To the 3:00 P.M. session at today's 2023 Global Property CEO Conference. I'm Nick Joseph, here with Craig Mailman with Citi Research. We are pleased to have with us Prologis CEO, Hamid Moghadam. This session is for Citi clients only. Media or other individuals who are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can log on to live QA, to submit any questions if you do not wanna raise your hand. Hamid, I'll turn it over to you to introduce your company and any members of management that are with you today, provide any opening remarks, and then we'll get into Q&A.
Great. Thank you, and good afternoon, everyone. To my left is Tom Olinger. No, he's not Tom Olinger. Tim Arndt, our newly minted CFO, who's been with the company for about 20 years. To my right is Dan Letter, who's our newly appointed President, also with the company for about 20 years. If you ask me general questions, I'll answer 'em. Real estate questions, Dan will take, and any financial questions, I think, Tim will handle.
Awesome. Well, yeah, we're starting off every session with the same opening question. What are the top three reasons an investor should buy your stock today?
Yeah. Fundamentally, the backdrop is that we're in a sector where fundamentals of the demand and supply are very strong. Vacancy rates are in the mid 3s. Demand is moderating, but it's still very strong. Supply is moderating even more as we speak. The fundamentals of the business are really good. Second reason is that our portfolio has a 67% mark-to-market already embedded in it, regardless of what rents may do from here on forward. We have almost a guaranteed built-in growth rate from that mark-to-market of leases. Our average lease is about five and a half years. As those leases roll over, we capture that spread. We have taken this real estate and built a couple of really valuable franchises on top of it.
The one that you know the best is our private capital franchise that this past year generated $1 billion of EBITDA, and has been... That was a high number, but it's a very profitable business. Doesn't take a whole lot of capital. We've started a bunch of new businesses that we call Prologis Essentials that are in the energy, sustainability, mobility, labor, different areas that our customers need to do what they need to do in our buildings. Because of our scale, we can do that in a very profitable way for us and in a very advantageous way for our customers.
To me, you mentioned that fundamentals are still extremely strong here, you guys started earning season, I think, better than people had expected from the Same-Store NOI Growth expectation number. It really helped differentiate you guys relative to other property types, especially shorter lease term, where second derivatives are rolling over. At the same time, there still seem to be some concerns out there about the sustainability of demand, particularly with talk of pending recession maybe in the second half of the year. Can you just talk about what you guys are seeing, what your expectations are there? I know we talked about a little bit on the earnings call, but what it would really take to throw a wrench in the gears of market rent growth and demand for industrial at this point.
Sure. Let me start it then I'll pitch it over to Dan for some more color on the, on the markets. You know, there's the imponderables that we have nothing, no control over, geopolitical stuff, all those things. Put those aside. I can't do anything about them, and nobody seems to be able to predict those anyway. With respect to the things that are going on with our customers, the trends that drive the long-term success of our business, whether it's e-commerce, whether it's general economic demand, whether it's rebuilding of inventories for resilience, all those structural long-term factors are in place. I really can't see anything that is gonna derail us. I suppose extra supply can. We're gonna have a fair amount of supply this year.
I think this will be one of the only years since the global financial crisis where supply may actually exceed demand. Vacancy rates, no matter how you stress test supply and demand, you have a hard time getting it much higher than the low fours, even if stuff doesn't lease from this point forward. In that kind of environment, I think there's pricing power. We had an exceptionally strong year in terms of rental growth last year, way above our expectations, and this year is starting off slightly better than our expectations for the first quarter, but we got a long way to go. Dan, color.
Yeah, 2 things to pile on here. First of all, even as the vacancies expand due to some supply coming on this year, starts have come to a screeching halt over the last 2 quarters, we don't really see starts ramping up in any sort of meaningful way until the back half of the year, and I think there's only a few of us that will actually be able to do that. We think that occupancy will actually come, maybe correct back to where it is today, 1 year plus out. As it relates to demand, we are pleased every quarter, and we look at our very robust leasing pipeline, and it's a very diverse, broad-based customer base, whether it be from e-commerce, apparel, customer goods.
We are continuing to see very strong momentum.
Yeah. One other thing that I failed to say, we lease 1 million sq ft a day. I mean, today, since I've been here, we've leased 1 million sq ft around the world. You get a lot of visibility, you get a lot of data points. You guys are in a tough position because you get those data points, once a quarter, and you get it among 120 other companies and, you know, there's a lot going on. We watch this stuff every day, you know, we've got an advantage in seeing where the market is going.
Yeah. To that point, I mean, quarter to date here, are you seeing any material shifts in demand from tenant verticals? I know e-commerce had slowed. It seems to be coming back. You know, the silver lining actually was Amazon is not the only guy in the market anymore, right? You're seeing a broadening of demand there, which is actually healthier for the market than just having one dominant tenant. I mean, is there anything on the horizon from a tenant credit or industry group that you're seeing a shift at all?
Well, there are a couple, but they don't concern me. First of all, leasing, as I mentioned to you, and rent achievement is a little bit higher than we thought, going into the year and at the time of our earnings call. That's a positive. The other thing is that we have a, you know, the normal cast of characters, retailers, some of whom are struggling. We have a couple of Bed Bath & Beyond. We have Wayfair. You know, we have weaker tenants, in our spaces, but most of those spaces are literally half the market rent, and they're perfectly generic buildings. Actually there's upside in the case of a possible default, but our defaults have not crept up in any meaningful way.
Just to give you a context for that, our average over the last 10 or 15 years has been about 20 basis points. During the first couple of months of COVID, when everybody was losing their job and things were really bad, we got up to about 50 basis points. Global financial crisis, we got to about 50 basis points. Credit is not a consideration. There are individual cases at any point in the market cycle. The third thing is that we have not seen inventories jump back up to the level that they need to be, to support the needs of the customers and also to build in that resilience that they all desperately need to insulate themselves from events like the pandemic.
It's interesting, right? 'Cause you have, take a tenant like Target, right? Where they just announced 6 more sortation centers, but at the same time, they're taking larger format stores to have that e-commerce in the back and be able to fulfill more. I mean, it's been talked about using brick and mortar in a different way. You guys, you know, a long time ago had a retail background. I mean, do you ever think that that could supplement some of the space needs, or is it just too small of a contributor relative to inventory restocking and the wave of SKUs that need to be in a warehouse to fulfill same day, next day, and all the kind of the moves towards getting things to people as quick as possible?
Yeah. There's no question that retail space, particularly big box retail space, is 80% warehouse and maybe 20% display and selling area. The, the 80% can be deployed to drop on a curb or have somebody pick it up from the back and all that. I think omnichannel and leveraging the retail infrastructure is certainly gonna be part of the solution. If you were gonna build it from scratch today, you would build a new logistics channel which handles parcels. Fundamentally, warehouse space handles pallets, large, bulky things that go in a truck. An e-commerce warehouse handles parcels. They need to get packaged, they need to get wrapped. They're smaller, they're smaller packages.
You can't mix on the warehouse side the traditional warehouse that fulfills a retail store and mix it with an e-commerce store. They've got to be two separate operations. This parcel situation takes up three times the space that the infrastructure for retail takes. Yes, some of the demand is gonna be fulfilled by the space in the back of the stores for omnichannel fulfillment, but there's such a powerful multiplier on the pure e-commerce channel that demand for warehouse space has really stepped up. I think we're in the early stages, just like you said, Amazon is pretty advanced, but everybody else is running to catch up.
If one thing happened in the pandemic is that people are no longer putting their head in the sand and saying, "This e-commerce thing shall pass as well." They're scrambling to build those channels.
Going back to the rent side of things, I'm gonna mix in mark-to-market and market rent here to make things confusing for everyone. You know, as we sat here last year, your mark-to-market was sub 40%. As we sit here today, it's closing in on 70%, right? Market rents, you guys always seem to be around that 10%. I don't know if you guys pay Chris Caton on beating that expectation every year, but-
Yeah. He actually pays me because he's lost every single bet that he's ever had on rent growth. I'm always higher than he is.
It just feels like given where, you know, you mentioned supply could meet net absorption, but you're not getting to a point where you're losing pricing power, right? With that backdrop, plus the fact that transportation costs are still elevated, labor is still difficult to get, and you're seeing additional cost increases on the low end from Walmart, Home Depot, and whomever else, right? I mean, Tenants' ability to push back, you always said it's never a top 5 reasons tenants leave. You know, at the same time, you're talking 1 million sq ft a day. Like, what are you guys seeing from your internal rent curve today, and, you know, how is this just continuing to kind of march higher, and how does that impact that mark-to-market, maybe as we sit here in a year from today?
I wouldn't be surprised if a year from now, as long as the rents grow at a faster rate than the old leases coming up are being marked up, and that calculation, the mark-to-market across the entire portfolio will grow. But whether it's 67% or 60% or 75%, it's a really big number, and most of it is in the bank. Construction costs have moderated, but they haven't yet declined. I expect them to decline maybe 5%-10%. The cost of building that marginal product is much higher, and with higher yield requirements, the rents you need to pencil a development are getting higher and higher, and the banks are no longer financing the merchant developers.
As you heard from Dan, the pipeline has really come to a stop. I think the market is working the way you think the market would work. Now, with energy costs and labor costs going up, the real estate, the warehouse costs are about 3%, actually 2%-5% of the supply chain costs. If you're gonna spend that much of your supply chain costs, you might as well pick the best locations near the biggest population centers. The dichotomy between rents in really good markets and the so-so markets that have only going for them the cost advantage, has actually gotten wider because you save on transportation, you can, you can deliver the stuff to your customers a lot faster, you can adjust to market trends much better.
Actually, we continue to have a lot of pricing power. That's why our rents are ahead of what we thought they would be. The only thing that's different, I don't wanna tell you that everything is rosy, but, from the second half of 2021 to the second half of 2022, that 12-month period was crazy. I mean, literally, we had people fighting over 10 different tenants over a piece of space, and we're 98.6% occupied. That was crazy. If that's your benchmark, the market is softer than that. If you... I've been doing this for 40 years. If you look at any period other than that 12-month period, markets, market rents and dynamics are as strong as I ever remember them being, by far, and the numbers support it.
Looking at U.S., major U.S. markets, where are land values today relative to peak levels? Are there reasons to be optimistic that transaction activity will pick up over the next year or 2?
Rents are higher. They're by definition higher than peak because in the US, rents have never declined.
No. I'm sorry. I mean land values, development land.
Nobody knows. I think land values should be down about 25 to a third. If you look at the cap rate expansion and the erosion of terminal value, that should logically translate into a 25 to a third difference in land values downward. Nobody's selling that land, nobody's buying land, nobody really knows. Even if you mark down the land significantly, our embedded cost basis is half of the market values, even with a decline of a third. I don't spend a lot of my time, honestly, thinking about that. We can, with our land bank, build another $39 billion of industrial real estate, over 200 million sq ft. We own this, some of the best land in the country, and it's entitled, and it's inventory for future development.
Got it. Yeah. Thank you. If I recall correctly, e-commerce spiked to about 25% total retail sales in the pandemic. It's come off, I think, significantly since then. I can't think of anybody better to comment on where do you think e-commerce as a percentage of total retail sales will be when?
Not within my career and not within their, these two guys', careers because they are, I don't know, 20 years younger than I am. I think that number will keep going up because the first generation of kids that grew up with an iPhone, they're hitting their mid to late 20s. They don't even know what a store is, really. I think that their propensity to spend online is much greater than the rest of the cohorts. As they get into their prime buying age and all that, I think that percentage is gonna keep going up at a, at a slower rate. I mean, you know, we went from 0 to 25 in 15 years. We're not gonna go another 25 in the next 15 years. It's gonna moderate, but I think it's gonna keep going up.
There are technologies that are being introduced as we speak that make the shopping experience online much more attractive, in terms of fit, in terms of virtual reality, augmented reality, other technologies that retailers are employing that allow you to really experience the product in a very real way. I think that number will keep going up. I will tell you a story. I'm on the board of Stanford Management Company, which is the endowment, and we had five investors sitting on a panel. One major shopping center developer. On the other end was the partner at Sequoia that does their e-commerce stuff. Then there was a distressed debt guy and a couple other guys around.
If you ask them that question that you just asked me, their numbers ranged, this is like 3 or 4 years ago, from 12% from the owner of the malls to 100% from the Sequoia guy. Really, nobody knows. We're all guessing, but it's going up. By the way, the fact that it moderated and came off of the peak of e-commerce is something that we predicted in May 2020 and put it in a paper. It's on our website. It's not surprising us. If people are cooped up for 2 years, of course, they're gonna go on trips, of course they're gonna go shop and have that experience. None of this is to say that good retail is gonna struggle. I think good retail will do well.
The enemy of retail has not been e-commerce. The enemy of retail has been too much retail. 28 sq ft per capital, 5 times anywhere else in the world. So it's not our fault, it's somebody else's fault.
Hamid, I just wanna go back. Someone had a follow-up question when we were talking about market rent growth. They're asking, you know, if market rent growth is expected to grow by 10% and your rent spreads are growing to be 60%+, how can you maintain your mark-to-market heading into 2024? Maybe just kind of explain how the math works with the mark-to-market versus the rent growth and how that kind of accretion goes.
We're 98.6% leased. We've already dealt with half of the vacancies coming up in 2023. Half of it is put away. We know what it is. When you capture, you're capturing the 67%, actually probably more than that because the oldest leases have the biggest mark to market. On a very small, on half of the 15% that rolls over. You're getting the 10% rent growth on 80%, 99% of whatever the balance, 90%+ of your portfolio. That seesaw still is in favor of increasing spread, but at some point it will reverse. I mean, if it doesn't reverse this year, it will probably reverse next year. When do you think, Tim, it's gonna reverse?
Yeah. I think if we have, say, 3%- 5% market rent growth thereafter, after this year, if we were to just slow, the slope that we see this lease mark-to-market declining at is maybe 10 points a year or something. It's got a very long tail to ultimately wind down.
We are not gonna have 10%, much less 30% or 40% rental growth forever, the business is good, it's not that good.
Another question coming in just on the integration of Duke. You know, how is that going, number 1. Number 2, you know, there's been just a little bit of M&A in the industrial space over the last couple years. The question is, would you consider doing another large-scale M&A deal in the near term? Thoughts on the Summit Industrial transaction in Canada as well as Indus in the U.S.
Any others you wanna ask about?
It's a four-part question. Okay. Duke integration.
Duke integration, done. It was done the day after we closed the deal. It was actually done before we closed the deal. We've gotten really good at integrating these companies, and we were fortunate to get a lot of good Duke people along with it. About 70 colleagues came over from Duke, and they've really found a new home, and they're pretty happy. The board is going fine with Jim on the board. You know, we got the synergies before the deal closed, and we're getting a bit more revenue out of their portfolio than we thought. What would you guess that is today?
I would guess, we're getting 11%, 12%, call it 12% or 13% more revenue than we underwrote. Assume ADA that's coming from the market, so outperforming pretty handsomely.
Four or five points more than the rest of our portfolio we're getting out of that portfolio right now. We think it was a little more, a little less leased than ours, and we're capturing that on this first go-round. With respect to M&A, we're always looking at M&A. We do a lot of $5 million acquisitions. We look at everything. I mean, it's not a mystery for somebody who has a piece of real estate that they wanna sell or sometimes when they don't wanna sell, to call 1-800-Prologis. I mean, we're the obvious candidate for seeing the right kinda deal. Summit was not our kinda deal. It's very appropriate for other types of buyers that are traffic in that kind of space. It's not our kind of profile.
You know, not to belabor the point 'cause I don't want to ask you questions you're not gonna answer. In the past, after you've done a big deal, whether it was DCT, Liberty, maybe now Duke, it always seems like there was a year or two digestion period. Not that you haven't integrated it, but is that sort of a good timeframe to think of from Your standpoint to demonstrate to the market the justification of the previous M&A deal before you would go out and do more, especially at this point where industrial valuations, you know, some froth was taken off last year, but this year the group's done a little bit better.
Maybe on a stabilized basis, we could argue that, the group still looks relatively attractive, particularly against the REITs on sort of a stabilized implied cap rate given your growth. Just kind of broader thoughts on maybe that angle of the question.
Boy, if it took us a year to integrate DCT and Liberty, you know something that I didn't know.
No, not integrate, before you went out and did the next big deal, right?
Well, you gotta do the deals when the. We have a target list of companies that are a good fit for us, and you gotta look at the right time and the right place. I mean, a lot of these things are driven more by social circumstances than the e-economics of the deal. The economics are very compelling because we have the ability to pay a premium. These are acquisitions, not mergers. We kind of have dialed in what the synergies are, certainly on the cost side. Our target, and the way these deals usually work out is that they're slightly accretive on an AFFO basis, on a cash basis. On accounting, they're accretive, but that's phony baloney. On cash, they're slightly accretive.
Once the revenue synergies come through, essentials, private capital, all this other stuff that we do on top of the real estate, then they become really wildly accretive. The other thing that happens in some of these deals is that when we bought DCT and Liberty, we indicated to everybody how, what portion of the portfolio we were gonna keep, what portion of the portfolio we were gonna sell. By the way, don't forget KTR. That was private, but it was a big deal. I think we've exceeded cumulatively our projections for selling the non-compliant assets by 40%, and that represents $ billions of sales over the last couple of years. I think we know what we're doing in this area. That would be the last thing I would worry about.
You guys have the benefit of being global, right? If you, from a capital allocation perspective today and where valuations are, what's the most attractive market to deploy capital in your portfolio today?
anywhere we have existing land that's entitled and ready to be developed in a tight market. A lot of places. I think it's a type of deal that's most accretive as opposed to necessarily a geography. If I were gonna give you a geographical answer, I would tell you that the markets that are the lowest cap rate markets are the best markets for doing that development. Unlike what most people think, the markets that have had the lowest appreciation are actually the ones that are going to have the lowest appreciation in terms of rents, because people are becoming much more location sensitive.
We don't have a lot of that stuff, but that, you know, the tighter maybe coastal markets, some people call them coastal markets, but they're markets with decent demand dynamics that have really anti-growth regulations and entitlement processes that constrain development. Those are the places where we like to deploy capital.
Shifting maybe to the strategic capital business. You know, you guys made the conscious decision to kind of hold off on contributions until the back half of this year. I guess twofold. Number one, kind of what are you guys seeing on the Q side of the house, from demand there? Is there an opportunity for you guys potentially to deploy capital to the extent investors are looking to reduce exposure there? Just. We'll kind of go with those two.
Well, I would say, the last 2 quarters of last year were slow fundraising times, there were more redemptions than Qs. The Qs basically are down to zero, we are 13% levered in our U.S. portfolio, and we're 19% levered in our European portfolio. By the way, each one of these is a $25 billion-$26 billion company, they're unsecured borrowers. These are huge entities with lots of balance sheet capability. We could have made our Qs 4 times as long, the investors wanna see their money invested. We weren't taking new money when you could raise money because we didn't wanna have the pressure of putting the money out in nonsensical ways. That's the dynamic of the allocation.
We will, that we did in 2009, 2010, and we will when the valuations reflect the marketplace as we see it. Again, our valuations are done by third parties, not by us, unlike some other situations. When the valuations reflect what we believe is true market value, we will step up and put money in our own funds. We love our own funds. I mean, they're the properties we know and like, and it's a great place to deploy capital. Unfortunately, our policy is to give our investors the first right to do that, and I think they're gonna take up most of that opportunity.
If it works out the way it did in 2009, 2010, all those redemption requests will be withdrawn, rescinded, because that's exactly what happened when we put money in this. These guys putting money in their own fund, it's gotta be a good deal. Having a balance sheet in this business and being in a fund management business is a great thing. It's not just a place that you put your developments, it's also a place where you can deploy capital at the right point in the cycle, and that helps your customers and investors.
The other question. You guys have contributions starting in the second half. What are you seeing on the valuation front, or what's the trigger from your vantage point to get comfortable that there's enough, you know, a lack of volatility where it makes sense to start contributing again to where you're not maybe feeling like you're forcing these assets into the funds?
Well, there are three things we can do, and they're all related. We can continue contributions or start contributions at a given time, we can redeem people at a certain price, and we can deploy capital at the same price. All three of those things have to work around one price, and that price is the right price. When the price, in our view, is right, we will restart contributions, we will deploy capital into our funds, and we are already redeeming people, and we'll keep redeeming people as those requests come. We don't think there are gonna be that many requests because again, when the portfolio is attractively priced, people wanna be invested in high quality industrial real estate.
Some people early in an inflection point, wanna jump in in front of everybody, put in a redemption request, and sell the properties as yesterday's values, versus the declining values of today because of interest rates. The mechanism in the funds are such that there is 1 to 2 quarters of lag to avoid that problem, but they will get their money back. They just get their money back at the right valuation.
From a technicals perspective, I've gotten this question before. Do your funds have gates like you're seeing at some of the other fund companies out there that they've thrown down? Are you guys, because you have the balance sheet to buy out, there's never really a limit on redemptions?
We do have some limits on redemptions that have actually, in a few instances, been triggered, but we've completely ignored them because we have the ability to redeem, and if we like the value, we'll redeem. Look, it's not about redemptions and holding assets for AUM fees and all that. It's all about making sure that you're doing the right thing for all the remaining investors in your fund. If 5% of the fund wants to get in really fast before the appraisals reflect reality, I don't wanna disadvantage the other 95%. That's why we've set up this mechanism where there's a lag until values adjust. We're gonna redeem everybody. By the way, we've had this conversation, obviously, with our private capital investors, and they love what we're doing.
Okay. We'll with a minute left, we'll run to the rapid fire. Same-Store NOI Growth for the industrial group, not PLD specifically in 2024?
6%-7%, we'll be 200 basis points above that.
Best real estate decision today for PLD: buy, sell, hold, develop or redevelop?
Develop on our existing land bank in markets that require space.
Last question. For the industrial group, are there gonna be more, less or the same amount of public companies a year from now?
I take the fifth on that. Your Honor.