Prologis, Inc.

Greetings and welcome to the Prologis third quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to Jill Sawyer, Vice President of Investor Relations. Thank you. You may begin.

Thanks, Daryl, and good morning, everyone. Welcome to our third quarter 2022 earnings conference call. The supplemental document is available on our website at Prologis.com under investor relations. I'd like to state that this conference call will contain forward-looking statements under federal securities laws. These statements are based on current expectations, estimates, and projections about the market and the industry in which Prologis operates, as well as management's beliefs and assumptions. Forward-looking statements are not guaranteed, and performance and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the forward-looking statement notice in our 10-K or other SEC filing. Additionally, our third quarter results, press release, and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures. And in accordance with Reg G, we have provided a reconciliation to those measures. On October 3rd, we closed on the acquisition of Duke Realty. As a reminder, Duke's results are not contained in our third quarter earnings release. However, within our supplemental, we included a summary of the portfolio integrated as a quarter end. please refer to our website for details on the transaction. I'd like to welcome Tim Art, our CFO, who will cover results, real-time market conditions, and guidance. Hamid Moghadam, our CEO, and our entire executive team are also with us today. With that, I'll hand the call over to Tim.

Thanks, Jill. Good morning, everybody, and thank you for joining our call. We are clearly in a volatile macro environment where ongoing inflation, steeply rising interest rates, and the war on energy crisis in Europe are pressuring the global economy. And while we're closely monitoring each element, the fundamentals in our business are very strong, and our read of supply and demand in our markets remains out of sync with the headlines. This morning, we reported excellent third quarter results, which generated many new records in the quarter. You will spend less time on these results and more time describing our view of the market and how we're navigating the environment. Before doing so, I'd like to thank our teams across the entire organization. who did an exceptional job keeping focus on the business, especially while working through the Duke acquisition, which closed on October 3rd. We fully integrated the portfolio, achieved our day one synergies, and look forward to the next phase, which is to build AFFO accretion through incremental property cash flows and essentials income. We move forward with a better portfolio, a larger and stronger balance sheet, talented new employees, and new customers to whom we can introduce to our essentials business. Turning to results, core FFO was $1.73 per share, including 57 cents of net promote income earned principally from our PELF venture in Europe. Our annual guidance for promotes was 60 cents, with most of the revenue to be earned in the third quarter. The amount came in below expectations due to a nearly 5% write-down of European asset values in the quarter, partially offset by an increase in NAV from debt mark to market. In the end, the promote was a record high, while the fund enjoyed a high team's annualized IRR across the three-year performance period, despite the recent markdown. I'll note a few operating stats from the quarter, all of which were records for the company. Ending occupancy increased 10 basis points over the quarter to 97.8%. Same store growth was 8.3% on a net effective basis, 9.3% on a cash basis. Both were driven primarily by rent change, which was 60% on a net effective basis. Separately, the Duke portfolio ended the quarter with 99% occupancy and net effective rent change of 54%. While these markets are outstanding, they're also backward-looking, so we've kept focus on more contemporaneous data, namely rent change on signings, which was 84% during the quarter, and our lease market, which now stands at nearly 62%. Finally, we had a very active quarter on the balance sheet, raising over $3 billion of debt in a variety of markets and currencies given our broad access, including a $650 million green bond issued in late September. We ended the quarter with debt to EBITDA 4.3 times, excluding gains, providing a significant investment capacity. Turning to our observations of current conditions, we continue to see scarcity of available space across our markets. Vacancy rates are at historic lows, and our own occupancy sits at a record high. Market rent growth in the third quarter remained robust in response to this scarcity and continued strong demand. Color across the markets remains generally upbeat in terms of customer inquiries, and our proprietary metrics also reveal healthy activity, even if they soften from the peak demand generated during COVID to levels still above long-term averages. Transaction gestation was stable during the third quarter at 62 days. Proposals by available units slowed during the third quarter to levels more in line with the pace of 2019 and indicative of less urgency to renew space far ahead of expiration. Inside our properties, our metrics point to activity that is increasing with our IDI index at 63.8, the 80th percentile, and utilization up to 86.6%, the 95th percentile. Now, certain customers have publicly announced a pause in CapEx spending, particularly those with more mature supply chains. But active dialogue with the majority of our customers confirms an overarching need to increase space as supply chain resiliency remains a top concern. Shifting to supply, we're seeing initial signs of a deceleration in development activity across our markets as construction and capital costs continue to increase. We believe we could see a gap in deliveries emerge in late 23 or early 24. As for today, our true months of supply metric sits at a healthy 22 months, up from 18 months last quarter. We've previously explained that we expect to see this metric climb into a low 30 months range, still at a level reflecting a strong operating environment. It's important to acknowledge where supply is being delivered, as our sub-market location strategies minimize our exposure to new supply. For example, in our coastal U.S. markets where we generate over 50% of our global NOI, vacancies are just 1.7%. Geographically, we have an increased level of focus on Europe, given the ongoing war and growing energy crisis. While we're reporting record results, including occupancy at 98.6% in a market with 2.4% vacancy, we are closely monitoring conditions. Customers are exercising caution in response to rising energy costs, which may create headwinds to near-term demand. That said, we also believe that new supply will now decline around 15% in 2023, which should support occupancy. The U.S. remains strong, where we now generate 87% of our NOI with the addition of Duke. Our teams continue to see solid activity, although acknowledging a reduced number of prospects for space compared to what we saw during the frenzy of COVID. Rent change on signings during the quarter was 93%, demonstrating a continuation of favorable pricing dynamics. In Latin America, both Mexico and Brazil are performing well, with very high occupancy, over 98%, and rent change across the region of 24%. And in Asia, construction costs in Japan are rising most acutely from the weakness in the yen as well as from competition for key materials to complete construction. Market vacancies have increased, but this constraint on new supply, particularly out to 23 and 24, should provide an offset. The combined picture was positive to third quarter market rent growth, exceeding our expectations and driving a 300 basis point increase of our 22 global forecast to 26%, with the U.S. at 28%, significantly up from the 10% and 11% respectively in our initial guidance. It's difficult to fully know the impact of this market rent growth on values given the limited transaction volume in the market, but our view is that the increase in return requirements is more than offsetting rent growth and indeed pressuring values. Based on prior cycles, we can safely assume it will take a few quarters for full price discovery to be made as markets stabilize and transaction volumes build. With all this in mind, we're carefully managing the business and approaching our markets with a sense of caution, much as we did at the onset of the pandemic. In leasing, despite the very strong spot environment, we are carefully watching for softening demand and will assume that there will be further macro deterioration. In some markets, this will have us managing more for occupancy than rent growth, but in many others we believe pricing will remain favorable given very low availability. This is an environment where our revenue management capabilities will be the most useful and allow us to manage such decisions lease by lease. With deployment, we are reducing our starts guidance to a range of $4.2 to $4.6 billion, and we expect our fourth quarter starts will be 60% billed to suit. Reflecting a more cautious approach to deployment in the coming months, aiming to be very selective in new projects. And in terms of strategic capital, we previously mentioned that we expect to see an increase in redemption activity. While we did have inflows from numerous investors, redemptions grew by $1.3 billion, which for context is just 3% of our open-end third-party AUM. Our funds have sufficient equity cues to address this activity. In combination with equity call during the quarter, we now sit at net neutral cues. The open-ended funds have ample investment capacity based on overall low leverage, and we are optimistic about the long-term growth of the business. In the near term, we will be prudent as we evaluate further capital deployment, including a pause on contributions in the short term. Turning to guidance, which includes Duke portfolio for the fourth quarter. We are maintaining our guidance for average occupancy while increasing our net effective same-store guidance to 7.5% to 7.75% and our cash same-store guidance to 8.5% to 8.75%. We expect to see our lease mark-to-market around 65% at the end of the year. We now expect acquisitions to range between $1.9 to $2.1 billion, which increased due to our acquisition activity in Europe during the quarter, and contributions and dispositions to range between $2.1 to $2.3 billion. Finally, we are increasing core FFO excluding promotes to $460 to $462 per share, which includes approximately $0.05 of accretion related to the acquisition of Duke. We are guiding core FFO with promotes to be $512 to $514 per share, which incorporates a lower promote guidance of $0.52, reflective of the higher share count resulting from the Duke transaction. I'd like to point out that our earnings have been unimpacted by effects over this extremely volatile year due to our capital strategy and approach to hedging. The same is true for our equity base, which has very minimal exposure outside of the U.S. dollar despite our global footprint. We will continue to protect both proactively and programmatically. To close, we're proud of how we've positioned the business and are optimistic about the organic growth ahead. We own hard assets with contractual revenues, significant embedded mark-to-market, and have meaningful secular drivers that continue to play out. As an organization, we have long had an entrepreneurial and growth mindset. Today, adding new business lines and cash flow streams that are synergistic with our already unique model. We have built the company to thrive across cycles, including uncertain environments like today. where we can seize opportunities and continue to set our business and portfolio apart. We'll now turn the call over to the operator for your questions.