increases to reflect their growing FFO. With that being said, the company has regularly cut dividends to reflect changes in the marketplace and maintain a balanced payout ratio, so don't be surprised to see dividend growth with a few cuts in the interim.
However, the company's increased cash reserves and low debt ratios will help it maintain ratios, hopefully without rate cuts for a while. Share prices are trading at or above pre-COVID-19 levels, meaning investors aren't scoring a value trade but do have the potential to benefit from major upside in this sector in the future.