Prologis Q3 2021 Earnings Call Transcript

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Provided by Quartr
October 14, 2021

Key Takeaways

  • Third-quarter leasing demand surged with 56 million sq ft of new leases signed, spaces over 100k sq ft effectively fully leased, and e-commerce accounting for 25% of new deals.
  • Prologis raised its 2021 U.S. net absorption forecast to a record 375 million sq ft against 285 million sq ft of deliveries, driving year-end vacancy to a new low of 4% and pre-leasing 70% of U.S. development pipeline.
  • Market rents and valuations hit all-time highs: U.S. rents grew 7.1% in Q3, with full-year forecasts up to 19% in the U.S. and 17% globally, while portfolio values climbed 9.5% in Q3 and 24% YTD.
  • The in-place to market rent spread widened by 500 bps to approximately 22%, implying more than $925 million of embedded annual NOI growth (about $1.25/share).
  • Full-year 2021 guidance was raised: core FFO now expected at $4.11–4.13 per share (nearly 14% ex-FX growth), free cash flow of $1.2 billion after dividends, and development starts increased to $3.7 billion.
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Earnings Conference Call
Prologis Q3 2021
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Operator

Hey, thank you for standing by. Welcome to the Prologis third quarter 2021 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask questions during the section you need to press star one on your cellphone. Please be advised that this conference is being recorded. To ask for assistance please press star and zero. Without further ado, I'll introduce Tracy Ward, Senior Vice President of Investor Relations. Go ahead.

Tracy Ward
Tracy Ward
SVP of Investor Relations at Prologis

Thanks, Sarah. Good morning, everyone. Welcome to our third quarter 2021 earnings conference call. A 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. 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 SEC filings. Our third quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP measures. In accordance with Reg G, we have provided a reconciliation to those measures.

Tracy Ward
Tracy Ward
SVP of Investor Relations at Prologis

This morning we'll hear from Tom Olinger, our CFO, who will cover results, real-time market conditions and guidance, and also here with me today are Hamid Moghadam, Gary Anderson, Chris Caton, Tim Arndt, Mike Curless, Dan Letter, Ed Nekritz, Eugene Reilly, and Carson Helbig. With that, I will turn the call over to Tom, and Tom, wave to begin.

Tom Olinger
Tom Olinger
CFO at Prologis

Thanks, Tracy. Good morning, everyone, and thanks for joining our call today. Third quarter results exceeded expectations and were underpinned by record increases in market rents and valuations. Operating conditions are being shaped by structural forces that continue to drive demand. At the same time, vacancies are at unprecedented lows. Space in our markets is effectively sold out. In the last 90 days, supply chain dislocations have become even more pronounced with customers acting with a sense of urgency to secure the space they need. As demand surges, having the right logistics real estate in the right locations has never been more mission critical to our customers. During the third quarter, we signed 56 million sq ft of leases and issued proposals on 84 million sq ft. Spaces above 100,000 sq ft are effectively fully leased.

Tom Olinger
Tom Olinger
CFO at Prologis

Our Last Touch segment continued to gain momentum with new lease signings growing by 44%. e-commerce requirements continue to broaden across a range of industries, with this segment representing one quarter of new lease signings. The activity was down sequentially as anticipated, although remains above trend. Given the sharp ramp-up in demand, we are raising our 2021 U.S. forecast for net absorption to 14% to a record 375 million sq ft against deliveries of 285 million sq ft, resulting in year-end vacancy reaching a new low of 4%. I want to point out that we revised our data set here this quarter to reflect only Prologis markets. As strong demand is being met with historic low vacancy, re-leasing in the U.S. delivery pipeline has reached 70%, its highest level ever as customers continue to compete for space. Acute scarcity in our global markets is driving record rent and value growth.

Tom Olinger
Tom Olinger
CFO at Prologis

In the third quarter alone, rents grew 7.1% in our U.S. markets, far exceeding our expectations. We are increasing our 2021 market rent forecast significantly to an all-time high of 19% in the U.S. and 17% globally, both up approximately 700 basis points. Our in-place to market rent spread jumped 500 basis points in the quarter and is now approximately 22% with an upward bias. This current rent spread represents embedded organic NOI growth of more than $925 million, or $1.25 a share. Record rent growth is translating to record valuation increases. Our logistics portfolio posted the largest quarterly increase in our history, rising 9.5% globally, bringing the year-to-date increase to an impressive 24%. Sorry about that. We expect that the ongoing network reconfiguration and expansion required to meet consumer needs and minimize disruptions will fuel demand tailwinds over the next decade.

Tom Olinger
Tom Olinger
CFO at Prologis

Switching gears to results for the quarter. Core FFO was $1.04 per share with net promote earnings of $0.01. Rent change on rollover was strong at 27.9%, slightly lower sequentially due to mix. Average occupancy was 96.6%, up 60 basis points sequentially, and we reached 98% leased at quarter end. Cash fees for NOI growth accelerated to 6.7%, up 90 basis points sequentially. We had a very productive quarter on the deployment front. Margins on development stabilizations remain elevated, coming in at 47%. Our development starts were $1.4 billion, consisting of 31 projects across 21 markets, with estimated value creation of more than $520 million. Turning to strategic capital. Our team raised almost $500 million in the third quarter and $2.5 billion year to date.

Tom Olinger
Tom Olinger
CFO at Prologis

Equity queues for our open-ended vehicles were $3.2 billion at quarter end, another all-time high. Moving to guidance for 2021, our outlook has further improved, here are the key updates on a per share basis. We're tightening and increasing our cash same-store NOI growth to now range between 5.75% and 6%. We're increasing the midpoint for strategic capital revenue, excluding promotes, by $12.5 million and now range between $480 million and $485 million. We expect net earnings of $0.05 per share for the year, an increase of $0.03 from our prior guidance. In response to strong demand, we are increasing development starts by $450 million to a new midpoint of $3.7 billion. Our owned and managed land portfolio now supports 180 million sq ft in more than $21 billion of future build-out potential, providing a clear runway for significant value creation over the next several years.

Tom Olinger
Tom Olinger
CFO at Prologis

We're also increasing the midpoint for acquisitions by $500 million. The increased pace of acquisitions relates to our focus on covered land plays and urban last-mile opportunities. We're now expecting that deployment uses of $650 million at the midpoint. Taking these assumptions into account, we are increasing our Core FFO midpoint by $0.03 and narrowing the range to $4.11-$4.13 per share. Core FFO, excluding promotes, will range between $4.06 and $4.08 per share, representing a year-over-year growth at the midpoint of almost 14%, while de-leveraging by more than 300 basis points. We expect to generate $1.2 billion in free cash flow after dividends with a very conservative payout ratio below 50% range. While our year-to-date results have been extraordinary, most of the benefits from the current environment will accrue to the future.

Tom Olinger
Tom Olinger
CFO at Prologis

Our 22% in-place to market rent spread, valuation impact on promotes, our leverage capacity, $21 billion of development build-out, and most importantly, the vast opportunity set that our global footprint provides all pave the way for both significant and durable long-term growth. As I mentioned at the outset of my remarks, the disruptions within the supply chain won't be solved overnight. Prologis plays a unique role in the industry, and we're committed to helping find long-term solutions. That's why we're working closely with our customers, policymakers, and community partners to help address the problems, which range from warehouse space to transport infrastructure and labor scarcity. In closing, I want to highlight two important upcoming Prologis events. First, this Monday, we'll be hosting a webinar that will dive into our development and strategic capital businesses.

Tom Olinger
Tom Olinger
CFO at Prologis

Second, on October 27th, we're bringing together supply chain and community thought leaders to focus on some of the most pressing issues in logistics today, including workforce, energy, and transportation. Please visit our website for more information and the registration links for both events. With that, I'll turn it back to Sarah for your questions.

Operator

As a reminder, to ask a question you will need to press star on your telephone. To withdraw your question press star key. Your first question comes from the line of Caitlin Burrows from Goldman Sachs. Your line is open.

Caitlin Burrows
Caitlin Burrows
Analyst at Goldman Sachs

Hi, everyone. Good morning. Maybe just the earnings release mentioned that your investment capacity is around $15 billion. Do you think Prologis will actually be able to deploy capital and use that opportunity? If so, how? Do you think that spread will actually increase as cash flow increases?

Tom Olinger
Tom Olinger
CFO at Prologis

As you know, we really never provide guidance, at least voluntarily, on deployment because, as I've said many times, it can range between zero and a lot. Last year, it was $21 billion. I don't know, honestly. It just depends on the returns that are available. The only reason we talk about capacity is that you sort of have a feel for what we can do if the right opportunities came about. There's no urgency around investing in a particular timeframe.

Operator

Your next question comes from the line of Emmanuel Korchman from Citi. Your line is open.

Emmanuel Korchman
Emmanuel Korchman
Analyst at Citi

Hey, everyone. Good morning. Tom, I kind of wanted to reconcile a point you made earlier in your script, which was that customers are keenly focused on getting more space. We're reading a lot of headlines on shortages of inventory, of labor, of other things. I guess, help me reconcile the two points where customers looking for space that maybe they can't fill right away. Are they just expecting the supply pipelines to rebound quickly? Are they moving stuff from other warehouses? Sort of, I guess it's a little bit counterintuitive for somebody to be taking more space when product is sort of an issue like that. Sorry for the long question. Thank you.

Tom Olinger
Tom Olinger
CFO at Prologis

Yeah. Let me try to answer that question. The supply chain is very long, and it's gotten longer in the last 10 years. Basically, what happened is think of it as a big, long hose, and somebody turned off the water, and the hose ran dry. As economies came back, different markets got opened, and production started, and it's now flowing through the supply chain. It is not flowing smoothly, and the old models for predicting demand and carrying inventory are basically thrown out the window. Inventory, particularly mid-product inventory, not finished product inventory, sort of ends up piling up in different places because if there's one part missing into something, it's going to hold up the inventory. The other 99 parts have to be stored somewhere.

Tom Olinger
Tom Olinger
CFO at Prologis

It's creating a pretty significant extra demand just to balance out the system, given that the buffers are not predictable anymore.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

The natural follow-up question from that, I would guess, would be, well, do you guys think about this being a one-time event or a sustainable event? I would say this particular factor is likely to be temporary, although probably a two or three-year type of process before everything straightens out. Right behind that are the two big structural drivers that on top of normal absorption, they include increased share of e-commerce and inventory levels being higher than prior to this pandemic. Those two things people aren't even thinking about right now because they're struggling to keep their heads above water. I think the short-term thing is really interesting.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

It's great for headlines and all that, but I think the much more interesting factor in terms of assessing the quality of our business is the long-term driver or the two long-term drivers of demand on top of the normal drivers of demand.

Operator

The next question comes from the line of Tom Catherwood from BTIG. Your line is open.

Tom Catherwood
Tom Catherwood
Analyst at BTIG

Excellent. Thank you so much, guys. A question on cap rates. We've seen incredible compression this year, and unlike prior years, it's really seemed to be across the board. Does that create any risk in certain markets or regions where fundamentals and demand may not meet kind of the lofty valuation expectations we now have?

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Boy, that's a tough question to answer. I'll give you mine, and Eugene, I'm sure, will have ideas about this. First of all, we're in the first week back of predicting cap rates. We've been saying for about five years that they're too low, only to watch them go lower. Remember, cap rates are a function of two things. One is general returns available in other capital markets, mainly interest rates or risk-free rates. More recently, this rent growth and the growing power of that initial yield is orders of magnitude higher than it's ever been. I'm not smart enough to parse why cap rates are compressing. I suspect it has more to do with the demand growth rate in the last six months than it does with the interest rate picture. In fact, the interest rate picture, if anything, has increased.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

The tremendous growth in rents, I think, has a way to see the drag from slightly higher interest rates. Eugene, what do you think?

Eugene Reilly
Eugene Reilly
CIO at Prologis

Yeah. I think you may be getting to the spread between primary and secondary markets. That actually hasn't tightened up that much. It has tightened up a little bit. Spot cap rates in primary markets are extremely low. I think there's always a risk as cap rates in secondary or even tertiary markets are dragged down by the overall strength of the market because you're going to see more supply in those markets going forward against probably less demand. We'll see how it plays out. I don't really think, from a uncertain standpoint of view, that those spreads have actually tightened that much further.

Operator

Your next question comes from the line of Jamie Feldman from Bank of America Merrill Lynch. Your line is open.

Jamie Feldman
Jamie Feldman
Analyst at Bank of America Merrill Lynch

Thank you. We get asked a lot about just the potential supply coming online with so much capital going into this sector. Can you talk a little bit about whether it's a competitive moat or just kind of how Prologis will be able to kind of protect itself as supply grows? Maybe that's the wrong way to think about it. Just how should we think about the supply risk overall? If that's easy to tell.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

I think you should think about supply risk as very market-specific. You can have all the desire to bring on supply in L.A. or San Francisco or Seattle or even Inland Empire, certainly Inland Empire West or New Jersey. Take all your good markets. How are you going to do it? There is no land, and their entitlement picture is getting to be harder and harder every day. Even markets like Dallas that we historically would have discussed as what we refer to as non-constrained in terms of land, believe it or not, are getting more constrained. Still entitlement-constrained, but they're more constrained, certainly in the good locations. I think the big driver is that it's just hard to come up with the land to build buildings on.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Supply is responding to demand, but my gut feel, and of course, you can't prove this one way or another, is that demand would be higher if supply were higher. I think people are just based on the number of people competing for the same good spaces and all the inbound calls we get from all our good customers trying to gain an advantage over another good customer, people are kind of in a panic almost when it comes to buying or committing to real estate. Demand is just crazy.

Eugene Reilly
Eugene Reilly
CIO at Prologis

Jamie, I also add that it's market-specific. It's actually sub-market specific. In terms of how do we protect ourselves, we do this all the time, whether it's a strong market or a weak market. We're always monitoring where's that supply going to come from. I don't think we really change our protocols in that sense.

Operator

Your next question comes from the line of Derek Johnston from Deutsche Bank. Your line is open.

Derek Johnston
Derek Johnston
Analyst at Deutsche Bank

Thank you. Hi, everyone. In January, on 4Q 2020's earnings call, your in-place-to-market rents were 12.8%. With that in-place-to-market now at 22%, that's nine, 10 months later. What are the key drivers for this change? Really, how sustainable is this mark-to-market across the portfolio?

Tom Olinger
Tom Olinger
CFO at Prologis

Yeah. I'll take that. I'll anchor you back. Well, first of all, the increase is all driven to high market rent growth. I think, as I mentioned in my remarks, we're almost 22% today, and there is an arrow up, just given a very minimal roll in the fourth quarter and given our market rent growth expectations. I would expect the 22% to go higher when we're on this call in January. One thing I would anchor you back to is, at our Investor Day back in November 2019, that in-place-to-market was 15.5%, and that was underpinning what we said our GAAP same-store growth at that time was at 3.5%-4.5%. Now, here we are today at 22%. When you think about that increase, that really takes the 3.5%-4.5% up almost 4.5%-5.5%. That's the impact. We've really extended.

Tom Olinger
Tom Olinger
CFO at Prologis

Here we are almost two years later, and it's up dramatically, and our runway has arguably gotten even longer. The underpinning of the organic growth potential that we have is sitting right there for you to see.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Yeah, the only thing I would add to Tom's comment is actually land prices in most markets are going up faster than rents, and construction costs are going up faster than rents. Actually the rent required for that marginal square foot of supply is ahead of that 22%. That's why the arrow is up. It's just we're running but sort of standing still or going a little backwards with respect to keeping pace with inflation costs.

Operator

Your next question comes from the line of Ki Bin Kim from Truist. Your line is open.

Ki Bin Kim
Ki Bin Kim
Analyst at Truist

Thanks. Good morning out there. I wanted to talk about your development pipeline. It's obviously grown very nicely to $5.20. Can you remind us the hard costs and how much of the costs are hedged or I believe some material of materials or options. As those expire and the annual benefit of those hedges expire, what kind of impact can it have to your future development in terms of margins or yields?

Tom Olinger
Tom Olinger
CFO at Prologis

Ki Bin Kim, we think we've contained about 25% of the cost increases we've seen to date. In our pipeline in terms of the starts going forward, there's probably 4% sitting there that's beyond the underwriting of those projects. Most of that is going to be picked up in contingency. As we look forward, we don't really see risk. I'm not going to get into the details of what we've done with pre-buying steel and other components on these projects, but I think we've mitigated quite a bit so far. We do see these markets kind of stabilizing at this point in time. The other thing that we've done, which is really critical, is we've maintained our schedules. I think today, I think we've picked up 30 days of schedule versus the market.

Tom Olinger
Tom Olinger
CFO at Prologis

In France, we build these buildings faster than the market anyway, but that's an incremental 30 days. The supply chain disruptions aren't just cost, they're schedule. I think ultimately you're getting to how much have we sort of mitigated? I've told you what we've done so far. We're probably out six months ahead of the curve, but you can't really get much further than that. I feel really good about what we've done this year, and I feel like we've prepared really well going forward. We feel good about the outlook and obviously we're raising guidance in May or August.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Yeah. I think more importantly than hedging construction costs is the fact that rents are going up faster than some of these costs if you take an overall average and certainly in the best markets. That's why margins are expanding with cap rates being there also compressing. So far so good. Will it continue forever? Probably not.

Operator

Your next question comes from the line of Ronald Kamdem from Morgan Stanley. Your line is open.

Analyst at Morgan Stanley

Hey, guys. Good morning. This is Juan. Just retention shooting up 50 to 58 points year-over-year. Any color what drove that specific geographic strength there?

Tom Olinger
Tom Olinger
CFO at Prologis

Nothing unusual about mix or geography, but as we said, customers don't have options, really a lot of places to go, and I think there's a race to secure really good, well-located real estate, and that's what we're seeing.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

That number can be very volatile quarter-to-quarter. Quite honestly, I wouldn't pay too much attention to it over a quarter.

Operator

Your next question comes from the line of John Kim from BMO Capital Markets. Your line is open.

John Kim
John Kim
Analyst at BMO Capital Markets

Good morning. I was wondering if you can comment on how you see occupancy trending, which you're at least right now at 98%. You're also pushing rents harder. Also, if you can comment on the sequential increase in occupancy in Asia as a quarter.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Occupancies have to go higher. If your demand is 385, and supply is 285, there's 100 million sq ft that's going to come out of somewhere. After that, you have obsolescence. That's a different amount of product that's taken out of circulation because people build something else on it, like apartments. I think for sure, vacancy rates, at least in the markets we care about, are going to be going down in the foreseeable future. In the long term, we need to see. I don't expect 385 million sq ft of demand being the new norm forever because some of it is just people being desperate for putting their stuff somewhere. I think it will stabilize at a higher level than historical because of those two unique drivers that we're seeing in this cycle that we didn't have in other cycles.

Mike Curless
Mike Curless
Chief Customer Officer at Prologis

John, your question on Asia, that's being driven by China. We've seen some very good lease activity in China. Japan, theirs remains extremely high occupied.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

The new team in China has done a really great job. Really interesting.

Operator

Your next question comes from the line of Craig Mailman from KeyBanc Capital Market. Your line is open.

Craig Mailman
Craig Mailman
Analyst at KeyBanc Capital Markets

Hey, guys. Just curious on the rent growth piece of things you guys have talked a lot about today. Consider the champion negotiations. Are you guys trying to push escalators higher as a way to combat the potential inflation here in the near term or just maybe smooth out some of the rent increases some of these tenants may have through all the big sticker shock at the end of the lease?

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Right. Well, there's a variety of rationale for that. Escalators are moving up. We're pushing them everywhere, as you can imagine. As importantly, the markets are accepting this and the competitive landscape is doing it, perhaps partially for the reasons that you mentioned, to smooth that effect with the customer. Of course, a lot of our customers are going to streamline it anyway. I think it's part and parcel with overall net effective rent growth. We feel pretty good about that.

Operator

Your next question comes from the line of Steve Sakwa from Evercore ISI. Your line is open.

Steve Sakwa
Steve Sakwa
Analyst at Evercore ISI

Yeah, thanks. Most of my questions have been asked. Just on the development increase, I'm just wondering if you could maybe talk about regions, kind of where you're seeing the most demand, and if you've kind of thought about spec versus build-to-suit, maybe giving your commentary about customers, and how do you sort of see that trending moving forward?

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Yeah. Steve, I'll take the first part of it. We've got about 100 projects we're starting this year, so it's really broad-based. I wouldn't say that the increases are targeted to certain areas because frankly, there's so much demand in all the markets. We're pulling forward projects that we can, number one. Number two, a lot of those increases, build-to-suit activity, and maybe Mike can comment on that.

Mike Curless
Mike Curless
Chief Customer Officer at Prologis

Steve. I would tell them we have about 60% of our activity with build-to-suit. That'll normalize end of the year in the mid-forties. I remind you, that's going to be on a much harder base, which is representative of two basic things. There's fewer spec opportunities for people to move into, and that's paired up with major structural rollouts that are well underway with a whole lot of companies worried about Amazon. We see a bunch of diverse activity there. No surprise, margins are as solid as they've ever been, reflective of how important entitled land sites are, and again, the dearth of available space out there has us in a really good spot on build-to-suit.

Operator

Your next question comes from the line of Brent Dilts from UBS. Your line is open.

Brent Dilts
Brent Dilts
Analyst at UBS

Hey, guys. With the shortages of certain items in the supply chain, how is that impacting your Essentials programs for tenants, things like forklifts, lighting, racking, et cetera? How are your tenants managing labor challenges against the backdrop for record demand?

Mike Curless
Mike Curless
Chief Customer Officer at Prologis

Yeah. Certainly, there's delays in some of our Essentials projects as well for crisscrossing those sorts of things. OEM manufacturers in those businesses are also struggling. Lead times are longer. We're using, again, our leverage and our scale, just as we do on the construction side of the business, to get through them quicker than they otherwise would be able to. On the labor front, I don't know if you guys want to chime in now.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Clearly, labor is on the minds of a lot of our customers, and we're seeing them getting creative on how they're attracting labor. You see the commercials for lots of companies on TV and what they're doing there. It's also having an emphasis on automation, and we're seeing plenty of discussions about automation. Automation these days is not the old version of it where it's fixed to scope. We're seeing lots of flexibility out there in terms of robotic forklifts and autonomous forklifts and those types of things, which we think our buildings are very well suited because the primary criteria for that is a good floor. We spent over 30 years making sure our floors are in really good shape. We think we're in real good shape to address automation, which I think will be a function of this labor issue going forward.

Operator

Your next question comes from the line of Michael Mueller from JPMorgan. Your line is open.

Michael Mueller
Michael Mueller
Analyst at JPMorgan

Yeah, hi. Tom, you previously talked about base case annual promote levels. How does that change for where cap rates have moved to today?

Tom Olinger
Tom Olinger
CFO at Prologis

As a reminder, we talk about, call it $0.07 of annual promotes if you net promote income, if you go back and you look at our historic performance. Clearly, given where valuations have gone, I would expect 2022 promotes to be substantially above our historic run rates. Now, clearly, we'll talk more about it in January, directionally, that's what you should expect.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Yeah. Promotes are pretty levered on the upside because once you pass the breakeven return, that incremental unit of return produces promotes. Whereas getting up to your breakeven rates, you're not getting any promotes. For sure, it will expand non-linearly.

Operator

Your next question comes from the line of Anthony Powell from Barclays. Your line is open.

Anthony Powell
Anthony Powell
Analyst at Barclays

Hi, good morning. A question about the building acquisition guidance that the OTC shares talked about covered land plays and your Last Touch. How competitive is the environment for acquisitions there and how are cap rates flowing for those types of deals?

Eugene Reilly
Eugene Reilly
CIO at Prologis

It's very competitive for Last Touch. There's no question. Cap rates are tough to talk about because you have in-place rents. You're capping income that's literally all over the place. I'm not sure it's actually constructive to talk about the cap rates, but it is competitive. I think we have a strategic advantage in the markets we want to be in, because we've been doing this now for three or four years. I think we have scoped out the sub and sort of micro markets pretty effectively. It is competitive and there's a ton of demand there, and that's not going to change.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

The yields on our covered land plays, on the entire portfolio covered land plays, which is about a quarter of our total land base, is about 5%, which means that we're actually getting better yields on some of these covered land plays. I know some of it is historic and rents have gone up a lot, 5% is pretty good. You're getting paid to wait, that's the wait category land. I mean, the wait category land is covered land plays and auctions. Really, owned land that's just sitting around there, that's the most expensive way of carrying it all. We've been onto this strategy for a long time, and we have a good base of covered land plays that are now sort of cycling through development.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

A lot of our development in the next 12 to 24 months is going to be building out on the covered land plays. The good news is we're replenishing that inventory and then some as we chew through it.

Eugene Reilly
Eugene Reilly
CIO at Prologis

Yeah, just to add on to what Hamid said. We have about 180 million feet of FAR built out on our land bank, auction land, and covered land plays combined. With the income flowing to the covered land plays, we have about a 2% stabilized yield for the entire land bank, including all three components of it. After you pay taxes, you're still in the plus. We're kind of carrying this for free. Frankly, some of those income profiles on the early covered land plays have a serious up-arrow to them. It's another way to think about land exposure.

Operator

Your next question comes from the line of Michael Carroll from RBC Capital Markets. Your line is open.

Michael Carroll
Michael Carroll
Analyst at RBC Capital Markets

Yeah, thanks. From folks who see leasing activity or demand improve as these supply chain disruptions dissipate and inventory levels improve, for our customers just looking to solve these problems right now and really trying to build their logistics network that they need over the next three to five years.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

I think they're doing both. I think most people are focused on just joining the Christmas. They literally should be not thinking about the long term, and people are. Some of the larger, more sophisticated players are, and those would be the Targets of the world, Home Depots of the world, people like that. There are lots of people just trying to survive the next year or two months. I think that crazy crunch will diminish over the next two to three years, for sure. I think then they'll turn to the longer-term strategies, and I think that one has legs for a long time.

Operator

Your next question comes from the line of Dave Rodgers from Baird. Your line is open.

Dave Rodgers
Dave Rodgers
Analyst at Baird

Yeah, most of my questions have been answered, but I did want to just follow up on the labor point. Obviously, labor, a big concern today, 400 million square feet of additional demand kind of in the last 4 quarters alone. Are you seeing customers making different decisions on locations, campus settings, whatever it might be, related to kind of longer-term labor concerns? Notwithstanding kind of the technology. Are you seeing kind of imminent decisions that are changing due to labor?

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

People have to figure out where their customers are, and the networks are based on where the customers are. Real estate and real estate costs are 2% to 5% of the total cost. By the way, that number hasn't gone up because of rents going up because the other components, labor, transportation, energy, are also going up. They're not going to optimize around real estate costs. They're going to optimize around where their consumers are and how long it takes to get them there, what they want, and it's mostly time, not cost. They're going to have to operate in the big markets. You're not going to go in the middle of this sparse space in the middle of the country because real estate rents are cheaper to service the desirable markets where a lot of the growth is. It's not a cost thing.

Operator

Your next question comes from the line of Nicholas Yulico from Scotiabank. Your line is open.

Nicholas Yulico
Nicholas Yulico
Analyst at Scotiabank

Thanks. I just wanted to follow up on the leasing market and in particular the 3PL market, which has been incredibly active year to date. Talk a little bit more about the trends you're seeing there. I imagine we've heard anecdotes of increasingly maybe Amazon using that market for future good space on a real-time basis. Any perspective would be very helpful. Thanks.

Mike Curless
Mike Curless
Chief Customer Officer at Prologis

This is Mike. 3PL activity was up 500 basis points last quarter, we've seen this really play out over the last several years, where 3PLs might have viewed space as a bit of a commodity many years ago. Today, they view it as an offensive weapon to help accommodate their customers, we're seeing this play out in the form of them leasing more space than they have underlying customers lined up for because they need that space to attract the customers. we are seeing them go for longer-term leases, both of which are good signs of the health of this business. a whole lot of that is driven by the e-commerce segment, which continues to be very diversified, way over about just Amazon.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

They are definitely committing space ahead of having customers, they're definitely filling up those spaces. This is not 1999 or 2000 dot-com, where people are going in hoping that their business will triple. They can't keep up. Literally, that's the takeaway for all you guys. You can ask the guidance 15 different ways, the supply market cannot keep up with the demand that's out there.

Operator

Your next question comes from the line of Blaine Heck from Wells Fargo. Your line is open.

Blaine Heck
Blaine Heck
Analyst at Wells Fargo

Great, thanks. I wanted to touch on acquisitions in general, not just specifically on the covered land space, which you touched on those earlier. You guys were able to do just under $400 million at your shares during the quarter at a 5% cap rate, and you increased guidance pretty significantly. Can you just talk about what caused that cap rate on deals during the quarter to be higher than we've seen in a while? Is that just a mix issue, or are you guys finding more opportunities to maybe acquire off-market? Related to that, what's giving you the confidence to increase acquisition guidance when there's so much capital out there chasing deals?

Eugene Reilly
Eugene Reilly
CIO at Prologis

The 5% is definitely a mix issue. On our acquisition activities, we're generally not out there to buy core portfolios at the highest try and hit that highest bid. We're constantly sourcing deals off-market. Yes, those do come with better returns. 5% is a mix issue. With respect to the confidence in the future, frankly, as Hamid said earlier on, we had a $330 million quarter. We might have a $2 billion quarter. We might have a zero. It really depends on what's out there, what's available to us, and we have confidence in the next quarter because we have a lot of irons already in the fire. Confidence long term, who knows? If these returns begin to completely blow out over replacement cost, you're not going to see us as active.

Eugene Reilly
Eugene Reilly
CIO at Prologis

Yes, if there's a strategic opportunity, we may have a quarter that's 10x the quarter we had this. Acquisitions are hard to forecast. They should be hard to forecast, frankly.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

If somebody gives you a precise forecast for acquisitions, you should run for the hills. There's also another two, I think, important differences between us and others. First of all, our playing span is the globe, and that's lots of different ways to deploy capital than just in the U.S. I'm not saying by the way Europe is any easier, but I'm just saying we have really multiple ways we could deploy capital. Secondly, a lot of the incremental capital that's come into the business is from allocators, is from people that basically go and buy existing product, and we can buy substandard product that's well located on fixed.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Even though there's competition in that too, but the number of players in that fixed market hasn't grown as much as the number of marquee players in the, I buy office buildings and malls today, and now I'm going to buy a warehouse because it's cool. That's the difference.

Operator

The next question comes from the line of Jonathan Petersen from Jefferies. Your line is open.

Jonathan Petersen
Jonathan Petersen
Analyst at Jefferies

Oh, great. Thanks. I'm just curious for your thoughts on maybe some of the structural headwinds that a lot of the coastal gateway markets are facing, particularly New York and San Francisco. Obviously, people are going to come back to the office, a lot more flexibility and expectations of migration more towards lower cost markets or tax markets. I'm just curious how that impacts the industrial sector and your, I guess, willingness in underwriting around developing and expanding in those markets.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

I think I've honestly heard this wishful thinking by the part of people who are in other regions of the country now for probably 20 years. Every time you've invested on the basis of that thesis, you've left money on the table. I don't see it. Yes. Is Elon Musk moving from California to Texas? Yes. Does he get a lot of headlines? Yes. He doesn't consume any more than somebody who makes $60,000 a year. The big consumption bases are in these markets. The land is covered with buildings. Those are the differences. The fact that they're sitting next to a beach, that's not so important. It's just that those populations are still growing. There's just a pause last year. They're still growing.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

The vast majority of the movements are in the same region from maybe the urban core to the suburbs or something like that. There's a lot of data on this. Maybe Chris, you want to elaborate on this. In terms of the distribution business, we don't have buildings that are in different places for servicing the urban core versus the suburbs. They're all sort of within the same driving area.

Chris Caton
Chris Caton
Managing Director of Global Strategy and Analytics at Prologis

Yeah. I just had a couple of data points for you. First, the business has never been stronger when we look at California and New Jersey. Business is excellent from a demand perspective and a pricing perspective. As you look at real-time migration data, and I'm specifically talking about the USPS data, you see migratory trends dictate that it's slowed down. It is not continuing. It is not accelerating. As you look at other real-time data, for example, the housing, you also see the same trend. Just a couple of data points to reinforce the points that Hamid's making.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

By the way, let me just say this. It's not like California doesn't have problems or New York doesn't have problems. They do have problems, and they need to solve those problems, and they need to become more business-friendly, and they need to improve the quality of life, and homelessness is a real issue, and all of those things are real issues. At the end of the day, people go where the job growth is, and that's where the job growth is.

Operator

We have a follow-up question from Emmanuel Korchman from Citi. Your line is open.

Emmanuel Korchman
Emmanuel Korchman
Analyst at Citi

Thanks, Evelyn. Chris, one for you. In the past, you've talked about how much logistics is as a % of sort of overall, whether it's product cost or distribution cost. Has that essentially stayed consistent now and the rise in rents is consistent to rise in other costs? At some point, is that relationship that messed up either with rents becoming a bigger piece or the other costs becoming a bigger piece? Thanks.

Chris Caton
Chris Caton
Managing Director of Global Strategy and Analytics at Prologis

Hey, Manny. It's our assessment that right now that ratio has not changed. For those who are not familiar with the data, rent is roughly 5% of supply chain costs, and supply chain costs are roughly 5% of revenue. Rent is about 25 basis points of throughput distribution. With the growth we're seeing in transportation costs, the growth we're seeing in labor, that has in fact been ahead of the rest of the market rent growth, and so that ratio has not needed to change. If anything, it's gone down a bit.

Operator

We have a follow-up question from the line of Ki Bin Kim, Truist. Your line is open.

Ki Bin Kim
Ki Bin Kim
Analyst at Truist

Thanks. I have a question for you. Your market cap is now over $100 billion. Obviously, you've grown a lot over the past several years. When you talk about the mental math that you do in terms of the economics you get from contributing to 12 assets into a fund, when you're a smaller company, obviously that math works out very favorably. As it gets bigger, I wonder, when do we hit that point where you would want to keep more of your development on balance sheet versus contributing to funds at the same pace?

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

Yeah. I actually don't think that math necessarily ever reaches that point, Ki Bin. I think if you think about it, the reasons for being in the private capital business are beyond scale. They're mitigating currency exposure. It's leveraging the return on our capital, et cetera. We've got a good history and a good brand in that business. It's a very important business for us, and we'll continue to do that in a meaningful way. The key to our growth is not external growth. Now, we've done more external growth than anybody on the planet, but our key is not external growth. The key is internal growth. That comes from portfolio construction, and that comes from 20, 30, 40 years almost of meticulous, steady work to build up these positions. That's what's going to really, in the long term, drive earnings in this company and create value.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

The fund is great. It's interesting. It enables us to get scale that drives down G&A ratios and create value that way. It increases our liquidity, which reduces the cost of capital. It does all kinds of things. At the end of the day, it's those location selections. Like, look at all our core five M&A deals. Some of them, probably between the five of them, we sold probably 30%, maybe 35% of the assets because we just don't believe in those markets. We kept the ones that we want. By the way, probably the right short-term decision would have been to keep those assets because cap rates have compressed each. Knowing what I know now, we should be more levered and have owned those assets. Frankly, that doesn't set us up as well for the long term.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

We'll make that up in terms some in the long term by having this portfolio in the right place. Organic growth and the external growth is actually on the table.

Operator

Your last question comes from the line of Jamie Feldman, Bank of America. Your line is open.

Jamie Feldman
Jamie Feldman
Analyst at Bank of America Merrill Lynch

You had said in 2017 for rent growth in Europe. Can you talk about how your ability to push rents there compares to what you're seeing in the U.S., and if there are certain markets that are looking better than others?

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

U.K. is like the best markets in the U.K., and the continent is like the average markets in the U.S. minus 50 basis points. That's the way I think about it. That may not be price. In terms of rental growth, I think the average of the continent is probably lower than the average of the U.S. today. The cost of capital is lower in Europe also compared to the U.S. Interest rates are lower. I think it all makes sense in the context of the cost of capital. U.K. is more coastal U.S.-like, and the continent is more like the rest of the U.S. Okay, Jamie, I think you're the wrap. Really appreciate everybody being on the call. I think we had about 780 of you on the call today, which has got to be a huge record.

Hamid Moghadam
Hamid Moghadam
Chairman and CEO at Prologis

I really appreciate the interest in the company, and look forward to talking to you in the next couple of months. Take care.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

Executives
    • Chris Caton
      Chris Caton
      Managing Director of Global Strategy and Analytics
    • Eugene Reilly
      Eugene Reilly
      CIO
    • Hamid Moghadam
      Hamid Moghadam
      Chairman and CEO
    • Mike Curless
      Mike Curless
      Chief Customer Officer
    • Tom Olinger
      Tom Olinger
      CFO
    • Tracy Ward
      Tracy Ward
      SVP of Investor Relations
Analysts
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