Prologis Earnings: Fundamentals Should Start To Normalize in the Second Part of the Year

No-moat-rated Prologis’ PLD second-quarter results were in line with our expectations as the firm reported core funds from operations, or FFO, of $1.83 per share, 65% higher than the $1.11 in FFO during the second quarter of 2022. The sharp rise in FFO during the second quarter can be mainly attributed to the promote income in the strategic capital segment. The real estate operations of the company, which exclude the strategic capital segment, reported a core FFO of $1.18 per share in the second quarter, 18% higher on a year-over-year basis. We are maintaining our $124 per share fair value estimate for Prologis after incorporating the second-quarter results.

The net effective re-leasing spread for the leases signed during the second quarter was 78.5% on a GAAP basis and 48.1% on a cash basis. The lease mark-to-market for the company’s portfolio was 66% as of the second quarter, down from 68% in the previous quarter. Although the re-leasing spreads are still exceptionally high for top-notch industrial real estate, we think that the growth in market rents will moderate in the near to medium term largely because of the weaker macroeconomic backdrop, slower adoption of e-commerce, normalization of warehouse demand, and elevated development deliveries.

Management also expects the fundamentals of the sectors to cool down in the second half of the year. The trend toward normalization of industrial fundamentals can also be seen in other indicators like lease proposal activity, new lease negotiation gestation period, and pre-leasing of under-construction projects which are all within a few percent of the pre-COVID levels. Management commentary indicates that fundamentals will regain momentum in 2024, as new development starts to decline. However, we think that the industrial supply pipeline should remain robust from a medium-term perspective, given the relatively strong development yields and value creation potential on new industrial construction projects.