Prologis Warns Higher Borrowing Costs Will Slow Industrial Deals, Development
Industrial operators are again absorbing the impacts of rising volatility as bond traders drive up the cost of debt, leading Prologis executives to forecast a slowdown in capital markets.
High costs and macroeconomic volatility will weigh on industrial development starts and lead to fewer sales, at least in the near term, Prologis executives said on the firm’s third-quarter earnings call Thursday. The world’s largest industrial firm reported results slightly ahead of analyst expectations.
“On the supply side, the bar for new development is going up,” CEO Dan Letter said. “Construction costs are escalating, financing is more expensive, and return requirements are trending higher. That makes projects harder to pencil at today’s rents. All else equal, we expect fewer starts and a more favorable supply environment.”
The REIT spent $644M in the third quarter acquiring real estate and made $58M in additional investments. It broke ground on $1B in new development and had dispositions and contributions totaling $169M.
The groundbreakings come despite rising development costs that management expects will restrict the supply pipeline across the sector in the near term.
“The rents needed to justify new construction have expanded to 27% above current market levels,” Letter said. “That leaves meaningful room for rent to grow before new supply makes economic sense.”
Despite the difficult financing environment, Prologis modestly increased its midpoint for development starts this year, citing a strong pipeline of build-to-suit projects. In the third quarter, 80% of construction starts were speculative development, but Prologis expects to end the year with between 55% and 65% of its developments being build-to-suit.
“We have a very large build-to-suit pipeline — it’s actually probably about 20% to 25% larger than it was at this time last year — and these are big lumpy deals,” Letter said.
The higher cost of capital will also slow down sales in the near term as operators adjust to rising operating risks, Prologis management said. For most of the year, investors’ risk appetite was growing, but the run-up in yields on U.S. Treasury bonds has shifted buyers’ calculations.
“The market is now digesting the recent increase in treasury yields, and we are observing a wider bid-ask spread,” Chief Financial Officer Tim Arndt said. “We expect transaction volumes to moderate in the near term as buyers and sellers recalibrate.”
On the leasing front, Prologis management said demand remains durable, and Arndt said in-place rents were resetting 38% higher on a net effective basis at expiration.
Demand was led by e-commerce, advanced manufacturing and a newly budding sector of businesses that support the data center market. Those firms accounted for 17% of leasing activity in the quarter and are quickly growing.
“Our customers invest in their supply chain when their businesses are growing, and the conversations are very constructive,” Letter said.
Prologis reported core funds from operations at $1.5B for the quarter, up 8.3% from the same period a year ago, and the industrial giant collected $2.2B in rent and other revenue across the quarter. The global REIT inked 60M SF worth of leases in the third quarter and had an average occupancy rate of 95.1%.
In a note to investors Thursday morning, analysts for JPMorgan Chase wrote that the earnings results suggested “that pricing power remains healthy even as customers continue to manage inventory tightly.”
Shares of Prologis were up in premarket trading but dipped after the opening bell and were trading down more than 2% midday Thursday.
Source: www.bisnow.com — article syndicated from the publisher’s feed; all rights remain with the original publisher.