All right, good afternoon, and thank you all for joining us. My name is David Vernon. I cover North American Transportation and US airline stocks. We are pleased to have Prologis here today. Co-founder, Chairman, and CEO Hamid Moghadam and his IR team are here with us today. We are gonna have a pretty wide-ranging discussion around the Prologis business. I'm not a REIT analyst, but I do cover supply chain and logistics, and in a former life, was a big customer of Prologis when I worked at DHL. So I know just enough to be dangerous, so we'll try to make this as interactive and discussion as possible. You do have access to the Pigeonhole site.
If you'd like to submit questions, those will work their way up to me, and I can work those into the discussion. With that, I'd like to just kinda, first of all, welcome you. Thank you for supporting the conference.
Thanks for having us.
Maybe you can start us off with kinda your view of the state of the industrial economy, right? As one of the leading suppliers of raw materials to the logistics and supply chains of the world, how do things look?
They look actually pretty good. I would say they're not euphoric like they were in 2021, 2022, and early 2023, but pretty solid. I would say demand for our product is probably a little bit lower than normal, coming off of 150% of normal. But things are good. And unlike prior cycles that I've been through, and I've been through many, hate to say, you know, very reasonably disciplined on the supply side, and pretty good moderate demand.
Moderate demand. So, well, you know, when I think about, PMIs kind of being in contractionary territory, what you're saying—you're saying it sounds a little bit better than that.
Yeah. I mean, just to put some numbers around it, normal demand for our products in the US is, call it 250 million sq ft a year. It ramped up to, like, 350 post-COVID, and it's now running at 175.
Okay, so there's still, there's still some level of demand-
Yeah
... that, that's out there in the market.
The supply response has been more dramatically tighter than that.
Okay. And as you think about new projects in the pipeline, is there anything that you can glean about what direction the economy is going in off of the sort of inbound requests you're getting right now?
So, it's tough to measure that because there's been quite a bit of shift, as you know, between the East Coast and the West Coast, and because of the labor situation and the Panama Canal and everything. But I would say it is pretty normal once you look at it as an overall picture. But there are obviously pockets of difference between the East Coast and West Coast and the Gulf ports.
Okay, so I wanna talk a little bit about some of those trends in nearshoring in a minute. But I do think I wanna start, you know, with this okay demand environment. We—you did have a little bit of a slower start to the year, right? And reduced guidance.
Well, yeah.
As you think about the drivers of that, can you help kinda frame the-
Yeah. So we've literally come off of a three-year period that has been unprecedented in my career, and I started this business in 1983, so it's been a long time. It was just crazy. So trying to figure out how that euphoric environment has geared down to a more normal environment has been a difficult thing to do. And in the Q1, we had a great January, we had a great February, we had a really slow March.
Mm-hmm.
So we moderated our expectations for the year by about 1%. Nothing dramatic, by about 1%. And if anything, I would say the last couple of months, we're feeling better about, about where things are shaping up in terms of customer inquiries and demand. So, a little bit slower, but it seems like it's reverting to a more normal environment.
Was that showing up in terms of, like, less absorption of projects that were already in development or lower rents, or how was that... How is that manifesting inside of the financials in terms of the business?
Sort of in a very perplexing way. Inquiries, and showings, and proposals were higher than normal. Conversion to actual leases was lower than normal. That is now normalizing.
Okay.
So conversions are going up, and proposals are moderating to normal levels. But it was really sort of-
Yeah.
March was a weird month, is all I can tell you.
Do you have any sort of hypothesis around why that might have happened or what was going on in the market that?
I think March is when people's psychology changed from, is it 3 Fed cuts to, I don't know, -3 Fed cuts? I don't know, whatever it is.
Yeah.
But I think the psychology around interest rates and people kinda throwing the towel on moderation of the interest rate environment changed dramatically in March. And I think people are getting used to that now. And given the outlook for interest rates, obviously, every time somebody leases space from us, it's a major capital commitment, not just the lease, but all the other things they need to do to equip the space and get into business. So I think a lot of people just put ... hit the pause button on that, and now that it's a more stable environment and people kind of getting used to these rates, are then getting back to business, because demand is continuous.
And so that rate uncertainty, that increased uncertainty, is what, what maybe drove that down?
Yeah.
Yeah, it's interesting. That's a similar commentary that we've heard from some of the railroads in terms of their construction-
Yeah
... business being very herky-jerky on this unsettled interest rates. So you talked a lot, you talked a little bit about this unprecedented growth in demand during the pandemic.
Mm-hmm.
Obviously, we were just buying way too many goods, but what else within that period of time made it so unprecedented, aside from just the surge in the amount of demand for space? Was there... You mentioned a couple things about East-West, and could you dig into that a little bit for us?
... Well, yeah, I mean, somebody's gonna analyze this 10 years from now, and there'll be 16 different things that happened and all that. But what I can tell is that inventory ended up in the wrong place at the wrong time. So it wasn't so much about the overall flow, but just where things ended up. And as a result of that, there was a total bottleneck in the supply chain and all the shortages and all that. So people got into ordering more than they needed just to make sure they had enough for the Christmas season and all that, and it didn't arrive in time.
So basically, they ended up with a bunch of inventory that couldn't be sold, and then they panicked, and they pulled back, and then the next time around, they got caught with fewer goods that they had at their disposal to sell. So it was just a very confused period of time. In terms of how things played out in the U.S., there were a couple things going on with respect to the labor strike in LA, ports of LA, and also the situation in the Panama Canal. And both of those meant that a lot of the volume actually shifted to the East Coast ports. Now, there's talk of maybe more labor issues on the East Coast, and the West Coast has now opened up. So yet to be seen how that's gonna play out, but I think it's normalized.
Okay, so that surge in capacity, the bottlenecks that were created from the breakdown in the supply chain, led to increased demand. Now, is that demand gonna be—is the demand for that extra space still gonna be there, or was this something that was like a Band-Aid on the supply chain, and then maybe-
No
You got some idle capacity that's out there?
Well, all of the above, but, but I think some of that demand was very real and has stuck, and it came from e-commerce. So e-commerce takes three times as much logistics space as regular bricks-and-mortar retailing. So the infrastructure to support e-commerce is, needs three times as much warehousing. There was a shift from about 15% of retail sales being e-commerce to about 25% during the pandemic, and that 10% increase in share resulted in a bunch of demand for warehouse space that tightened up the market tremendously. Now, when the vaccine came through and the market opened up, some of that was given back, so we went from 15% to 25%, down to 23%. But we got four or five years worth of growth during the pandemic, and it's, and it's kinda stuck at that elevated level.
So I think there was a permanent shift in demand for warehouse space because of higher ratio of e-commerce. And we're going off of that higher percentage. In other words, before, we were going off 15%, now we're going off of the 23%. I think that's very much real. There was another thing that was happening, which is that people were basically carrying more inventory for resilience purposes because they didn't want to get caught short. So that part of demand, I think, has reversed. People are not hoarding inventory as much as they did before because they can depend on more predictable flow of goods.
But every time people get comfortable about these things, there's a problem in the Suez Canal, or there is storms in Texas, or there is an earthquake someplace in the world that raises havoc.
Yeah.
So this predictable world that we've been building our supply chain around, as you well know, in the last 20-25 years, which has meant very lean inventories and fast movement of inventories and a very global supply chain, has really changed because people have to be more resilient going forward. Have companies fully spent the money to become more resilient? Not yet. I think that's still coming.
Okay, so as you think about putting some numbers on that, right, with the build-out, and then we're gonna mainly be maintaining that, has vacancy rates changed at all? Kind of coming out of the pandemic, is there still, like, a little bit of slack to be absorbed in the system, or are we kind of at a point where we actually are gonna see getting back to building again as robustly as we were during the pandemic? Because I remember kind of the last couple of years, you couldn't read any of the trade magazines around logistics, supply chain, anything, without hearing about the real estate shortage and all that kind of thing so.
Okay, let me give you some numbers. In a normal business cycle, vacancy rates for industrial real estate, logistics real estate, at the low side was about 7%, at the high side was about 9%-10%. That was considered market normal for long periods of time. During the pandemic, the vacancy rates got into the mid-3s, and in some markets like Southern California, they got to be under 1%, which basically means that you're completely sold out of space. And that resulted in spectacular growth in rent in certain locations that were short on space because people simply had to have space to put their goods. That vacancy rate, the supply responded to that, and that vacancy rate started creeping back up to a more normal level, and today we're in the low 5s.
I think we're gonna peak at 6 or maybe 6.25. And then, and this is probably the most important thing I'm gonna say today: Supply stopped about 6 months ago. So starts of construction of new buildings are down 80% from the peak. So we know exactly what's gonna be supplied in the next year or 2, because that's how long it takes to deliver a building. And so the only question becomes, what's gonna be demand? And if demand is even two-thirds of normal or half of peak, we see that vacancy rate going back down to 5% within a year.
Okay, so there's a lot in there. When you think about that, that building rate coming down 80%-... Is that just the, well, now we've gotten the ten-year up to 500 bips, and we're not financing projects anymore? Or is that, is that, "Hey, you know what? We're uncertain about the economy. We're not, we're not putting shovels in the ground anymore." Like, 'cause there's-
So-
There's two different reactions to that, like.
So, real estate construction and development is financed mostly by banks, construction loans. Banks are out of the business of lending to commercial real estate because they read the headlines, they hear about the office buildings declining in value and all that. Has nothing to do with our business, but they basically are reducing the exposure of their portfolios to so-called commercial real estate and commercial construction. So developers that depend on that kind of financing to kick off their projects are basically stuck and can't get the money to put on that supply. I think that's the primary reason. Secondly, interest rates have gone up, construction costs have gone up, and therefore, the rents that you need to justify that new construction are significantly higher than market rents today, which means the projects don't pencil with new land and new financing costs.
Which is actually great, because that means we have a great pricing umbrella under which we can operate. So very little new supply is gonna come on with those high rates and those high construction costs and high land costs. Third thing is that municipalities, particularly the ones in these very popular areas like New York, New Jersey, LA, these markets, are passing left, right, and center moratoria against construction of warehouses. Everybody wants their package from Amazon this afternoon, but none of them want their real estate in their backyard. So the confluence of those three factors has really curtailed construction. Couple of those are permanent situations or long-term trends. I mean, this business of being anti-warehouse, I think, has got a long-term... It's gonna be a long-term trend. The lack of availability of financing, I'm hoping that that will be a shorter-term thing.
It is actually an advantage for our company because we don't depend on construction loans.
Yeah
... to do anything. So we can respond to demand a lot faster than the private banks can.
So I wanna talk about your Strategic Capital business in a minute, but what you're basically saying is, new construction for industrial real estate space is coming down, is, has hit a wall. If the economy does get back into expansionary periods, we're talking about a whole another chapter of supply chain disruptions and inflationary pressure on-
On rent
... retailers, transportation companies, pretty much across the board.
Correct. And, one other thing I will tell you-
It's good for you. It's not so good for,
One other thing I would tell you, that, logistics real estate accounts for about 3%-5% of the entire cost of the supply chain, okay? So people are realizing that they need to be really close to the customer.
Mm-hmm.
These locations that are more infill and close to the customer are becoming, people are becoming very insensitive to the rent levels, because by paying a little bit more in rent, even paying double the rent, they're only increasing the overall cost by a couple of points. And if that saves them some money on transportation or energy costs, it's a trade-off worth making every day.
So, that's an excellent point around the forward stocking stuff, which I wanted to get into a little bit. You mentioned how e-commerce is increasing the real estate intensity of supply chains.
Mm-hmm.
What are some of the other things that you're seeing in the way companies are operating that are changing demand for real estate? And, like, this forward stocking location idea is one that's come in quite a few of my conversations with shippers and how they're thinking about designing their supply chains.
So labor is becoming a much more important issue for customers. There is no labor. No, particularly no labor to work in warehouses. So what does that mean? You have to bring in more automation into these warehouses. And automation is very capital intensive, and today, automation is not super flexible, meaning that if you want to optimize the operation of your warehouse, you need a very bespoke investment in automation, and that really increases the cost and the CapEx associated with these projects, which is why the spike in interest rates caused a bigger pause in new commitments than it would have normally done, because you have to get the automation to fill up these warehouses. So the costs are huge. It's not just the cost of the capitalized rent, but it's all the other stuff that you have to put in there.
So, and also, locational decisions are being driven more by labor availability now than a lot of other things would have been. So-
Interesting.
That's a new equation that didn't exist before.
As you think about an automated facility being put online versus what you traditionally do manually, is there a difference in sort of the real estate square footage you need to support an automated versus a manual operation?
Great question. So you've got to break it down. There is... Basically, to look at it without getting too technical in a warehouse, there's the receiving and there's the shipping, inbound, outbound, and then the middle is where all the stuff gets stored. I think there's good automation that is available for the unloading of the trucks. The automation that's available for the middle of the warehouse is very difficult and space intensive because you need conveyors and bespoke things instead of filling up the space with racks all the way to the roof. And the outbound stuff, again, can be automated. So I think the net impact is probably a marginal increase in the amount of space that you need.
Mm-hmm.
But nobody really knows that answer until we let it play out for a couple of years.
But I think one of the things you said before about it being very bespoke, right? Meaning that, you know, when you put up a building to run an automation of a certain set of processes, that building then becomes either very expensive to reconfigure for the next tenant or less marketable.
Well, it depends on who puts in the investment.
Yeah.
We don't put in that investment, the tenant does. So from our point of view, it's a good thing because it makes them very sticky. They're much less likely to move out because they gotta replace that automation in the new facility. So, right now, we renew about 75%-80% of our tenants when they renew. I think that number is gonna go up with more automation.
It's sort of interesting to think about, though, right? Because you've gotta have, you gotta have somebody who will be willing to commit to the CapEx for the automation along with the building. Does that also then make them wanna just, if they're gonna put all the CapEx in it, just have a new building versus going and refitting something older, or is that something you've seen as well, or no?
Well, I thought you were gonna ask a slightly different question, which is, would they be more likely to own the building as opposed to leasing it from us? And we're not seeing that-
Yeah
... because of all the accounting rules around-
Sure
Capitalization of leases and all that. But once they commit to an automation, it's a longer-term decision than a 5-year lease, which is what our average leases are. You need 10-15 years to get the amortization or the useful life out of that investment, so they're gonna become much stickier.
Okay, so as you think about this, the drawbridge kinda coming up on new construction, is that just a rate-driven decision when that comes back, or what do you think is gonna open up the bottleneck around sort of the new construction side?
Part of it is rate, but part of it is simple availability of bank financing, and I think that's driven by risk-based capital rules and all those sorts of things that are gonna take a while. And I don't see these office building loans getting resolved anytime soon, so this will be under pressure for a long time before they can really allocate a lot of new capital to construction loans and all that. So I think that's a longer-term proposition. And then these, some of these macro factors, like entitlements, ability to get zoning, ability to get permits, these are long-term problems that are not going away, and they're getting worse, actually.
Okay, so let's talk a little bit about the strategic capital business, which is, I think, what you were mentioning before in terms of your ability to get around some of the bank bottlenecks. Can you give us, in very simple terms, tell me, like, is it just private credit for real estate, or what, what are, what are we talking about here with this?
So actually, we don't need that to do to do conduct or development business. Just to give you numbers, the company is about a $150 billion enterprise value entity with a Single- A balance. On top of that, we have another $60 billion+ of capital in a series of joint ventures with large institutional investors. So we have the unique ability to tap the public markets and the private markets for capital, depending on the relative cost and where you are in the cycle, to basically help customers with their burdens. So access to capital is not an issue for us. It is where do we want to deploy that capital and at what rate of return?
In this environment, we can be more selective about that than we could in an environment three years ago when everybody can access the capital.
All right, so let's talk about the where, right? There's a ton of ink that has been spilled on this topic of nearshoring, supply chain regionalization. Where in the world are the hot markets for you right now?
Mexico is the hottest market because everybody's using Mexico as a backdoor to the US. There's plenty of labor and a lot of good and because of NAFTA, too, or whatever they call it, that's almost as good as being in the US. The problem with Mexico, the big bottleneck on Mexico, is the lack of energy. They just don't have enough electricity at the right price because their infrastructure has been running way behind. But northern cities in Mexico along the border are literally on fire, with demand from manufacturers wanting to locate there.
As you think about... is that like taking operations out of Asia and going to Mexico, or is this just new operations? Like, what are we-
Well, a lot of people are basically shifting China production to elsewhere in Asia, non-China Asia-
Mm-hmm
... and to Latin America, and specifically Mexico.
Okay.
Or some of each.
All right, so as you think about the challenges of operating in Mexico, you know, obviously, we talk to a lot of transportation companies that are involved in that trade, and there are other challenges.
Yeah.
What are some of the other challenges that you hear about from your customers in terms of setting up operations in Mexico?
Well-
Beyond power
... Their rail tracks are not the same gauge, so the railroads are not connected. There is, the availability of Mexican drivers to actually drive goods in America is a problem.
Mm-hmm.
So there are all kinds of practical issues with, with respect to goods, but some of those supply chains are very well developed. For example, for the auto industry, a lot of parts get manufactured in Mexico along the so-called NAFTA Corridor, I-35, basically, that works just fine. No problem.
Okay.
So, I think those, those issues will be resolved. It's a matter of time. So, and the Mexican ports are not as efficient as the American ports, and a lot of them are seeing surges in volume, and the infrastructure is not quite there to handle what they're experiencing in terms of demand.
What does your research team tell you about how long it's gonna take to solve some of these issues? Because obviously, the benefits of having production closer to consumption are, you know, there are many, right? Especially with the wage arbitrage in China kind of closing. How soon do you think it can be that you don't have some of those problems and that you can kind of get more efficient, for operators to relocate to Mexico?
I don't think it's binary. I think it's a continuum. I think for a lot of industries, like the auto industry, those... Mexico is not an issue.
Mm-hmm.
You know, the infrastructure exists. A lot of it is already taking place. More of it will take place. Electronic manufacturing, flat panel TVs. All of that stuff is already happening, and it's well established. On some of the newer stuff, they need to develop the labor, the training, the education, the company base, being there, et cetera, et cetera, and that will take time. But I think it's a matter of four or five years, maybe a decade, but it's gonna be a continuum. It's not gonna be a switch one day that-
Sure
It's okay and it's not. So it's happening as we speak.
So you mentioned some of the industries that are having successes relocating to Mexico. Are there any that stand out that have been more challenging, where you've seen people kind of go in, "I don't really like this. I'm going somewhere else?
I really can't think of any. No, I haven't. I can't think of any. I'm sure there's some. I can't think of anything that's more than a case-specific example.
Okay. So you talked about automation, being more customer-funded, right?
Mm-hmm.
So like, somebody who's a tenant, who's gonna lease a space from you, they're gonna put their own CapEx into automation. Do you, as Prologis, do anything to facilitate that process? Do you have a team that kind of understands sort of logistics and process engineering, or do you rely on other third parties? Like, how do you, how do you collaborate with your customers in terms of bringing automation into their facilities and-
So that's a great question that leads to a very long answer, I'm afraid. So we figured out a number of years ago that when a customer spends a dollar on rent with us, they spend $8 or $9 on other things: labor, transportation, energy, forklifts, racking systems, et cetera, et cetera, et cetera. So all of a sudden, we saw an opportunity for us to take a share of that extra $9 of business with our customers. So we started a new line of business about 4 or 5 years ago called Prologis Essentials, which allows us to help our customers with capabilities on all these other areas. So those fall into 3 or 4 different buckets. One bucket is energy and renewable energy. So we have covered about 5% of our roofs with solar now.
We're the number 2 on-site solar producer in the US. That's 5% of our roofs. Once we expand that to the majority of our roofs, we can be an 8-10 gigawatt a year producer of power on our roofs. We can be a utility scale player in renewable energy, and we have very ambitious plans and projects underway that will get us there. We think we're gonna cross a gigawatt by the end of 2025. So that's a very interesting area of opportunity for us. Basically, renewable solar energy plus storage. That's one line of business. Secondly, EV charging. A lot of these trucks, particularly the short-haul, lighter trucks and vans, are becoming electrified. That's the only way people are gonna get the permits to operate these facilities, because remember the people being opposed to trucks and diesel and all that?
Well, the answer to that is electrification of the fleet. So we started a line of business helping our customers with EV charging stations at the buildings. What's the best time to charge an EV? It's when the van is in the warehouse, getting loaded with goods, and it's parked there. So that's a very interesting area of opportunity. Then we are also helping our customers, for example, with racking systems and procuring racking ahead of time. Biggest bottleneck for a warehouse user moving into a facility is that the racks have a long-term lead time. Well, we got a big balance sheet. We have the ability to pre-commit to some of this stuff, and so our customers don't have to wait around for a couple of months to get the racking installed in their space. And et cetera, et cetera, et cetera.
There's a whole suite of products and services called Prologis Essentials, that span all these different areas that we are working on and having a great deal of success. So those are gonna be... We think those are gonna be multi-billion-dollar EBITDA businesses in the next 5 or 10 years.
Can you give us a sense for how big a part of the business they are today and kind of what the specific growth rates are in those businesses, and then relative to the core?
So they're very small right now. So, our entire Essentials business is about $150 million of bottom line against a company that has about $6 billion of bottom line a year, roughly. But we think each one of those lines of business can be $1 billion or more in bottom line within a 5-10-year period. So it can be pretty significant. I mean, I wouldn't be surprised if 7-8 years from now, a third of our business comes from energy, from Operations Essentials, mobility, and we haven't even started talking about the data center opportunities that we see in our business, which is a whole another area of big opportunity that we're spending a lot of time and money in.
Well, why don't we start with mobility and then talk a little bit about that data center opportunity that you see out there?
Mobility is actually a couple of 100 million dollars of EBITDA business. And, by the way, one of the-
What do we mean when we say mobility? Just-
Mobility means it's charging stations at our facilities-
Okay
... for vans and light trucks today.
All right.
Eventually, will mean hydrogen charging for long-haul trucks at the same facilities, and it also means hubs that are built not within our buildings, but within central areas in our big logistics parks, where people can come in and charge their trucks, not on their own site, but at a common, basically, a big gas station-
Yeah
-for EVs. Okay, so that's that opportunity. We think that's a $200 million-dollar business by 2030.
So as you think about those businesses, energy and mobility, it does sound like there's more investment that needs to be made, right?
Sure, of course.
The solar panels aren't buying themselves. Is that stuff that you're putting capital to work on top of the building that's being leased? How does that-
We are
-economic relationship work?
We are. Those are, those are, investments that will... I mean, our capital plan is about $8 billion of investments in all of those things in the next 10 years. Those are mid-teen return, unleveraged return investment opportunities, which are quite a bit higher real estate investing opportunities.
Okay, so this is a sweetener on top of the portfolio-
You got it.
Okay. And then, data centers. Obviously, a lot of demand for data centers, and we're starting to hear some more about, you know, the, maybe the Mexico power problem also being a problem in parts of the US. Like, I'd love to hear your thoughts on what opportunities you see in data centers for Prologis, and then how do we think about, you know, some of those challenges that are gonna be in, in-
Yeah
out for the industry?
So Prologis built its first data center in 1999, actually. So we've been doing this for a while, and we have, I think, 28 or 29 data center facilities already up and operating. We've had a higher and better use business for some time in our company, which means... What does that mean? That means the warehouse is the cheapest house on the block, okay? So over the last 10 years, we've converted many of our warehouses to office parks and apartment buildings, and things that are worth more than the underlying warehouses, life science facilities, et cetera. Data centers are becoming the most important category of higher and better use real estate. So, and, and the demand is coming from hyperscalers. They're basically four companies: Microsoft, Amazon, Oracle, and Google. Those are the big drivers.
There were the data centers, the old style data centers that were mostly fueling the cloud, those still exist. Those are smaller opportunities, but the big opportunities, the mega hyperscale opportunities, are coming from these four players. They consume a huge amount of power, and basically, the grid is half as big as it needs to be. The grid, and the generation capacity is half as big as it needs to be to fulfill all these needs in the next 10 or 20 years. So there is a scramble for getting access to that energy from the utilities today. That would be the short-term answer. In the long term, we got to develop new sources of power, like fuel cells on site, ultimately SMRs, you know, modular nuclear facilities and all that.
Power, renewable power that can be stored and converted to base load power with batteries and storage devices, that we're putting into some of the buildings. So this whole energy area is a huge bottleneck on the growth of data centers. And AI is fueling data centers like crazy. And I think people haven't solved that problem, and we're working hard at it. At least we have a leg up because we have the facilities, and we have the ability to generate some renewable energy on our own, but that's nowhere near enough to feed the ambitions that we have on the data center sites.
So we have, within our real estate company, 150 people that spend their entire time on energy, whether that energy is developing renewable energy on roofs, storage, utility-grade storage for the utilities that we work with, or trying to procure power for our power, our data center conversions and new builds. That's the business we are now in. It's just as important as getting entitlements to build a new building, is the access to the power that you can provide for the building. And it's not just data centers and AI, it's EVs. Everybody's talking about plugging everything into the wall. Nobody's really worrying about where all this power is gonna come from. So it's a huge problem, but we see it as a huge opportunity for us.
So as you think about the data center opportunity itself and the scale in terms of orders of magnitude relative to the essentials part of the business, are they considered the same, or are they separate? Do you think about them separately?
It's about it. They're, they're different.
Okay.
They're completely different.
Yeah.
One is meeting the needs of more of our existing clients. That's the essentials business. Same clients, just meeting more of their needs.
Yeah.
The data center business is meeting the needs of a whole new set of clients, at the end of the day. So it's a new line of business. We're not sure we want to be in the ownership business of data centers in the long term, but we definitely are in the development business of data centers. We hope to deploy about $1.5 billion plus a year in building out data centers, and we can do those at 30%, 40%, 50% profit margins, given the land that we already control and the ability we have to secure power for them. And the demand is insatiable, and some of these companies are actually coming to us and inviting us into situations where they control the land, and they control the power, and they just need our help to build it out for them.
So, it's a very attractive business for us.
Is that as attractive as developing your own sites, though, or would you like-
No, it's not as attractive because they extract some of the profit, but it could be a 20% margin business, no problem.
Still a good business.
Yeah.
Okay. So we talked a lot about essentials, data centers, power, mobility. We didn't talk much about autonomous and autonomy in terms of-
Autonomous, I think technologically, is closer than people think. But I think from a regulatory point of view, it's gonna be a while before coming. And it doesn't really, at the end of the day, affect the warehouses or where they're gonna be. It affects the transportation costs, and really, what's gonna drive it is the lack of availability of drivers. There's a real shortage of drivers, and that's what's gonna drive it.
Well, if I could just maybe push back on that just a little bit, right? So if you think about the autonomous trucking technology and getting rid of the eight-hour driver day, and be able to extend reach, I would think that would have some implications for the real estate business and where you'd want to have... How many warehouses you might have, and if all of a sudden you can cover 600 miles in a day instead of 300 miles in a day, you might put more capital into one building than that trade-off between transport and warehousing, but I would think that autonomy might impact that a little bit.
It might, but let me give you two counterarguments for that. Everything about the world of purchasing goods is about increasing choice and increasing immediacy. If you look at the trends in the last 10 years, the most important thing has been, every time you go on Amazon and order something, you want it in 26 different color choices, and you want it there this afternoon. Pretty hard to do that unless you're close to the customer. So I think proximity to the customer trumps any kind of savings in driver costs. It's all about getting it to the customer immediately. And there's a race, and Amazon has to set the pace on that race, and everybody else has to fall in line because they've trained the customer to want it immediately and with a lot of choice.
Interesting. Okay, so we talked about the essentials business, we talked about the data center business. I want to come back to the core for a minute. We've seen interest rates reset higher. We've seen a period of time when vacancy rates were down to 1%. That obviously had an impact on rents during that period. Can you help us understand what the repricing opportunity is on your existing book? Because I'd imagine market rates today are way above where they might have been-
Yeah
… 5, 10, 15 years ago. Duration of leases, I'd imagine there's a pretty steady flow of repricing opportunity for Prologis.
Yeah, we capture—I mean, if you do the math, our average lease is a little under six years, so there's 15%, 15, 16% of the space that rolls over, and we can capture the new rent. And by the way, 75, 80% of those renew, so, but we can capture the new rent from the renewals as well as the new leasing. So the mark to market on our portfolio today on a cash basis, not a GAAP basis, the GAAP is higher. On a cash basis, is kinda around 45% today. And obviously, that number is going down because every quarter that goes by, we capture more of it.
Yeah.
But that's significant. That means there is embedded in the company somewhere around $2.5 billion of embedded FFO growth, earnings growth, embedded without rents going anywhere-
Yeah
... just waiting to capture those. So that's pretty significant.
If you're right that the new development cycle has ended, you're gonna have another catch-up opportunity.
Oh, for sure. On the new buildings-
Yeah
... are in higher rent because your next competitor can't build that building for the same price that you can. And obviously, we're not gonna price our product according to our costs, we're gonna price them-
To the next guy.
To the next marginal C-player.
Yeah. Absolutely. That's helpful. So, a couple questions from the audience around competitive advantage, right? What makes you different relative to other industrial REITs or other development companies?
Well, for one thing, we have 1.2 billion sq ft of space. We're the largest real estate company in the world, and that gives us tremendous G&A efficiency and cost of capital advantage. So, just to put some numbers around that, our G&A across the company is about 34 percent, 34 basis points over our assets. The average company has 70-80 basis points. That's a huge cost of differential in G&A costs, when you're looking at a 6% return on capital type of business initially, and maybe a 8%-9% unlevered IR business. That's huge. We're a Single- A borrower. We have ample access to capital, and our spread is as tight as anybody and quite a bit tighter than anybody else in the marketplace. So we have access to capital and very low cost of capital.
We have an amazing team of people in the most desirable markets around the globe, and we are global. We're in 20 countries that know the players, they know the politics, they have access to the best land opportunities, they have the access to execute and get entitlements. The name of the game is all about the entitlements, and entitlements go to people who invest in the community and are permanent members of that community. They're not to they don't go to developers that are gonna flip the building the next day to somebody else. And we've invested in these communities for 30 years now, so that's a tremendous advantage. And fourth, and perhaps most important, we've been dealing, doing business with these customers. Our customer relationships and our repeat customer relationships are bar none because we've invested, and we've delivered for these customers.
And remember, you would know this better than anybody. If your DC is supposed to open up on November first and it opens up on December first, you're dead. You cannot afford to take that chance. Now, when there are 15 people accessing 0% capital that can do that for you, it's one thing. But when that goes away, then the reliability of your provider becomes super important. So those are, those are the things that we've really worked hard on creating that.
Okay. What about competition from private equity for space and for development opportunities?
Private equity has become very interested in the logistics sector, and they're putting a lot of money. By and large, that money is going into acquisition of existing assets. Private equity is also in the business of investing in office buildings and shopping centers and apartments, and those property types have fallen in popularity because some of the issues that particularly the office buildings have had. So a lot of that capital has been shifted to the logistics space, and I think over time, that will put pressure on cap rates and yields and will make logistics real estate even more valuable. They are not in the business of creating new real estate because they don't have land, they don't have people who can get entitlements, they don't have people who can build building.
They gotta go find partners that can do that, and those partners don't have the scale and the existing customer base that Prologis has. Deal.
Interesting. A little bit of a an alternative scenario question. So let's say, rates go up, inflation's not under control. We end up in a situation where we do push ourselves into a world of 6% rates and then an eventual recession. How does that impact your business? Like, what's the-
Well, if it causes a recession, that recession could translate into anemic or negative demand for our business. In 40 years of doing this, we had one quarter of negative demand in the dot-com collapse in 2000.
Mm-hmm.
And we had three quarters of negative demand after the Global Financial Crisis. So you do the math. 40 years is 160 quarters. We had four quarters of negative absorption. I think that's those are pretty good odds to operate in. Our business is not conducive to negative absorption because population grows, people eat more, people need more clothes, people consume. So there's a pretty significant base of demand that's there. That's necessities. This is These are not luxuries. These are things that people need every day. So I'm not saying that demand will always be robust, what I'm saying, it hardly ever goes negative and has ever, in the past, has not gone negative more than four quarters that I can think of. So, if interest rates go up, that means required rates of return on investment will go up.
That means that rent that the next building needs to get to come online is higher and higher, and thankfully, we own 1.2 billion sq ft of existing product that can be mark-to-market over time. So-
Get a little bit of a cushion against that, just in terms of the former rate.
For sure.
Yeah.
To replicate that 1.2 billion sq ft, that cost is gonna go up with inflation. So that would be a real issue for somebody who didn't already own the assets and was trying to get into this business. Look, other than the potential temporary downturn or recession, it's not a bad pricing umbrella to operate under.
Especially if you're coming out of a period where you've been, we've been rewarded.
By the way, I don't think that's gonna happen. I don't think we're gonna be in a period of negative absorption. Not based on anything I'm seeing.
Anything you're seeing. Okay. So, if you think about the U.S. market again for a second, are there any particular markets that were overbuilt or areas in-
Yeah
... the country where you know, it's gonna take longer to absorb?
Yeah, there are some markets that there are too many developers and too many pieces of land that get overbuilt across the cycle. Indianapolis would be a classic example of that. There are markets that are actually very tight markets normally, but because they've been so tight, people over-committed to real estate just to not be caught short, and now that that vacancy rates are going up, those people find that they're not needing that space and are putting that space on the market, on the sublease market, and that is having a disproportional short-term effect on vacancy rate. Southern California would be the classic example of that. Rents tripled in the last five years in Southern California. Vacancy rate was under 1%.
So what would happen after the user lost the third building, he or she probably turned to the real estate procurement officer and said, "You're not gonna lose the next one because we're gonna be out of business." So they committed to more space to get the next deal, and they probably paid more for it than they should have. Right? That's why-
Right
... rents triple. That stuff is gonna come on the subleasing market, and it's gonna have to get absorbed. So vacancy rates in Southern California went from 0% to 1% to maybe approaching 5% now, and that will take a couple of years to normalize again, but rents have tripled. I mean, I would take that market over any other market if I had to do it all over again in the last three or four years.
Do you worry a little bit about the California market and some of the CARB limitations in terms of-
Yes
... of what impact that could have on-
For sure
... industrial activity?
It will have a lot of impact on supply of new industrial space because there are all kinds of moratoria that are being proposed in Southern California against warehouses. Again, would I want to see that happen? No, because I'd like to be an active participant and developer in the marketplace. But let's assume it happens. We have over 100 million sq ft of the best real estate in Southern California, with no potential future competition coming online. So, I think we're gonna be in pretty good shape because of the position that we already have. And you asked about the other companies. I mean, literally, Prologis at 1.2 billion sq ft, is bigger than the rest of the sector together, and therefore, a more liquid investment and best customer relationships.
So I don't like to sit here and brag about our business, but it's a pretty good base that we've built.
Well, I'm gonna ask you to brag about your business, 'cause we're coming to the end of our time together here on stage. Could you maybe give it a high level, the algorithm for shareholder return over the next year, couple of years? Why is this a good time for investors in the audience to be looking to put capital to work in Prologis?
Two reasons. One, we reduced our guidance by 1% and the stock went down 20%. Okay? So I don't know about that, but that sounds like a pretty good entry point from, for us. Secondly, we pay a 3.7% dividend, and we have consistently grown at high single digit, low double-digit returns on growth with 20% leverage for decades. So I think that's a overall low teens rate of return is pretty good business in my book.
Excellent. Well, thank you so much for joining us today.
Thank you.
Thank you to the team for coming out. Thank you all for supporting the Bernstein Conference, and I wish you luck with the best of your meetings and the rest of your time here.
Thank you.