Are Industrial REITs Poised to Grow Despite Normalizing Demand?
The U.S. industrial real estate sector, while exhibiting signs of normalization following the extraordinary demand spike during the pandemic, continues to project healthy fundamentals. In this article we’ll delve deeper into the second-quarter performance in terms of demand, net absorption, leasing activity, vacancy rates and rents, and then further probe into the future outlook of this asset category.
Finally, we will try to figure out how the four major Industrial REITs – Prologis PLD, Rexford Industrial Realty REXR, Americold Realty Trust COLD and EastGroup Properties EGP – are likely to have performed in the second quarter and what lies ahead for them.
Industrial Real Estate Market Fundamentals in Q2
Per a Cushman & Wakefield CWK report, the industrial real estate sector is starting to normalize after two years of exceptional demand fueling a cumulative rent growth of 30% or more. Net absorption for the second quarter measuring 44.9 million square feet (msf) marks a decline from the heights of the previous year. However, it is still in line with the healthy pre-pandemic absorption levels.
Leasing activity too mirrors this trend amid economic challenges. While gross new leasing of 141.1 msf is down 8.9% from the first quarter, it is still in line with the quarterly average experienced from 2015 to 2019. Moreover, the market is on track to surpass 500 msf for the eighth consecutive year. The rise in vacant sublease space in certain markets has had a moderating effect on the overall absorption figures.
The second quarter saw a swift influx of new industrial supply, with a staggering 139.5 msf of new developments reaching completion. Amid this, the national vacancy rate increased 60 basis points to 4.1%, surpassing the 4% mark for the first time since mid-2021. Despite the rise, the vacancy rate remains well below the 10-year average, suggesting a resilient market.
However, despite the softening market conditions, rents continued to rise. The second quarter asking rental rates increased 4.6% quarter over quarter, pushing the figure to $9.59 per square foot. In several markets, the healthy delivery of Class A speculative logistics space at a premium price is exerting upward pressure on prices.
However, developers are dialing down amid the slowing demand, with the construction pipeline declining 5.1% quarter over quarter. Notably, the current speculative developments make up 83% of the pipeline, and only 19% of that space has been pre-leased by tenants.
What Lies Ahead?
Per the CWK report, construction completions are likely to outstrip demand in the second half of 2023 and 2024, pushing the vacancy rate to more than 5% by 2024. However, compared to the 15-year historical average of 6.6%, vacancy will still be considered tight, favoring landlords.
The report also expects absorption totals to hover marginally below pre-pandemic levels in 2023 and 2024 as softer demand for consumer goods merges with the challenges of high inflation and interest rates. Despite this, net absorption is expected to remain in the positive territory in both 2023 and 2024, indicating the enduring resilience of this sector amidst prevailing economic challenges.
Moreover, going forward, rents are projected to trend higher, albeit at a slower pace. While annual growth is expected to decline and be within the 10-11% range in 2023 and slow further to 3-4% in 2024, rents are still expected to surpass the $10 mark for the first time ever in 2024.
Stock Discussion
Prologis: Prologis is a global leader in logistics real estate, with a portfolio that spans 19 countries. While the company might face challenges amid slowing demand and rising vacancies, its sturdy portfolio indicates a promising mid to long-term performance. PLD is likely to show resilience in terms of rental growth and occupancy rates.
Moreover, its strategic buyouts and solid balance sheet bode well. In October 2022, Prologis closed on the acquisition of Duke Realty in an all-stock transaction valued at $23 billion, thereby boosting its presence in the key markets. In late June, Prologis announced an agreement to acquire close to 14 million square feet of industrial properties from opportunistic real estate funds affiliated with Blackstone in a cash-funded transaction valued at $3.1 billion.
PLD currently carries a Zacks Rank #3 (Hold). It is scheduled to release its earnings on Jul 18 before market open. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The Zacks Consensus Estimate for PLD’s second-quarter 2023 funds from operations (FFO) per share of $1.67 indicates a whopping 50.4% increase from the year-ago reported number. For 2023, the consensus mark for the same is $5.48, suggesting a 6.2% increase year over year. For 2024, FFO per share is expected to rise 2.1%.
Rexford Industrial Realty: REXR is focused on owning and operating industrial properties in Southern California, a region characterized by high demand and limited supply. REXR's strategic positioning in the supply-constrained Southern California, coupled with its focus on infill properties, could provide stability amidst the sector-wide cool-down. The region's potential for premium rents presents a promising outlook.
REXR currently carries a Zacks Rank #2 (Buy) and is slated to release its earnings on Jul 19 after market close.
The Zacks Consensus Estimate for REXR’s second-quarter 2023 FFO per share of 54 cents indicates a 10.2% increase year over year on a 27.6% projected increase in revenues. For 2023, the consensus mark for FFO per share is $2.19, which suggests an 11.7% increase year over year on a 21.8% rise in revenues. For 2024, FFO per share is projected to increase 15.4%.
Americold Realty Trust: As the world's largest publicly traded REIT focused on temperature-controlled warehouses, COLD benefits from the rising demand for cold storage facilities. COLD, with its temperature-controlled warehouses, could fare well in the changing market conditions. The need for cold storage is unlikely to wane, which suggests a strong demand for its specialized real estate assets.
COLD currently carries a Zacks Rank #2 and is scheduled to release earnings on Aug 3 after market close.
While the Zacks Consensus Estimate for COLD’s second-quarter 2023 FFO per share has moved marginally down in the past month to 24 cents, the same for the third and the full-year 2023 climbed north over the past month to 31 cents and $1.21, respectively. It has a long-term growth rate of 9.5%, which is ahead of the industry average of 6.7%.
EastGroup Properties: EGP is a self-administered equity REIT focused on the development, acquisition and operation of industrial properties. EGP's focus on high-growth Sunbelt markets and diversified tenant base might alleviate the effects of the overall slowing demand.
EGP currently carries a Zacks Rank #2 and is scheduled to release earnings on Jul 25 after market close.
The Zacks Consensus Estimate for EGP’s second-quarter 2023 FFO per share has moved marginally north over the past two months to $1.88, implying a 9.3% increase year over year. For 2023, the consensus mark for the same has climbed marginally to $7.56, suggesting an 8% increase year over year. For 2024, FFO per share is projected to increase 6.5%.
Here’s how PLD, REXR, COLD and EGP have performed over the past three months.
Image Source: Zacks Investment Research
Parting Thoughts
While the industrial real estate market cools offs, the underpinning fundamentals and continuing healthy demand paint a promising picture. Investors should remain optimistic about the resilience of this sector and consider the compelling opportunities offered by Industrial REITs like PLD, REXR, COLD, and EGP. The specific geographic focus and property types of these REITs may provide stability and potential returns during the market's normalization phase.
Note: Anything related to earnings presented in this write-up represents funds from operations (FFO) — a widely used metric to gauge the performance of REITs.
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Prologis, Inc. (PLD) : Free Stock Analysis Report
EastGroup Properties, Inc. (EGP) : Free Stock Analysis Report
Rexford Industrial Realty, Inc. (REXR) : Free Stock Analysis Report
Americold Realty Trust Inc. (COLD) : Free Stock Analysis Report
Cushman & Wakefield PLC (CWK) : Free Stock Analysis Report
