Prologis Inc
NYSE:PLD
Earnings Call Analysis
Q3-2023 Analysis
Prologis Inc
The company is riding a positive wave with an updated full-year 2023 core FFO guidance to a range of $5.58 to $5.60 per share, displaying strong growth of nearly 10.5%.
In 2024, the Duke portfolio will join the same-store pool, with minimal impact on net effective same-store growth and earnings since the Duke rents were already marked to market a year ago. However, this will align with the rest of Prologis' portfolio for cash rent change.
While current market demand is slightly softer than usual, and companies are hesitant to commit to build-to-suits, the company's occupancy rates have surpassed expectations. Additionally, the build-to-suit segment for data centers continues to be significant.
The company has shown prudence by funding business growth without issuing equity, emphasizing a solid financial strategy.
Data center operations are expected to yield significantly higher margins, multiple times the norm for logistics build-outs, marking an advantageous divergence from traditional business lines.
Data centers are shaping up to be a perennial part of the company's build-to-suit activities, with a strong focus on maximizing the value of existing land holdings in burgeoning data center markets.
New market development starts exhibit a decrease of 65%, yet market rent growth has enhanced by 60 basis points compared to the past quarter, indicating resilience and potential for future positive growth.
Current market conditions remain stable, and rent growth is expected to generally match or outpace inflation. The team is strategically positioning itself in anticipation of a capital-limited market, aiming for leveraged IRRs around 9%, and are actively seeking quality acquisitions.
The market is experiencing a wider than anticipated gap in supply and demand, partly due to a recent unforeseen jump in rates and the associated delay in companies committing to significant capital expenditures. However, long-term demand remains evident according to ongoing customer dialogue.
The demand for data centers is underscored by technological advancements like AI. These developments open up new possibilities and confirm that the company's strong markets are driven by consumption figures, not manufacturing.
The company has navigated credit challenges efficiently, predominantly with retailers, and has successfully improved its position by buying out or renegotiating leases, showing adaptability and active portfolio management.
A comprehensive total return perspective is applied to every deal, factoring in quality, long-term holding potential, and essentials revenue among other criteria, ensuring a balanced investment approach.
The trends of reshoring and Amazon's investments do not particularly signal a manufacturing-driven demand in their product market. Instead, strong consumer-driven consumption, which is the core driver for their demand, is expected to persist.
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greetings, and welcome to the Prologis Third Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jill Sawyer, Senior Vice President of Investor Relations. Thank you, Jill. You may begin.
Thanks, John, and good morning, everyone. Welcome to our third quarter 2023 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 third quarter results press release and supplemental do contain financial measures such as FFO and EBITDA that are non-GAAP and in accordance with Reg G, we have provided a reconciliation to those measures. 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. The third quarter marked the continuation of themes we've been anticipating for more than a year, namely growing supply translating to increased market vacancy, continued moderation of demand and market rent growth that will slow until the low levels of new starts drive reduced availability over time. We've operated in accordance with these views in both our approach to leasing as well as timing of new development. What's incremental to our forecast is that continued hawkish posture from central banks and the impact it's had on rates is delaying decision-making and willingness to take expansion space early. The geopolitical backdrop has clearly become more troubling as well amounting to a lack of clarity that will likely weigh on demand. In the meantime, and also playing out to our expectations, is that our existing lease mark-to-market will drive durable earnings growth as it did in delivering record rent change this quarter as well as strong earnings and same-store growth. We remain focused on the fact that we own assets critical to the supply chain with long-term secular drivers that remain intact. Further, the outlook for future supply will continue to face structural barriers ultimately driving occupancy rents and values. In terms of our results, we had an excellent quarter with core FFO excluding net promoter income of $1.33 per share. This result includes approximately $0.03 of onetime items related to interest and termination income as well as the timing of expenses, which we can address in Q&A. Occupancy ticked up over the quarter to 97.5%, aided by retention of 77%. Net effective rent change was a record 84% of our share, with notable contributions from Northern New Jersey at 200%, Toronto at 187% and Southern California at 165%. Same-store growth on a net effective and cash basis was 9.3% and 9.5%, respectively, driven predominantly by rent change. We saw market rents grow roughly 60 basis points during the quarter, the slower pace embedded in our forecast. In combination with the strong build of in-place rents, our lease mark-to-market recalculates to 62% as of September. We raised approximately $1.4 billion in new financings at an average interest rate of 3.2%, comprised principally of $760 million within our ventures as well as a recast of our yen credit facility, increasing our aggregate line availability. In combination with our cash position, we ended the quarter with a record $6.9 billion of liquidity. Finally, it's noteworthy that our debt-to-EBITDA has remained very low and essentially flat all year, hovering in the mid-4x range despite our increased financing activity, a demonstration of the tremendous growth in our nominal EBITDA. Turning to our markets. While rising, vacancy remains historically very low in the U.S., Mexico and Europe. Market vacancy increased approximately 70 basis points during the quarter in the U.S. driven by low absorption as well as recently delivered but unleased completions. Europe experienced similar dynamics with an overall increase in market vacancy of 50 basis points. At the macro level, our expectations for the U.S. are for completions to outpace net absorption by a cumulative 150 million to 200 million square feet over the next 3 quarters, then over the subsequent 3 quarters, we see that trend reversing with demand exceeding supply and recovering to net 75 million to 125 million square feet. That trend may extend further into 2025 as we believe development starts over the next several quarters are likely to remain low. Whatever the precise path, we expect that as vacancy normalizes over the long term, our portfolio will outperform the market due to both its location and quality as well as the strength of our relationships and operating platform. In this regard, our portfolio has been largely resilient to moderating demand. Our teams would describe the depth of our leasing pipeline as consistent with the last few quarters. And coming fresh off of 1 of our customer advisory board sessions, it's clear that our customers have plans to continue to expand their footprint, increasing capacity and resiliency. However, what's also clear is that they are slowing such investments until there is more clarity in the economic environment. In the U.S., rents increased in most of our markets with the strongest located in the Sunbelt, Mid-Atlantic and Northern California region. Europe and Mexico were also bright spots for growth in the quarter. Rents across our Southern California submarkets declined approximately 2% as it continues to adjust to higher levels of vacancy. While the markets and outlooks are mixed, we remain confident in continued market rent growth in the U.S. and globally over the coming year, albeit at a slower pace, while the pipeline continues to get absorbed. From our appraisals, U.S. values declined approximately 3% while European values remain stable, in fact, having a very modest write-up. The difference isn't too surprising as the Fed's language around inflation and the economy has had more effect in the U.S. capital markets, driving the 10-year up 100 basis points since our last earnings call compared to the bun at just 50 basis points. We believe that this is likely another instance as we saw 1 year ago where U.S. appraisals at the end of the quarter have not had sufficient time to react to the increase in rates and we are thus pausing on appraisal-based activity in USLF for at least 1 quarter. Elsewhere values in Mexico are up 8.5%, while China experienced its first meaningful decline of 6.5%, a write-down that we don't believe has fully run its course. Our funds experienced their first quarter of net positive inflows with approximately $180 million of new commitments versus new redemption requests of $115 million. Given other activity in the quarter, the net redemptions have been reduced from their height of $1.6 billion to approximately $700 million or roughly 2% of third-party AUM. In terms of our own deployment development starts ramped up during the quarter, crossing $1 billion, over half of which is related to a data center opportunity in our central region, a testament to our higher and better use strategy and strategically located land bank. Also notable is the acquisition of $118 million of land including a strategic part in Las Vegas, which will build out an additional 10 million square feet over time and brings our total build-out of land globally to over $40 billion. We are laser-focused in identifying and executing on value creation in our core business, our energy business and their adjacencies. Combined with the debt capacity and liquidity, we've worked hard to build and preserve, we see the environment as rich with opportunity. Moving to guidance. We are increasing average occupancy to range between 97.25% and 97.5%. As a result, we are increasing our same-store guidance to a range of 9% to 9.25% on a net effective basis and 9.75% to 10% on a cash basis. We're maintaining our strategic capital revenue guidance, excluding promotes, to a range of $520 million to $530 million and adjusting G&A guidance to range between $390 million and $395 million. Our development start guidance has increased to a new range of $3 billion to $3.5 billion at our share, driven primarily from the data center start mentioned earlier. We have $500 million of contribution and disposition activity during the quarter. And given our commentary on USLF valuations, we are pausing our planned contributions into that vehicle this quarter and reducing our combined contribution and disposition guidance to a range of $1.7 billion to $2.3 billion. In the end, we are adjusting guidance for GAAP earnings in the range of $3.30 to $3.35 per share. We are increasing our core FFO, including promotes guidance, to a range of $5.58 to $5.60 per share and are increasing core FFO, excluding promotes, to range between $5.08 and $5.10 per share, growth of nearly 10.5%. I know that many of you are focusing on 2024, so I'd like to take an opportunity to remind you that the Duke portfolio will be entering the same-store pool in 2024, which will widen the recently observed delta between net effective and cash same-store growth. This is, of course, because Duke rents were mark-to-market at close 1 year ago, so its contribution to net effective same-store growth and earnings will be minimal even though the cash rent change will be on par with the rest of the Prologis portfolio. In closing, we are navigating the current environment assured that whatever the economy brings in the short term, we are positioned to outperform over the long term. This stems from not only the premier logistics portfolio and customer franchise with 1 of the best balance sheets amongst corporates, but also highly visible earnings and portfolio growth ahead of us. We know that turbulent times can bring opportunity for those who are prepared, and that's been central to our strategy and management as a company. I'd like to also remind you of our upcoming Investor Forum on December 13 in New York, our first in 4 years. We're looking forward to spending the day with you sharing more about our business, outlook and opportunities ahead. Additional information is available on our website and in our earnings press release. And with that, I will hand it back to the operator for your questions.
[Operator Instructions] And the first question comes from the line of Michael Goldsmith with UBS.
I mean, Tim, can you help us reconcile some of the comments from the prepared remarks. You talked about maybe softer demand, but then there's -- you're calling for accelerating the number of build-to-suit developments. At the same time, occupancy has been stronger than anticipated, and that's before the lower development start hits the market. So how should we think about all of these moving pieces and just the trajectory of the supply-demand dynamics as we exit '23 and into 2024?
Sure. Demand is definitely softer. It's closer to normal, maybe even a little bit below normal at this instance. There is a lot of latent demand that large companies having large requirements are continuing to talk to us about build-to-suits, but they're reluctant to pull the [Technical Difficulty].
And the next question comes from the line of Craig Mailman with Citi.
Let me color here because I have a cover here in here. But I just wanted to touch on the data center build in the quarter. And so, if you guys could break out what the yields on those were relative to the blended yield on the overall development starts? And maybe just give a little bit more color about the opportunity with our partner on this one, the plan on whether you're going to hold this or anticipate selling upon completion of them just a little bit more about the capacity within the land bank to do more of these data center sales?
Ladies and gentlemen, please remain on the line. We're just having a little technical difficulty here.
I'm sorry, we're having some technical difficulties here, and I can't really explain it. Yes, you can hear me. Okay. So let me finish the first question and then I'll go to the second question to the extent I heard it, which wasn't great. On the first question, what I wanted to say is that the data centers account for a pretty significant volume of the build-to-suits and that's why they're higher. But industrial logistics build-to-suits are kind of on par and in line with our expectations. The reason occupancy is higher, it's unique to the quality of our portfolio and just a natural role of leases, but market occupancy is slightly lower. So we're outperforming the market by more than we did before. I think that covers the first question. The second question was how should we think about the build-to-suits in terms of its effect on our going in yields and the like? And for that, I'm going to turn it over to Dan here. But generally, we -- the build-to-suit strategy of ours is an extension of our higher and best use strategy. We own a lot of high-quality land in markets that are in the path of development and our popular data center markets. And while we may occasionally buy land for data centers, our primary strategy is converting our existing portfolio to data center product. To the extent they have power availability, we're getting a lot of people knocking on our door for those opportunities. And we think going forward, it's going to be a pretty significant part of our activity, although it's lumpy and less prone to precise predictions like the logistics business, but you'll hear more about that. Now strategically, this is important to understand, we funded our business without issuing any equity basically since 2012. Last 10 or 11 years, we have not issued any equity. How we finance our business is by disposing of real estate that was nonstrategic to us, logistics real estate. And we've done a lot of dispositions. You can think of the data center strategy as a way of funding our growth. That's where the growth capital is going to come from. We are not, at the moment, interested in being in that business in terms of long-term ownership. It's more of a development and harvest strategy. And that capital that comes out of the margins of those deals will be a substantial contributor to our growth going forward. Dan, do you want to talk about the initial yields on the data center?
Well, what I would say is on this particular data center, we're under a strict confidentiality. So we can't be speaking about any particular deal points by any means. But what I would say is we've been building capabilities internally to ensure that we hit the market for these deals, and you'll see those play out as we announce more data centers going forward.
What I would say generally, though, without getting specific on this opportunity, we think the margins that come out of our data center business, by definition, based on our historic cost of land or even the market value of land will be orders of magnitude higher than they would be on their logistics build-out. So multiples of a normal margin.
And the next question comes from the line of Steve Sakwa with Evercore ISI.
I just wanted to follow up on the development and just make sure I understand. On the fourth quarter, I think you've got something like $1.9 billion of planned starts given that you've done about $1.4 billion year-to-date. So just curious, does that include other data centers? Or is that all traditional industrial? And if so, what is the mix between spec and build-to-suit on that fourth quarter starts volume?
Sure, Steve, this is Dan. So the lion's share of our Q4 starts our logistics starts, we have 1, maybe 2 smaller data center starts that we have forecasted. But Overall, it's about 50-50, both to suit and spec. And let me just highlight that we've been calling for a back-end loaded forecast for about 4 quarters now. As you -- as we talk about, market development starts now at 65 -- I guess, down 65% from the peak. This is playing out exactly as we expected, and we've been gearing up all year for a really heavy Q4 start volume.
Yes. The portion of build-to-suits is obviously a lot higher than that if you include the data centers. What that meant was a mix of logistics and -- logistics spec versus build-to-suit.
And the next question comes from the line of Todd Thomas with KeyBanc Capital Markets.
Question, as you think about 2024, Tim, you mentioned that market rent growth increased 60 basis points relative to last quarter. That's down from 2.5% last quarter. I think you indicated that market rent growth is expected to be positive in the year ahead. As we think about the trajectory of rent growth and what you're anticipating, do you see potential for sequential or year-over-year decreases in market rents in the U.S. or globally over the next few quarters as deliveries outpace absorption? Or do you expect rent growth to stay positive throughout that period during that time frame?
Todd, it's Chris Caton. Thanks for the question. Yes, we expect rent growth to remain positive throughout that time period. Market conditions are stable. And there are a handful of markets that we've talked about that are softer, but by and large, markets are proving resilient with rent growth in line or ahead of inflation.
And the next question comes from the line of Caitlin Burrows with Goldman Sachs.
Maybe we could talk about property acquisitions a little. I know it's not as large of an activity as developments, but guidance for this year increased while transaction volumes at an industry level are down significantly. You did the $3 billion acquisition midyear. So what sorts of acquisitions are most interesting to you today. >Could you talk a little bit about who you're buying from, maybe why they're selling and how you get comfortable and what the right price should be?
Sure. It's a dynamic market, and I think that's the essence of your question. It's really hard to get a handle on what the returns should be and how we look at acquisitions. But here's here is a model for thinking about it. First of all, we are even pickier here than we have been with respect to quality and fit with our portfolio. We're not -- before you had to buy the good with the great in portfolios, and we had to go through the massive exercise of disposing of the properties that we didn't want, which we did actually quite successfully in a declining cap rate environment, and we actually made money on it. But we don't expect that to be the case going forward. So we're really being picky about what we buy. The portfolios that we're going to buy are almost virtually 100% home portfolios. Secondly, if you really think that look at where treasuries are, 150 basis points have gone to, call it, 4.5%, 300 basis points increase. Those kinds of properties, core properties were trading in the high 5s, low 6 IRRs, let's stay away from cap rates because of a mark-to-market complexity of talking about cap rates, but call it 6%. So just adjusting for the change in treasury yields, simplistically, you would have to see a 9% unleveraged IRR. And that's if supply and demand of capital were sort of an equilibrium, we get a sense that there's going to be more opportunities coming our way, and it is in a capital-constrained environment. And we happen to be in the fortunate position of having a really good balance sheet and able to take advantage of those. I don't think there's going to be distress in the terms of post savings and loan crisis or any of the downturns. But I think the opportunity set is going to exceed the available capital, and I think we'll be taking advantage of that. So I would say unleveraged IRRs that are -- have a 9% handle on them and maybe as much as 9.5% depending on the circumstances. And we are seeing that supply loosen up and come to the market. So expect to see more transactions in the next 6 months. Dan, do you have anything?
The only thing I would add is our teams around the globe are literally turning over every stone daily. And this is land acquisitions, this is core acquisitions, it's value-add acquisitions and the teams turned to opportunistic right now. And so it's really hard to peg exactly where we're going to land our acquisition volume for the year, which is why you saw us move it up a couple of hundred million after this Phoenix transaction. But overall, I think our teams are going to continue to find opportunistic transactions consistent with what Hamid just said on the returns.
And the next question comes from John Kim with BMO Capital Markets.
I just wanted to clarify. So you're expecting over the next few quarters a significant demand shortfall. And I'm wondering if during that time period, are you planning to be more aggressive on rents and concessions to try to hold occupancy? Or are you going to hold rates just given supply is going to start to come down after that? And also if you could provide an update on the market rental forecast for 2023.
Yes. On the rental forecast, I'm afraid you're going to have to wait for that when we issue guidance, and we get into that. And 1 thing we're going to stay away from is quarter-by-quarter forecasting of rent. It's hard enough to guess what it is on an annual basis, much less on a quarter-to-quarter forecast. So what was the first part of the question? Occupancy, trade-off. It depends on the actual markets. There are about 20% of the markets that I can see us driving for occupancy and about 80% of the markets that are still in equilibrium or tighter. But the key to your question is what you asked in the middle of it, which is, how do you expect that to change? And the reason we're not going to get super aggressive on rents is because we have a belief that -- I mean, just look at the starts, they're down 65%. And even with moderating demand, we're going to get something like 60% or 70% of that shortfall that we're going to encounter in the next quarter shortfall of demand. We're going to get it back in the subsequent 3 quarters. So there's no sense really going cheap. It's just -- but I would say 20% of our markets were going to be more focused on occupancy.
And the next question comes from the line of Nicholas Yulico with Scotiabank.
Just a 2-parter on Southern California. So I guess, first, I want to see if you're seeing any benefit in your portfolio since September in terms of the port being resolved, the worker's strikes impacting L.A. Basin or Inland Empire, are you seeing any benefit there and pickup in activity? And then secondly, just wanted to hear latest thoughts on why you think some of the weakness that you've cited there in rents in Southern California? What that dynamic is out there that would be different than other markets, meaning that Southern California is not a leading indicator for other parts of your portfolio?
Well, Southern California is very geared towards basically inflows, 40% of the inflows into this country came through Southern California, and that number dropped dramatically because of the labor issues. It's too soon to see any recovery because we're also going into the Christmas season and anything that's going to be in the store for Christmas has already been on the water and through the ports and all that. So I think you're going to see the effects of that next year in terms of recovery of flows. About half of what used to come through L.A. used to stay in the L.A. Basin, Southern California and half of it was shipped elsewhere. We think the half that stays in Southern California for sure will stay there or come back. And some of the rest will also revert back to Southern California. I'm not smart enough to know whether we're going to get half of it back or 3/4 of it back, but we'll get a pretty substantial portion of it back. It will be more into the first or second quarter of next year before you see them the numbers. Chris, do you want to add anything?
Yes, I'll build on that by saying is the market is digesting the demand and supply picture that Hamid described, we are beginning to see some differentiation in submarkets where L.A., Orange County is proving more resilient and Inland Empire is a bit softer.
And the next question comes from the line of Camille Bonnel with Bank of America.
First, a clarification that I want to get your thoughts on guidance. Can you clarify if the SoCal market rent change in the opening remarks is on a sequential or annual basis? And then I appreciate majority of your leasing for 2023 has been addressed and there's little that could change your core outlook from here. But I want to better understand the level of conservatives being factored into guidance looking into year-end, what could change your views more positively or negatively?
Camille, it's Tim. Yes, just a clarification on the first part, that was a quarter-over-quarter number in SoCal, the 2% decline. And then in terms of what could change in the fourth quarter, the answer is very little at this point. Certainly on the rent change side of things, most all of that leasing is already inked. We could have some surprises very moderate, I would say, on the occupancy side, but I actually don't expect that. We have a pretty tight range on occupancy, as you know. So I don't think you'll see anything take us outside of our.
And the next question comes from the line of Ron Kamdem with Morgan Stanley.
Just a quick 2-parter follow-up. Just 1 on the development starts and the data centers, which is intriguing. Any way to put some numbers on that on how many starts can be done annually? Is it $200 million? Is it $500 million? Like how big in this gap is the follow-up, number one. And then number two, on sort of the rent growth, I appreciate we want to stay away from sort of specific numbers. But as you're sort of thinking about next year, what are sort of the key markets, Southern California being 1 potentially being sort of a headwind? Maybe you can you talk about what are some of the neutral or potential tailwinds in terms of markets for next year?
Okay. Your first question was great advertising for our Investor Day because that's what we're going to devote the time to is understanding our Essentials business, our data center business, and all those things. So let me defer answering that question to that date. And by the way, even on that date, you're not going to get as specific an answer as you would like. I just tell you that in advance because these are very lumpy, and it depends what quarter or what your year a deal lands in. Chris, do you want to address the second part?
Yes, absolutely. I might start by just saying 1 way to think about rent growth going forward is to think about the replacement cost math. We have really seen construction costs prove resilient and replacement costs prove resilient. And the interest rate dynamic that Hamid described earlier, translates to the rents that are required to warrant new development. So over a medium-term horizon a couple of years, that's going to play 1 of the most important factors into evaluating rent growth. As it relates to different markets, which was your question, I think it's probably fair to point to Tim's comments on the markets that have proved the strongest so far this year. Mid-Atlantic, Sunbelt, Northern California are markets that stand out in my mind in the U.S. And there is a range of them globally, whether it's Toronto, Mexico, Germany and the Netherlands. So that's what I would look to.
And the next question comes from the line of Anthony Powell with Barclays.
I guess 1 more on market rent growth. I think last quarter, you gave a 2023 forecast of 7% to 9%. I don't know if you updated that today? And are you going to be providing those kind of updated on a quarterly basis going forward?
So hey, the view is 7% in the United -- globally and in the U.S. We're about mid-6s so far this year. So that implies growth in the fourth quarter, as we described earlier. And then as it relates to forward guidance, I'd like to underline our upcoming Investor Day in December as the time to look for new information.
And the next question comes from the line of Michael Carroll with RBC Capital Markets.
How does the 150 million to 200 million square feet gap between supply and demand over the next 3 quarters compared to your expectation for all of 2023? Now correct me if I'm wrong, I believe that you highlighted that there's going to be about 150 million square foot gap in '23. I mean is that still a fair assumption? Or has this delay in demand due to the market uncertainty has kind of wind that out a little bit?
Thanks for the question. Again, it's Chris. So just to give you the total numbers, we are on pace to see 490 million square feet of deliveries in the United States this year, against 195 million square feet of net absorption. So that gap is wider. And some of that relates simply not so much to the softness in demand that you're describing, but the timing of deliveries of the pipeline. If anything, our view of where the pipeline is going has come down, not gone up over the last 90 days related to the trend in starts. And so really, it's really timing as it relates to that gap.
Yes. But I would say our previous forecast did not anticipate the sudden jump in rates that has come in the last 1.5 months. We thought that treasuries were going to settle in the mid-3s, not mid-4s, maybe mid- to high 3s and not mid 4 or approaching 5. So that, I think, has taken and shifted some of the demand out. But the thing that encourages me and we'll have to see -- wait to see this, is that companies are not shutting down their dialogue with us in terms of their long-term needs and our build-to-suit discussions are every bit as good as they've been across most cycles. But they're not pulling the trigger just yet given that those things generally involve major capital expenditures, and those are all being scrutinized by the C-suite pretty tightly these days.
And the next question comes from the line of Vikram Malhotra with Mizuho.
I just wanted to get a better sense of, you talked about deferring growth, I guess, across -- in rent growth across SoCal, Mid-Atlantic, U.S. and Sunbelt. Can you just give us a better sense of the magnitude of this dispersion? And I guess, Chris, do you expect this dispersion to continue over the next, call it, 6 to 12 months?
So the magnitude of the dispersion. So just to be clear, in terms of strength versus weakness because I want to be sure that wasn't completed. The strong markets include the Mid-Atlantic, Sunbelt, Northern California. And really, there are only a handful of soft markets. SoCal we've talked about, market that's been flat all year. In terms of dispersion, there is a fair amount of saneness in the trend, whether you look at it on a quarterly or a calendar year basis. So rents are trending in the annualized rate from the third quarter that Tim discussed with some markets moderately ahead like the strong market that I described and then just really 1 or 2 markets that are notably weaker. So I guess I suppose there's that dispersion.
And the next question comes from the line of Mike Mueller with JPMorgan.
I know you've used land in the past for higher and better uses. But do you think you'd be looking at the development of the data center developments to the same degree that you would be looking at them if you weren't seeing a normalizing of the traditional industrial demand?
Absolutely because the margins embedded in the data center development, Mike, are orders of magnitude higher. Certainly on the basis of market value under industrial use or purchase products under the industrial use. So we would be doing that even if the market was tight as a drum, and by the way, let's not get carried away. The market is in the high 4s occupancy. I mean vacancy, sorry. That is -- absent '21 and '22, I would have said that would be my Christmas present would be vacancy rates that are sub-5% in any part of the cycle other than the last couple of years. So the markets are strong, but the data center opportunities, if you can get the power, the demand is there and it's been sort of boosted by AI and a bunch of other things. So we see sort of a rush of the large players, and they're all big credit players into the business, and they can't get enough of this stuff to keep up with demand.
And the next question comes from the line of Bill Crow with Raymond James.
Two quick questions. First of all, on the economy, I'm wondering if you're seeing any changes to your watch list among your tenants or any sectors in particular that are starting to show weakness. And the second question is really in order to get the kind of 9%, the returns on acquisitions. Do you have to target longer walls? Or how do you get that if we don't see the stress among current holders or owners?
So our credit issues are fairly modest, and they usually involve retailers, and we have a built-in 85% plus mark-to-market on those leases that we've identified as potential risks. And we've actually captured some of those spreads and already improved our position by buying out those leases or just getting them back and re-leasing the space in a short period of time. So I don't think credit is a particularly important consideration in this cycle.
And then the second question on the extended walls being necessary for the kind of IRRs we're targeting in acquisitions?
We're using the same lease terms and acquisitions then we always have been. There's not -- I mean, if you look at 30 years of history, I mean, our walls have been between 4.5 years and 6 years or something like that on average in our leases. So it doesn't move around that much.
Yes. Then I would just pile on there that we look at these opportunities of whether it be 1- to 3- or 4-year years of negative leverage as an opportunity really. We look at total return on every deal. And again, we take it through our filters of quality, mark-to-market -- and whether we want to hold it long term or not, and then we layer that on with our potential Essentials revenues and synergies and otherwise. So while it's 1 consideration, so are all these other factors.
And the next question comes from the line of Blaine Heck with Wells Fargo.
Just wanted to follow up on guidance. You touched on this a little bit. The guidance implies a decrease in FFO in the fourth quarter. Can you just talk a little bit more specifically about some of the moving pieces there and onetime items that are influencing the numbers in the third or fourth quarters and whether any of that noise is going to persist into 2024?
Yes, I'll answer the last part. No, I don't expect anything into 2024. Basically, of the $0.03, a couple of pennies that were related to termination income from some leases that were canceled and then higher interest income there's about $0.02 there, I would call that, that's permanent to the year. And then the other $0.01 in the quarter, I would say it was more of a timing issue, specifically in taxes. We'll see some lower taxes in the third quarter but higher again in the fourth quarter. So if you take that with regard to the role, if you take that $0.03 out you're basically rolling from, let's call it, $1.30 million to $1.28 million in the fourth quarter is what's implied in our guidance. And basically, you would roll NOI forward. We're going to probably add $0.02 from just base same-store growth quarter-over-quarter. And then the declines are going to come from mainly ramping of development. We see much more investment in land and CIP starting to build. And you should be aware in your models. Our cost of funding development in the short term is essentially 6%. Think of that as SOFR plus our line rate. We're capping interest at our in-place debt is how this works. That's at 3%. So in the short term, that's a drag on core FFO seen mainly in interest expense. Obviously, over the long term, the margin and value creation is there. But we will see that drag pick up as developments ramp.
And the next question comes from the line of Ki Bin Kim with Truist Securities.
Two quick ones here. First, on the utilization rate that ticked down a little bit this quarter. I was wondering if you can provide any more color on that? And second, if you look at the larger development landscape, and look at competitors that are developing, I would assume that the pressure for them to lease up space and maybe they have to pay back the loans to banks, probably increases as we move forward. I'm not sure how big these developers are or how much capital they have behind them. But is there any risk that as these developers look to secure tenants that could drive rental rates lower going forward?
Ki Bin, I'll take the utilization question. Thanks for it. As you see on the page and supplemental, there are multiple metrics on the page and we look at all of them in totality and additional ones that are not included in the supplemental. So we have a range of proprietary data, whether it's our IBI survey, tenants in the market, customer decision-making time frames, our sales pipeline. Specific to the utilization data, that lag that does not lead economic and real estate cycles. We've seen that over time. And so what I think, this is best understood in the context of today's retail sales numbers, which shows a resilient consumer that is outperforming expectations and leading to lower utilization levels.
Yes. On the second issue of opportunities, there are a lot of merchant developers that were bank financed and active in the market. And they are just about completing their projects now. They have some interest reserve, obviously built in into their lease-up plans, but their lease-up plans are going to get extended. So actually, I think what's going to happen is that they can't really be -- afford to rent the space at the lower rate. I think they're more likely to actually sell their positions to people with stronger balance sheets. And we've already seen and taken advantage of a couple of instances like this. So don't be surprised to see us buy some vacant completed shelves at discounts to replacement costs because it's because of our view on demand and supply with 65% decline in supply, we think if you get into late '24, early '25, we're going to be in a pretty strong market. So this is where our balance sheet matters. This is where the quality of location and product matters. And we're going to be very selective about the projects that I described, but that's why we've been building our balance sheet and keeping our leverage around 20% all this time. This is when we put it to work.
The next question comes from the line of Vince Tibone with Green Street.
I have a follow-up on an earlier comment about 20% of your markets, you're managing for occupancy, now pushing rents. So what are those markets where industrial landlords have less pricing power today?
Sure, Vince. We covered a couple of them, talked about Southern California, point to Houston, Indianapolis and then outside the U.S., the softest market might be Poland and China. And I think I'd offer now that market vacancies are beginning to gap out again, I think we're going to see quality make a bigger difference in terms of portfolio mix.
And the next question comes from the line of Vikram Malhotra with Mizuho.
Just wanted to get your thoughts to just clarify 1 thing more broadly. Two trends, I guess, one, just the whole reshoring theme that we're hearing more and more about. And then second, just Amazon, as they've put a lot of capital into the course and across the country. I'm just wondering sort of when you marry those 2 things together, is there sort of greater investment kind of moving towards the Midwest or more manufacturing pockets? Is that sort of an opportunity for PLD going forward?
So generally speaking, I would say, on where manufacturing is taking place in Asia, there's a lot of manufacturing still in Asia. It's not all in China, and it has been gradually declining in China in the last couple of years anyway. It was first moving to Western China, and then it was spreading to other places in Southeast Asia. But there are going to be strong flows still from those places. It's just not going to be all from China, but the container doesn't care where there is coming from somewhere else or China, it lands in the same ports. Secondly, demand is -- in our product is mostly driven by consumption and not manufacturing. In manufacturing, the finished product ends up in a container and on a truck or a ship, so the warehouse is a truck order ship. So that manufacturing per se doesn't generate a lot of demand. When those containers land in places where consumption takes place, that's when the demand is generated for deconsolidation. Now those markets happen to be in populous parts of the country because that's where the consumption is. And those markets tend to be high barrier to entry markets. So we don't think the dynamic of onshoring to the extent that it exists is going to change things around all that much. The biggest beneficiary of onshoring has been actually near shoring and it's been in Northern Mexico. North Mexico markets are 100% occupied, and there's insatiable demand for product in those markets. And most of that is for are basically distribution buildings that are used for manufacturing purposes. So that's where we've seen the material demand. If there's more demand coming from manufacturing in the U.S., a, we haven't really seen it. And if we do see it, we'll be the beneficiary of it because we're well positioned in those central markets as well.
And our last question comes from the line of Blaine Heck with Wells Fargo.
Hamid, just a bigger picture question for you. Can you talk about how you're thinking about managing exposure to geopolitical risk and instability? And maybe to what extent the latest turmoil in the Middle East could impact your operations, if at all?
Yes. I think the effect is going to be indirect because the Middle East is not obviously a source of product or exports or we're not active in any of those markets. So it will be a second order effect on the macro economy. And if the Fed remains very aggressive on rates, if you believe their talk, and all of a sudden, we have some drop-off in demand because people -- that conflict expands and the nightmare scenario would be that a couple of tankers get sunk in the Persian Gulf at the narrow end and oil goes to $200 a barrel. I mean the bets are off. But boy, if we see that scenario, I can't think of a better business to want to be, and I hate to see that scenario happen. But actually, on a relative basis, it should be good for our business because it will mean that people will -- first of all, inventory becomes really important. And it means that it's yet 1 more uncertainty like the pandemics, like the earthquake, like all these other disruptions that we've seen that will push the general posture of companies from just in time to just in case. So I hate to say it would be good because it's an awful situation that's going there. And before this is all over. a lot of innocent people are going to get killed, and I don't want to see this happen. But I don't think it's impact on the business on a relative basis is going to be terrible. I'm honestly more worried about the Fed overdoing it than that conflict escalating. But those things are very hard to predict.
I think that was our last question. So we really appreciate your participation. We really look forward to seeing all of you at our upcoming Investor Day, and I promise it will be really good. So take care.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.