Prologis Inc (PLD) — Q2 2022 Earnings Call Transcript

Thanks, Rob, and good morning, everyone. Welcome to our second 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 guarantees of 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 filings. Additionally, our second 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 July 13, we announced the merger between Prologis and Duke Realty. This call will focus on our second quarter results. The company will not provide comments related to this transaction beyond what is included in our prepared remarks. I'd like to welcome Tim Arndt, 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. This morning, we reported our second quarter results, which were strong and ahead of our expectations with occupancy, leasing and rent change all at record highs. Duke also released their operating results this morning, which tell a similarly strong story. That said, the macroeconomic environment is making it difficult for investors to fully assess the state of our industry. There's frankly a stark difference between what one reads in headlines versus what is actually happening in our business. Accordingly, we find ourselves focusing more on our own proprietary metrics and real-time feedback from our customers to build a forward-looking view of our markets and demand. Before going through that view, let me first step through our results. Core FFO, with and without promotes, was $1.11 per share, slightly ahead of our forecast. Rent change on rollover was 46%, led by the US at 54%. Retention in the quarter was 79%, driving occupancy higher by 30 basis points over the quarter to 97.7%. All of this led to net effective same-store NOI growth of 7.6% and cash same-store of 8.2%. We started $1.7 billion in new development projects, bringing our year-to-date starts to $2.7 billion. On the balance sheet, we closed on a refinancing of our lines of credit, expanding the total commitment to $5.4 billion, ending the quarter with $5.2 billion of liquidity. We are very pleased to have not only increased our line capacity, but also to have done so while maintaining our spread and staggering maturities. In strategic capital, our net equity queue, which combines the committed queue less outstanding redemptions and deployment, was $2.8 billion at the end of the quarter. While performance in the second quarter was strong, we recognize that with the current backdrop, markets do have the potential to soften. Instead of repeating macroeconomic statistics from media headlines, which you all know well, I'll instead share observations from our unique data and insights. At quarter end, we had proposals on 52% of our remaining availabilities versus an average of 38% prior to COVID, reflective of the very active dialogue we've had and the fact that little space remains available to lease in our portfolio, 71% of leases expiring in the next 12 months are either preleased or in negotiations, ahead of the pre-COVID average of 56%. Lease negotiation periods have lengthened by a few days to an average of 60, while up from the more rapid pace of 50 days across 2021, it has essentially returned to the normalized levels we saw pre-COVID. And as it relates to pricing, our Sphere data, which measures normalized effective rents against forecast, reflects that markets remain strong and rent growth stays ahead of our expectations. Our field teams report market activity, which is totally consistent with all of this data. While the number of customers competing for available space has decreased from unprecedented levels tempering urgency, our teams report still healthy demand and limited downtime. This is also reflected in our monthly customer survey data, which report high historical utilization at 86% and an IBI index that reflects growth in activity. In the end, we believe we're seeing a normalization in the volume and pace of demand which we expected as the world reopened from COVID and consumers seek more in-person experiences. But given exceptionally tight markets and availability, the fundamentals remain excellent. E-commerce represented 14% of new leasing, down from approximately 25% in 2021, a shift we've long telegraphed. As noted, overall occupancy and leasing have continued to grow with take-up coming from a broad set of users, most notably transportation, healthcare and auto. E-commerce remains a positive long-term trend for our business. Clearly, COVID accelerated its adoption from a 15% share of retail sales pre-pandemic and running at 23% during, at 21% today, it is roughly 150 basis points ahead of our pre-COVID expectations. We are also seeing the emergence of supply chain resiliency as a secular and incremental demand driver for our business. We hear it from our customers both in daily dialogue, as well as our advisory boards, including three events held this quarter. We expect that this need for safety stock will lift demand for years to come, although economic uncertainty could cause some delay this year. In light of very low vacancy and healthy demand, we are increasing our overall market rent growth forecast for the year to 23% on a global basis and 25% in the US. This is due to a very strong first half where we see rents having increased 14% globally and 16% in the US. We continue to see increases in construction costs which provide a pricing umbrella for continued rent growth given the need to uphold expected yields before new spec development can be started. The increase in rents over the second quarter has expanded our lease mark-to-market to nearly 56%, translating to over $2 billion of embedded annual NOI as these leases roll. Applying this mark-to-market to our lease expiration schedule will show that net effective same-store NOI growth through 2025 should exceed 8% without any further increases in market rent, an incredible amount of built-in organic growth and resiliency in our earnings. Before turning to guidance, we expect to imminently file the S-4 related to our acquisition of Duke Realty, which will guide the timing of our shareholder votes and the close date of the transaction. The filing guidance excludes the deal's expected accretion. Beginning with operating guidance, we expect average occupancy to range between 97.25% to 97.75%, an increase of nearly 40 basis points from our prior guidance. We are increasing our net effective same-store guidance to a range of 7.25% to 7.75% and cash same-store to a range of 8.25% to 8.75%, each an increase of roughly 90 basis points. Rent change on rollover is expected to grow from our first half levels, increasing spreads to over 50% in each the third and fourth quarters. Given our view of market rent growth, we expect our portfolio's lease mark-to-market will expand to over 60% by the end of the year. We are holding our guidance for net promotes at $0.60 for the year. Our current appraised values would generate net promote income above this level, but given market uncertainty, we're holding our prior guidance. Our overall deployment guidance is unchanged from last quarter with the exception of acquisitions, which we have increased to $1.2 billion to $1.7 billion at our share based on our belief that opportunities are likely to emerge in the back half, which will be well-positioned to pursue. I'm also pleased to note that despite extraordinary moves in both interest rates and FX, our forecast remains unimpacted due to our proactive approach to managing both risks through limited maturities and robust FX hedging program. In total, we are increasing our full year earnings guidance to $5.14 to $5.18 per share, including promotes and $4.54 to $4.58 per share excluding promotes, representing 11.5% growth from 2021. Before closing, I'd like to spend just a few minutes highlighting one of the more important announcements we've made in recent years. Last month, we announced a new commitment to achieving net zero emissions by 2040, a full decade ahead of the targets established in the Paris Climate Agreement. Our plan includes key milestones along the way, such as a dramatic increase in our solar energy production and storage goal to 1 gigawatt by 2025, more than doubling our previous goal. We will also conduct carbon-neutral operations and construction by 2025. Ultimately, we plan to get to net zero without reliance on carbon offsets and our Scope 1 and 2 emissions by 2030 and net zero in our entire value chain by 2040. It's noteworthy that we are one of very few REITs to commit to science-based targets for our Net Zero goal. Prologis has long been a leader in ESG, both inside and outside of our industry. We're extremely pleased to have once again raised the bar and hold ourselves accountable to real, measurable, and reportable progress for our investors, our customers, and our planet. We truly feel great about our business and how we've positioned our teams, our portfolio and our balance sheet to thrive across the cycle even in uncertain times as we see today. With that, I'll now turn the call over to our operator to take your questions. As a reminder, we won't be addressing questions related to the Duke transaction on this morning's call.

Hi. It's actually Craig Mailman here with Michael. I just want to hit on the market rent growth and mark-to-market piece. You guys had 79% retention, 25-odd percent cash mark-to-market just peak average occupancy levels. And so I guess maybe a two-parter here. Just what breaks the camel's back here in the near-term from an occupancy or market rent growth perspective? And then two, maybe, Tim, could you just address as you head into the back half of the year and into 2023, kind of remind us what that mark-to-market on a standalone basis means for FFO per share?

Yes, I can address the second part. We don't provide a breakdown of the numbers in that manner. We have guidance for same-store results for the full year, with a midpoint of 7.5%. The growth in the second half is likely to contribute an additional $0.01 to $0.02 to the run rate that you will see in the third and fourth quarters.

Yes, I didn't quite catch the first part of the question. Could you please repeat it?

Sorry, I was just saying kind of given the strength of the operating metrics, what breaks the camel's back from the sense of risk to occupancy market rent growth is a mark-to-market here? I know you guys talked a lot about kind of the headline risk versus the reality of what you're seeing on the ground. But just to maybe put out there from your perspective, what the real risks are given what you're seeing on the ground?

Yes. There has been much discussion about the risk of supply exceeding demand, and there is some confusion regarding the supply and demand balance in the overall US industrial market and the specific markets we operate in. I'll pass it to Chris to explain further, as this is an important distinction. I don't believe there is a risk to supply, especially considering the low vacancy rates we are currently experiencing. On the demand side, I've been in this industry for 40 years, and I would say that prior to the last couple of quarters, demand strength peaked at a 10 on a scale from one to ten. However, the last quarter and the quarter before were even stronger, around a 12 or 13. They were exceptionally good. I anticipate this quarter may be around 9.5 to 10. By historical standards, this is still very strong and falls within the top 5 percentile over the past 40 years. It won’t reach the same heights as the previous quarters because everyone is aware of the market conditions now. If you are a CEO considering expansion, you’ll likely take your time to avoid making hasty decisions. The difference between aggressively pursuing space, which might inflate demand by 10% to 20% beyond actual needs, and being more conservative can lead to a decrease in demand as we pull back from the intensity seen in the past two quarters. That’s my view, but Chris can provide you with the specific supply and demand statistics, as there seems to be a lot of misunderstanding regarding those elements.

Let's clarify. We publish our data quarterly to bring transparency to the marketplace. This data forecasts 375 million square feet of net absorption and completions for the calendar year 2022, with the vacancy rate expected to drop to 3.2%. Our statistics focus on our 30 US markets and are based on the best sources available in each market. Looking ahead to 2023, while it's early to predict, we anticipate a gap of about 50 million to 100 million square feet between supply and demand. This could lead to a moderate increase in market vacancies, though they will remain below 4%, which is significantly lower than pre-pandemic and historical averages. Our market commentary reveals that some sources are employing unconventional methodologies and including non-Prologis markets. For example, the next 20 US markets, such as Memphis, St. Louis, and Detroit, have vacancy rates about one percentage point higher than ours and are facing a supply/demand imbalance with 126 million square feet under construction compared to a trailing 12-month net absorption of 88 million square feet.

Yeah. The other thing that's going on, and we're probably over-killing this response, but I think it's probably the single biggest area where we get questions on. Construction has not only become expensive, but also construction periods have been really stretched out because of limited availability of certain components. And by the way, we've been really good about ordering that stuff ahead of time. I'm talking about the market, not our situation in particular. So an extended construction period will make the pipeline of supply sound bigger. So if you're having a third longer construction period, which is what we're estimating, with the same amount of supply, the numbers will just be one-third bigger. That's just math. So again, a lot of confusion about this issue. And I think it's the single biggest disconnect between investor perceptions and the reality on the ground.

Thanks. Appreciate the comments, Hamid, on supply and demand. Could you maybe just talk a little bit about region and what you're seeing both in the US and Europe, just given some of the bigger challenges that we're seeing in Europe right now?

Let me provide some general commentary on Europe. Europe is performing as well as I recall, largely due to the war and the influx of people from Ukraine and neighboring countries, which have actually boosted demand and improved market dynamics for unfortunate reasons. The UK has seen a bit of a slowdown due to its political situation. Overall, Europe is a more subdued market compared to the US in terms of both supply and demand, which is why we're observing a lower rental growth rate in Europe relative to the US. This is not unusual when looking at historical trends. Chris, do you have anything to add?

Yeah. I would add, look, the US has been a market leader, especially on the coast with rent growth meaningfully outperforming lower barrier markets. We're talking about 10 to 15 percentage annual rent growth, it's better on the coast. And outside the US, whether it's Europe, whether it's the UK, whether it's Toronto, whether it's Mexico, vacancy rates are below 2.5%, and we're seeing some of the best market rent growth we've ever seen.

Excellent. Thank you and good morning, everyone. Tim, I appreciate your comment about proposals on remaining availability of 52%. I think that was the number versus 38% pre-COVID. How does that 52% compare to the last few quarters? And then maybe more broadly on your kind of leading indicators. How much of a lag have you experienced during prior cycles between a falloff in demand and fundamentals and warning signals coming from your proprietary metrics?

Yes. Thanks, Tom. Basically, the 52% we measured this last quarter is the strongest it's been. It has accelerated from that pre-COVID number that we quoted of 38%, lifted up into the 40s through COVID and has now hit what I think is an all-time high. And Chris, maybe you can pick up the past cycles?

Yes. So, I'd start by saying some of these insights are based on our investments in data that are unavailable elsewhere in real estate and uniquely available in this cycle. One metric that we invented in the last cycle was the IBI by way of a preview or by way of retrospective, I suppose. That metric is great at predicting the next 12 months of net absorption and remains at a healthy level today.

Yes. The current vacancy rates are incredibly low, about half of what they were during previous market peaks. To clarify our discussion about market cycles, many of you may not have been around during those times, but I'm referring to the early 1980s oil crisis, the late 1980s and early 1990s savings and loan crisis, the real estate crisis, the dot-com bubble in the early 2000s, and the global financial crisis. In comparison, I don't believe we're in the same situation now, and certainly, we're not beginning with vacancy rates that start with a 3. It seems unreasonable to even consider those past situations.

Great. Thank you. Maybe shifting gears a little bit and thinking about asset values. It looks like you're going to ramp up your acquisitions in the back half of the year. I assume that means you're finding some interesting opportunities. Can you talk about how much you think cap rates have moved and how much do you think asset values have moved? And maybe what looks interesting to you that you're ramping up your outlook?

Yes, that's a good question. The reality is we're not observing significant changes because, similar to other market cycles, when there's an inflection point, transaction volume tends to decrease. Buyers usually attempt to negotiate lower prices on ongoing deals, and often they do not succeed, resulting in fewer transactions. Thus, there is limited visibility on potential values. However, according to our appraisal, external appraisers have increased our values by 4% this past quarter. But we take that with caution since appraisals reflect past data. Valuations seem to be less optimistic, especially since the typical leveraged buyer is finding it more challenging to participate. That said, I believe cap rates are likely to stay quite robust. If I had to estimate where this might settle, I would anticipate an increase of 10 to 25 basis points compared to the pre-downturn levels, which is in addition to the 4% increase already reported. In simpler terms, if we started at a value of 100, I would expect a decline of 10 to 25 basis points rather than an increase of 4%. Dan, do you have anything to add?

Yes. I would just like to add that six weeks ago at NAREIT, we mentioned that we were entering a period of price discovery. At that time, we expected it would take 60 to 90 days before we started to see some of those comparisons emerge, but we are not quite observing that yet. Deal volumes have dropped significantly, and we are hearing about several renegotiations for deals that were in progress before the negative headlines began. So at this moment, we will see how it unfolds, but this aligns with our thoughts from six weeks ago.

Thanks. Good morning, Hamid. So just putting together some of the commentary around normalized customer behavior or at least proposals, how does that translate into your willingness to deploy capital on developments? So, on a combined basis, you and Duke are probably reaching close to $6 billion. Is that a sustainable level, given some of the things that you're seeing or how should we think about that changing?

Our development activity focuses on specific deals and leasing opportunities rather than pursuing new markets. In areas where we already have a significant presence, such as Southern California, we have substantial ongoing activity. Our approach is not about reaching a particular goal but rather evaluating each opportunity independently. However, we don't anticipate deploying the same level of capital for development throughout the entire cycle. While we believe we're in a favorable phase currently, it’s hard to predict when that might change. Construction costs have increased substantially, and land values have risen significantly, which affects the rents necessary for acceptable profit margins. When I mention land values, I refer to market values rather than our costs, where we still enjoy healthy margins. This situation poses challenges for creating viable financials, particularly for competitors who acquire land on a just-in-time basis. Consequently, this condition serves as a significant constraint on profitable development. Over a 10-year cycle, I can confidently say we are currently on the higher end of capital deployment.

Thank you. I noticed that your development starts yield increased to 6.1% this quarter, which is a significant spread compared to your acquisition cap rates. It was also the increased acquisition guidance that caught my attention. I'm curious about how feasible it is to advance some development opportunities given the improvement in margins and development yields.

One thing I'll just highlight and maybe throw it over to Dan is just that the development yields you are looking at there while conservative would incorporate our view of rents at the time that the assets are stabilized and as the leasing is occurring, whereas acquisition cap rates are going to be reflecting current and in-place NOI. So, that's a pretty big gap in there to appreciate.

And as it relates to how quickly we can pull-forward starts, we've got this land bank as a differentiator right now, right? We've got $2.5 billion worth of land on the balance sheet worth nearly double. So, this is land that's largely entitled and ready to go. So, that's really the beauty of our development business is that we can start and stop as we see the demand.

Yes. The only thing I have to add is that implied in your question is that we think it's really important to pull-forward development. Again, it is not. We're not building to a particular budget or anything like that. So, if we see the market again bottoms up deal by deal, not being as strong as we wanted, we're just happy to sit and not develop in that market. Not to mention that the big portion of our developments are build-to-suit and lease. So, we know the economics going in.

Hi, good afternoon. Good morning. Thanks a lot for taking my question. My question is on the near-term expected strength and how that evolves. Your same-store NOI guidance implies it remains at about 8.5% in the back half. Last year growth in the back half was about 200 basis points higher than the first half. So, can you talk about the contributing factors that allow you to achieve stable results despite the more difficult comparison, so accelerating results on the two-year stack and not asking for guidance here, but can you help marry that with when the impact from the expectation that conditions normalize? Like when can that start to weigh on some of the fundamental numbers that you report? Thank you.

Yes, it's Tim. I would like to mention two points. First, the second half of the year, which we discussed last quarter, does not exhibit the occupancy increases we observed in the first and second quarters. The same-store performance is experiencing more subdued occupancy gains in the second half, primarily influenced by rent adjustments. Shifting the focus to the long term, I refer back to my earlier comments regarding our expiration schedule and lease mark-to-market. We have emphasized establishing market rent and examining the rents that will be expiring this year, next year, and into 2024. This is where I made the point about potentially achieving 8% same-store growth over many years. That’s how I would analyze the data and consider that resilience.

Outside of this cycle, the highest same-store growth in the company's history was 6.5% for the upcoming year. Achieving around 8% rental growth for multiple years, like five years, is incredibly impressive because the market rates are significantly high.

Hey, just a quick one on Amazon. They talked about putting space back on the market. Maybe can you give us what's the update in terms of what you've seen in your portfolio and in the market in terms of space being put back and what you're hearing? Thanks.

Hello, Ronald, this is Mike Curless. We've come across the same rumors circulating about 10 million to 30 million square feet, but none of this has been confirmed by Amazon. What truly counts is what we observe on the ground, and currently, there isn't much happening. During our national broker calls last week, we only heard about one sublease option in the markets we follow. More importantly, regarding our portfolio of 132 spaces, we initially had interest in two of those spaces, but those opportunities have been removed. So, we currently have none in play. If you're familiar with our portfolio as we are, this shouldn't be surprising. Those facilities are mission-critical and situated in European population centers. To highlight this further, over the last 18 months, our retention rate with Amazon in those locations has been 95%, which is 20 points higher than our overall company average. Looking ahead, we are 99% leased in the 36 markets where we operate with them, and we have 54% ready to market, which is quite favorable. Therefore, I believe we are well positioned for any changes that may come our way.

Yes. The only thing I would add is that I didn't listen to the Amazon earnings call, but I got more questions about that one comment than comments from the entire industrial real estate industry, which is pretty consistent. So I guess if you have a market cap of over $1 trillion, people listen to you a lot more. But I think the single biggest miss for investors is that they read too much into that commentary. And the facts on the ground just don't support it. So that's all I have to say. And I'm prepared to be on the record for that.

Hi, thanks. Good morning. Within the context and conversation about the lease negotiation period and decrease or, I guess, normalization and competition for space. Are you expecting some of the leading indicators you track to continue normalizing or softening a bit further as you look out over the next several quarters, or do you think that you might see conditions and underlying fundamentals stabilize at current levels, just a bit off the extreme peaks you discussed that you realized over the last few quarters?

I think if I were going to bet, of course, nobody knows is that I think that will normalize at a higher level than normal. But right now, I would say it's prudent to assume that will be slightly down, but better than most market cycles. So that's the way we're running our business.

Hi, good morning. You mentioned that you saw transportation, healthcare and auto pickup in terms of mix of leasing. What's driving those sectors really pick up their activity? And would you expect them to continue to lead the mix over the next several quarters?

Certainly. Here’s my response. We lease more than one million square feet a day. However, because of our size, when we break down the figures by market and economic sectors, a single one million square foot lease can significantly impact our quarterly numbers. Similarly, for other companies, even a 100,000 square foot lease can greatly affect their results. Therefore, I wouldn't rely on these statistics on a quarterly basis, as they can be misleading due to the law of smaller numbers. In short, I can't provide a definitive answer, but I wouldn't use this data to form any long-term strategies for our business.

Hi, good morning. Have your expectations for supply completions in 2023 changed in recent months? Are you seeing any other players taking a pause from new development starts due to macro concerns?

Hi Vince, it's Chris Caton. Yes, our expectations have evolved a couple of ways. One is, first, for this calendar year, we have reduced it, not increased it based on the challenge of delivering product as Hamid described earlier and products getting stuck in the supply pipeline. We have also reduced our view for next year just as you surmise based on fluidity and the landscape and the rise in financial return of…

Yeah. I just have a real quick question. I know the GAAP mark-to-market is about 56% today. Can you provide some color on what the cash mark-to-market is? I believe a few quarters ago, you highlighted was near 30%. Can you kind of highlight where that has trended?

Yeah, it's moving by the same delta roughly at the end of the quarter, it was 48%. You probably heard me say that's not a number I find very useful. I would focus on the net effective because that stat is heavily influenced by where you are with remaining lease terms. So it creates all kinds of problems interpreting it. And the net effective number that we gave you of about 56%. I think it's a better representative of what's going on in the economics and the leases and also better representative of what will go on in our earnings.

Hi, guys. Can you talk a little bit about the institutional capital in your funds business? A, conversations you've had with them? And is there any change in the amount of capital that these folks are willing to put into your funds? And any color you could provide around that subject?

Sure. I would say that similar to our business fundamentals, we have experienced greater demand for our funds in the last few years than we have been willing to accept. This means we have turned away potential investors because we had long queues and it was irresponsible to continue accepting money when we were struggling to deploy it effectively. That situation has changed slightly. Demand for new products has decreased, and we are seeing a slight increase in redemption requests, although previously it was nonexistent. This shift is indicative of what I refer to as the denominator effect, where clients' stock and bond portfolios have suffered, and their private equity and venture portfolios are facing write-downs. Consequently, real estate is becoming a larger portion of their portfolios, necessitating rebalancing. Industrial assets are likely the best sector for this rebalancing due to the liquidity and market strength it has shown in the recent market cycle. While this is not surprising, we still have ample private capital to sustain our business for a considerable time. We have a strong position in this area, which has been tested through several market cycles. This explains why we have maintained low leverage in our business; when others are increasing their leverage, it is wise to operate unleveraged. If we identify great opportunities from this cycle, our available capital extends beyond what is in the queues we mentioned and includes the potential to leverage up to the more normalized levels for those funds. Therefore, I do not see capital as a constraint for us on the private side.

Good morning. Thanks. Within the context of the market rent growth that we're talking about and the Street expecting kind of four or five years' worth, are you seeing any markets where either sequentially or on a year-over-year basis market rents are starting to come down from their peaks?

Go ahead, Chris.

Hi, it's Chris Caton. I went over the regional differences, and the growth rate this year is indeed higher than last year. The U.S. markets and Europe are both experiencing faster growth, not slower. We have significant momentum. Regarding specific markets, we monitor our supply risk, and that list hasn't changed much over the last year. We are paying attention to supply issues in a few markets, specifically Dallas, Indianapolis, and Phoenix. However, we don't consider the supply situation in these areas serious enough to hinder rent growth, but they are still markets to keep an eye on.

Hi, everybody. Many companies like retail, they're reporting higher inventory levels and inventory-to-sales ratios are creeping up. So how is the inventory build demand driver that you guys discussed impacted last quarter's leasing? And are you seeing any delays now for this year or really in the opening, just to clarify, was that cautionary, given the macro? So any more insight as you were working to get our head around this emerging driver? Thanks a lot.

Thank you, Derek. This is Chris Caton. Tim has indeed summarized our perspective, and we believe it is wise to be cautious given the current macro environment. We are receiving numerous inquiries on this subject, which is why we will publish a paper this week addressing it. The main point is that the accumulation of real inventories for resilience is still in progress and aligns with our outlook. While some retailers are experiencing excess inventory for certain products, the overall market continues to emphasize increasing inventory levels, minimizing stockouts, and reintroducing product variety. Regarding leasing, we are currently witnessing strong resilience in the marketplace. The basic numbers indicate that demand growth in our 30 markets is around 200 million to 225 million square feet per year, while we are achieving a pace of 300 million square feet annually. In fact, we have experienced significant growth, with recent realizations exceeding 400 million square feet over the past 18 months. Thus, we have begun to see some of these structural drivers take shape, but there is still more growth ahead than we have already witnessed.

Yes. I would say this is the second worst understood point about our business. I think I would put Amazon first and I would put a level of inventory second, that's why we've chosen to put out this paper, and I just invite you to get into the nuances. These kinds of numbers, particularly ratio type numbers, can be very misleading if you don't parse them out. For example, whether you include autos or non-autos or general merchandise or non-general merchandise, you'll see those conclusions to be radically different.

Thanks. I have a couple of questions about the leading indicators mentioned on page four. Regarding lease proposals, what do you think is causing that number to decrease? Is it related to the Amazon effect taking them out of the market? Lease proposals seem to be down 10% to 15% compared to your yearly average. Also, with the IBI activity index, can you clarify whether it's predicting future space demand, or does it appear more like a coincidental indicator based on how it correlated with the last two recessions?

All I can tell you is that, it's hard to increase lease proposals when you have less space to rent. We only have 2% vacancy. So, the metric that you should think about is the one that we mentioned in the script, which is that, we are 52% on our vacancy at this point in the cycle, which is by far higher than the normal point in the cycle in terms of pre-leasing or re-leasing of our vacancies. These are proposals by the way.

Yes. And as it relates to the IBI, which you asked, we find it to be more closely correlated with the next 12-month absorption than any other economic indicator.

Yes, thanks. Given the comments you made earlier, just about the price discovery in the market. Curious about your thoughts around asset sales dispositions, you didn't update guidance, but should we anticipate that, that pushes later into the year? And then maybe more broadly, as you bring Duke on board, not a question about them, but about you, that effective transaction as a deleveraging event, it seems for you guys. So, do you run leverage back up as a company? Are you comfortable you are? Do you run lower kind of in the future and trying to think about asset sales and recycling going forward?

Yes, pretty hard to run leverage any lower than where we are, but we're not conscious with thinking of leveraging up. And the fact that the combination will actually improve or reduce our leverage is totally coincidental. We're not doing the deal to reduce our leverage. Our leverage is pretty low. So, I would say our leverage is probably much lower than it's likely to be across the cycle. But again, that's opportunity-driven, not sort of top-down driven. Tim, anything else?

No, I fully agree on how we view that transaction. And then with regard to dispo timing, nothing has really changed in our forecast. The holding of our guidance reflects our original view. There's always puts and takes on which quarter some things will land in and what the right mix of assets are going to be, but we're good with our guidance.

Yes. Let me provide an example of our disposition guidance. We had a portfolio listed for sale, and a buyer requested a price reduction. We essentially told them to go elsewhere. A similar situation occurred during the early days of COVID when a buyer, who was far along in the acquisition process, also sought a price cut. We rejected their request at that time. When they returned a year and a half later, they agreed to pay 15% more than their initial offer, which was actually 20% higher than their original price request. I’m not suggesting that the same scenario will repeat, but I want to emphasize that no transaction—whether it involves disposition, acquisition, or development—will significantly impact a company of this magnitude and diversity.

Hey. I mean, just staying with sort of the investment market, I just wanted to get some of your views, thinking about it more so from an IRR perspective than a cap rate, just given how large the mark-to-market today in various assets, talking about a spot cap rate sometimes leads to different conclusions? And so I'd be curious of your view how you're approaching it from an IRR basis, either on a five or seven-year basis and how you're thinking about the required return, but also how you're seeing the usual investor change perhaps their view overall on underwriting?

It's important to clarify a point. The meaning of the spot cap rate is affected by the mark-to-market being 50 basis points. In apartment investments, there isn't a mark-to-market to consider, so the cap rate stands on its own. However, having that mark-to-market feature can significantly lower cap rates. Therefore, I believe the internal rate of return (IRR) is a more effective way to gauge return expectations. A quarter ago, we observed transactions showing unleveraged IRRs in the low five range, which aligns with our investment strategy. These transactions had an average rental growth forecast of around 3%. Currently, the discount rates being considered will likely start with a six, in the low 6s. Yet, even with the same 3% market rent forecast, the rental growth expectations have increased due to expanded mark-to-markets. Consequently, the total lease growth rate is on the rise. I'm uncertain how much cap rates will fluctuate due to the mark-to-market situation, as many may not fully understand it. This might lead to a temporary slowdown in investment volume. However, anyone looking to present a strong deal in our markets with a 50% mark-to-market at the cap rates we saw three quarters ago can reach us at 1-800-Prologis. We are eager to acquire as much of that type of asset as possible because investing in those conditions with the mark-to-market and a significant discount to replacement costs is ideal for us, and our leveraged counterparts may not be able to achieve that. It’s a favorable market for such opportunities.

Great. Thank you. I mean I don't know if you can quantify this or not, but when you think about your leasing pipeline, the proposals you've mentioned, 52% of remaining vacancies. Can you break that out by how much you think that is – how much of that do you think is recession-sensitive versus not? So I guess I'm asking, when you think about if they're really trying to get supply chain resilience and all the secular trends we're talking about, how much of the leasing pipeline would just power through that versus take a pause if we do, in fact, have a mild recession as a later calling for?

Jamie, it would be pure speculation. I have no idea is a personal answer. First of all, I'm not sure we're going to have a recession. Secondly, I have no idea if we have a recession, how deep or extended it will be? I'm not sure even what the definition of the recession is anymore because when got not just committee deciding whether we're in a recession or not, and they usually declare it a couple of quarters after it happens. So the answer is, I have no clue. That's the honest answer. Okay. That was the last question. Really appreciate your interest and look forward in our continued dialogue. Take care.