Prologis Earnings: High Mark-to-Market Leads to Record Releasing Spreads, but Demand Is Slowing

No-moat-rated Prologis PLD reported a decent set of numbers in its third-quarter results. The firm reported core funds from operations, or FFO, of $1.30 per share, 25% lower than the $1.73 in FFO during third-quarter 2022. The sharp decline in FFO during the third quarter can be mainly attributed to the promote income within the strategic capital segment that tends to be lumpy. We think that investors should analyze the underlying performance of the industrial portfolio of the company after excluding the strategic capital segment. Real estate operations, which excludes the strategic capital segment, reported a core FFO of $1.26 per share in the third quarter, which was 20% higher on a year-over-year basis. We are maintaining our $124 per share fair value estimate for Prologis after incorporating the third-quarter results.

The highlight for the quarter was the record-high net effective re-leasing spread of 84.0% on a GAAP basis and 54.2% on a cash basis for the leases signed during the third quarter. The lease mark-to-market for the company’s portfolio was 62% as of the third quarter, down from 66% in the previous quarter. The extremely high re-leasing spreads should enable strong NOI growth for many years to come. Having said this, we expect the growth in market rents to 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.

The same-store net effective net operating income grew by 9.3% on a year-over-year basis. Management has maintained a guidance of 9.00%-9.25% same-store net effective NOI growth in 2023. The overall average portfolio occupancy rate declined by 40 basis points on a sequential basis as it was reported at 97.1% for the current quarter. We expect occupancy rates to remain under mild pressure in the next few quarters and normalize to lower levels on a midcycle basis.