Prologis Inc

NYSE:PLD

Greetings, and welcome to the Prologis First Quarter 2024 Earnings Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Natasha Law, Director of Investor Relations. Thank you, Natasha, you may begin.

Thanks, John. Good morning, everyone. Welcome to our First Quarter 2024 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 first quarter earnings 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 will hand the call over to Tim.

Good morning, and thank you for joining our call. We've had a good start to the year in terms of our operating and financial results in the first quarter. We delivered strong rent change, drove occupancy slightly ahead of our forecast, raised nearly $5 billion in capital, including $750 million in strategic capital, and made important headway in our energy business.

That said, as we evaluate the market, persistent inflation and high interest rates have kept more customers focused on controlling costs. The resulting delay in decision-making easily observed through the first quarter's below-average net absorption will translate to lower leasing volume within the year.

Accordingly, we've opted to adjust our guidance early, getting ahead of what looks like a period of occupancy below our forecast in the near term and its effect on same-store in a number of our higher rent markets. This is punctuated of course, by a more pronounced period of correction still underway in Southern California.

New starts, however, continues to be surprisingly disciplined, adding to the expectation for limited new supply in the back half of '24, but also extending deeper into '25. When considered alongside muted demand, we arrive at a view that the operating environment has only changed modestly in aggregate and that demand is simply pushing out by a few quarters. The outcome of this may simply mean moving towards a long-term occupancy expectation more swiftly this year, which sets up for a better next year.

Turning to our results for the quarter. Core FFO, excluding promotes, was $1.31 per share, and including net promote expense was $1.28 per share, essentially in line with our forecast. Occupancy in the portfolio ended the quarter at 97%. For context, the U.S. market declined 310 basis points since its peak in the summer of '22, while our portfolio's occupancy has only declined 80 basis points, resulting in vacancy today for Prologis that is less than half of that in our markets and reflective of our portfolio quality.

Net effective rent change was 68% based on commencements and 70% based on new signings. Following this in-place increase and changes in market rents, our net effective lease mark-to-market stands at 50%, representing over $2.2 billion of rent to harvest without any additional market rent growth from here. Rent growth capture just for the single quarter was approximately $110 million on an annualized basis and at our share.

Our same-store growth on a cash basis was 5.7%, and on a net effective basis was 4.1%. The same-store from rent change alone was strong at approximately 9%, but is impacted by a 130 basis point change in year-over-year vacancy as well as 150 basis points from fair value lease adjustments with the Duke portfolio's inclusion in our same-store pool. Additionally, there were approximately 175 basis points of items specific to the quarter, including onetime reconciling items from 2023, as well as unfavorable comps from low expenses last year.

We started over $270 million of new developments in the quarter, bringing our portfolio to approximately $7.5 billion at our share, with estimated value creation of over $1.7 billion, a number we feel increasingly confident in with value stabilizing.

In our energy business, we've made meaningful progress on this year's deployment, including the signing of 405 megawatts of long-term storage related contracts with investment-grade utilities. We also delivered the largest EV fleet charging project in the United States, less than 15 miles from both the ports of L.A. and Long Beach. Finally, we raised $4.1 billion of debt across our balance sheet and funds at a weighted average rate of 4.7% in the term of 10 years. Our debt portfolio has an overall in-place rate of just 3.1% with more than 9 years of average remaining life, and liquidity at the end of the quarter of over $5.8 billion.

Turning to market conditions. Most broad economic data, from unemployment to retail sales, to the health of the consumer, remain very strong. And while our tour, proposal and other proprietary metrics are similarly positive, overall leasing activity and net absorption are running below expectations. Net absorption in the U.S., for example, was very low this quarter at just 27 million square feet. So while the macro landscape and supply chains continue to generate a need for space, we think it prudent to expect continued headwinds on overall absorption over the next few quarters.

The interest rate environment and its associated volatility have weighed on customer decision-making, especially as the 10-year has increased 70 basis points from its level just 90 days ago and expectations for Fed rate cuts have moved from potentially 6 to now possibly 0.

In parallel, sublease and space utilization rates highlight that some customers have available capacity, driven in part by the high rate of absorption through the pandemic. This dynamic of available space intersecting with the desire for cost containment is what leads to lower absorption and is playing out at different rates across some markets and customers.

For example, while slow leasing has persisted so far this year for less capitalized customers and 3PLs, we see a handful of large e-commerce and retail customers further along in this process, such as Amazon, who voiced caution 2 years ago but is now active in several global markets and has openly discussed plans to commit to significant amounts of new space.

The overall leasing slowdown is most felt in only a handful of markets, Southern California and the Inland Empire being the most acute. In fact, rents in most of our U.S. markets are generally flat, several are up, and it is mainly elongated downtime affecting near-term occupancy and NOI. While Southern California leasing has been challenging, it has not slowed the tremendous uplift we realize every single quarter from rent change on rollover, which was 120% for the market in the first quarter, with the Inland Empire at 156%, nearly the highest in our portfolio.

In Europe, rents grew overall during the quarter, which we believe will remain the case over the balance of the year. And of course, LatAm continues to impress with very high occupancy and market rent growth that has led the globe in recent quarters. Overall, global market rents declined slightly over 1% in the quarter, driven mostly by Southern California, and would have been slightly positive if excluded.

I'd like to spend a moment on Baltimore where we own over 18 million square feet and has been a dynamic market of ours for decades. Our employees, customers and properties are all safe following the bridge collapse last month, and our customers expect to be able to withstand the disruption with little impact to their businesses.

Shifting to capital markets. Valuations increased in all of our geographies, except for China, which saw a very small decline. Over the last 1.5 years, global values have decreased despite increases in cash flow due to cap rate expansion. As cap rates have stabilized, cash flow growth now has the ability to translate to value growth.

Even though modest, the value uplift in the U.S. and Europe are important as strategic capital investors have been looking for values to not only bottom but actually turn upwards before committing new capital. With Europe a bit ahead of the U.S. in this regard, it is indeed where we've seen stronger fundraising interest in recent quarters. We also have a successful equity raise in FIBRA Prologis, raising over $500 million for deployment into both assets to be contributed from our balance sheet as well as pursuit of third-party acquisitions.

Transaction volumes and activity have ticked up in recent weeks, and pricing has certainly improved. As always, we're actively looking at acquisition opportunities across all of our markets, but our focus remains on the development of our land bank, which provides an opportunity for over $38 billion of build-out with a return on incremental capital of approximately 8.5%.

In terms of guidance, in light of our views on demand and leasing pace in the coming quarters, we are reducing our average occupancy guidance to range between 95.75% and 96.75%. Of the 75 basis point adjustment from the midpoint, it's important to understand that approximately 2/3 of this change stems from our higher rent markets, meaning they create a disproportionate impact on same-store in 2024. Same-store growth on a net effective basis will range between 5.5% and 6.5%, a reduction of 150 basis points, which accounts for the average occupancy decline, slightly lower rent change for the year, as well as 30 basis points of annualized impact from the onetime items in the first quarter mentioned earlier.

Our revised range on a cash basis is now 6.25% to 7.25%. We are maintaining our guidance for strategic capital revenue, excluding promotes, to a range of $530 million to $550 million, and reducing our G&A guidance to a range of $415 million to $430 million.

We're adjusting development start guidance for the year through a revised range of $2.5 billion to $3 billion at our share, reflecting our disciplined and speculative starts and the timing impact this has in the calendar year. As we've always said, we don't consider our guidance to be a target internally and each deal ultimately needs to be rational and accretive on its own.

In the end, we're forecasting GAAP earnings to range between $3.15 and $3.35 per share. Core FFO, including net promote expense, will range between $5.37 and $5.47 per share, while core FFO, excluding promotes, will range from $5.45 to $5.55 per share. Our updated guidance calls for core earnings growth of nearly 8% at the midpoint.

As we close out, I'd like to underscore the message of the call, which is that while we have only a modest change of view in the intermediate term, our confidence in the long term is intact. And putting timing aside, we're encouraged by the outlook for supply in the back half of this year and '25, have tremendous lease mark-to-market to harvest in the interim, and are pleased to see valuations, fundraising and transaction activity all picking up.

With that, I'll turn the call over to the operator for your questions.

[Operator Instructions] And the first question comes from the line of Caitlin Burrows with Goldman Sachs.

It seems like, I guess, occupancy and maybe pricing are coming in a little lower than you had previously expected. So I was wondering, could you go through how much or what pieces might be more macro driven and how much is certain markets weighing on the outlook? Tim, you did mention how some of the high rent markets are having an outsized impact. So wondering if you could just go through what might be more macro versus market specific.

Caitlin, it's Chris Caton. I'll start by saying, I think it's a combination of factors. For sure, as Tim described, Southern California and a handful of other high rent markets, the leasing velocity has been subdued and rent growth has been a little bit below expectations. So there is that softness. But we also want to point to a couple of quarters of deferred decision-making leading aggregate customer demand across the United States to be a little bit below what we previously expected.

The only thing I might add, Caitlin, is -- would be just nominally in the sense of dollars and the impact on same-store. We do see about half of our adjustments as coming from SoCal.

And the next question comes from the line of Steve Sakwa with Evercore ISI.

I guess for Tim or Hamid, can you maybe just help kind of flesh out sort of maybe the timing of when some of these things became a little bit more evident? I guess I'm thinking back to some of the conferences and the like in March. And my sense was the tone and concern about the business maybe wasn't as acute as it is right now. And I know you have confidence in the long term. But it sort of feels like there's a sea change in your outlook in maybe the last 30 to maybe 45 days. So I guess, what is prompting that, other than maybe seeing hard data, but maybe just help flesh out kind of the timing of this? And are there other factors at work here?

Steve, let me take a stab at that. If you are sensing any acute change in our outlook, you're not reading our call correctly. We have picked a 3-year window, I think, in our Analyst Day to give you our expectations. And the first year of that window has moved around. So our outlook for the back period of second and third year, essentially the same, and could be even better given how much deferred demand is building up.

If our proposals were down, if our tours were down, I would be more concerned. But companies are out looking at this space. And if you think nothing has changed in the last 45 or 90 days with respect to the Fed outlook, you must be reading different newspapers than I am.

So I would tell you that people are just scared of pulling the trigger until the Fed gives the all clear sign with the first rate cut. So yes, we're not instantaneous in our data transmission to us and to you, but I can assure you that you will always hear our views immediately as we form them and as we get them from the marketplace.

And the next question comes from the line of Michael Goldsmith with UBS.

It sounds like demand has been pushed out -- or the rebound in the management pushed out of a few quarters. So I was wondering if -- what evidence do you have that would support that? And then how do we compare that to some of the proprietary metrics that you put together, which seem to indicate that things are actually pretty positive or accelerating?

Michael, Chris Caton. Thanks for the question. As we've kind of covered in the script, and I think worth pointing out here, whether it's consumer resilience has revealed by economic indicators like the labor metrics or retail sales, whether you look at our own customers and supply chain momentum as revealed by our IBI, volumes through the ports and our proposal volumes, the broader economy is generating a normal amount of demand.

A couple of things to consider, though. One is, as you can see in utilization data and in sublease space, some customers have spare capacity that they are utilizing to accommodate some of this growth. We also have these leading indicators, we need to simply see customers convert space requirements into signed leases. So just the simple conversion of investigation into signed leasing. And indeed, we already are seeing the front edge of some leading global e-commerce companies and other retailers begin to make space. It's just not broadly yet occurring across the whole marketplace.

Yes. The only thing I would add to that is that the effect is not uniform in all markets. And I think what's going on. And this is a theory, this is not a fact. It's a theory, but it's based on 40 years of looking at this stuff. Southern California has over 30% share for 3PLs. And the rest of the U.S. market has a little under 20% share of 3PLs.

3PLs are -- serve 2 purposes. One, they provide outsourcing of the logistics activities, but they also create surge space. In other words, companies use 3PLs as a way of flexing up and down. So markets that have a bigger exposure to 3PLs are likely to feel the impacts of shifts in sentiment sooner than other markets, on the way down and on the way up.

Also, there are certain customers who have instantaneous access to sales data and activity. And I would say the e-commerce players, the big ones, have the best data on that because they see the trends on a daily, minute-by-minute basis. Those guys were early in terms of curtailing their demand. And I got to tell you, they're after pretty aggressively. And don't listen to what we say, listen to what they say in their own annual reports, in their own interviews with the press, and I think you'll see that they feel pretty confident about their business and they're a bit ahead of the curve.

Now all of this is subject to missiles not flying in the Middle East and the Fed not going crazy, and God knows what else can happen in this world. So -- but as far as we see the indications are really good, and this certainly does not feel like any of the other downturns that I've been part of. So again, the word acute sounds a little bit of an overreaction to me.

And the next question comes from the line of Craig Mailman with Citi.

Maybe comment at this from another way. And Hamid, I know you don't like the word acute, but maybe this seems a little bit more preemptive, because if you guys are seeing a lot of the metrics in line with your budget, retention was kind of in line with where you guys have been in the last couple of quarters, it feels like this is an anticipation of maybe slower takedowns that you're seeing.

I mean, is there anything else on the exploration side of the equation that you guys have a couple of bigger known move-outs now that are going to skew numbers? I'm just trying to get a sense of how much of this is actually what you're seeing real time versus just giving yourselves a little bit of cushion so that you don't have to kind of readjust later in the year.

And also just a question on development. How much of this kind of occupancy decline is just developments coming on a little bit less lease than maybe you had thought a couple of months ago? We noticed your development margins were pretty -- were single digit this quarter. I don't remember the last time I've seen that. And is that a reflection of this or is there something else going on as well?

Okay. Let me start that and then I'll turn it over to Chris and then to Dan to talk about development margins specifically. We like to be early and thoughtful in outlooks that we share with you. And we've always prided ourselves in doing that. And in some cases, in the past, as you know, you've been following us for a long time, we've taken pretty bold statements on the way up and on the way down, and actually been proven pretty right about it.

So for us to be late on this stuff is not something that we look forward to. So we always try to be on the lookout for trends that may be interesting to our investors and to you who are looking at our company on a real-time basis. So I'm not smarting up to assign percentages of how much of this is preemptive and how much of it is. But I can tell you, there's nothing going on in the portfolio. There's not some news embedded deep in our customer behavior or some markets that we're not sharing with you. This is just looking at the tone of the marketplace and sharing with you what we see playing out in the next 2 to 3 quarters. Nothing beyond that. And the outlook for the long term is very much the same as it was before.

Dan, do you want to talk about the margins?

Yes. The margins this quarter is actually an isolated event here. We have 15, 17 projects stabilize. We had one project that just had a confluence of events take place, whether it be weather, some infrastructure, municipal requirements, and it just came in at a pretty negative margin weighing down the overall average margin for the quarter. If you pull that out, our margins for the quarter would actually be a more reasonable 15%, 16%.

And the next question comes from the line of Camille Bonnel with Bank of America.

Hamid, you mentioned how the company likes to be early on calling things, but I noticed that you only updated your outlook on operations and guidance. So can you help us understand how conservative guidance levels are? Or could we see more downward revisions, for example, if you start to pull back on the capital deployment front?

Well, on capital deployment specifically, you may remember that I'm always saying, the only reason we provide guidance is because you asked us. We actually don't have a budget or a plan for deploying capital. We look at every investment opportunity one at a time. So all our elements of our guidance, and this doesn't go for just this period, it goes to any period, I would take that one with a grain of salt. We're not afraid to deploy a lot more or a lot less capital if the market conditions warrant it.

With respect to conservatism, I would say we call it as close to the pin as we can get it, with a very slight bit of conservatism, it's not a lot, just a bit so that, in the majority of the cases, we're pretty confident of what we're saying. But we're not 100% confident. There is -- there could be downside beyond that. But I would say, we try to call it as we see it and be careful that we don't regularly -- we don't want to disappoint 50% of the time, which is really calling it right on the pin. We'd like to be a little more conservative than that. Now we don't always get it right. So let's admit that.

And Camille, it's Tim. I might build on your -- the first part of your question as well, which is that, at prevailing cap rates and the cost of debt and everything else, there's very little you could actually do in deployment in the year to affect earnings in year 1 or 2. I find that deployment changes tend to have kind of a push effect on earnings. So you should probably have that in your thinking as you watch our guidance.

And the next question comes from the line of Nikita Bely with JPMorgan.

The $150 million of other real estate investments, curious, what exactly was that on the sales? And maybe also if you could talk about the reduction in development starts. Any color on that? Geographic focus or maybe spec or something else?

That's basically -- the $150 million is some noncore assets. And we could not hear the second part of your question. Could you repeat that?

Reduction in development starts for this year. Any additional information you could provide on what drove that, whether it was geographic-based or asset specific or build-to-suit pull back?

Yes, thanks. This is Dan. I got a couple of thoughts on that point there on development starts. We adjusted our guidance on development consistent with the adjustment in the occupancy and the operating pool. So as we see demand shifting out, we just expect that we're going to start fewer buildings. We reduced it by about $0.5 billion. That's about half build-to-suit, half spec. We're raising the bar on spec, as Hamid said earlier, when we put that guidance out there because you asked for it.

We don't need to start these projects. We own the land. We have $38 billion worth of opportunity embedded in that land bank. We have entitlements. We have the teams, they're all geared up, ready to start. We can literally pull the trigger on $10 billion, $12 billion of that tomorrow. So we just look at that. We're just trying to be consistent and tie it to our overall outlook on demand. And there's no particular location or otherwise that we -- that dragged that down.

Yes. And the only thing I would add to that is that, even though we made the adjustment on both the build-to-suit and the spec part, the bias is greater on the spec part. We actually feel pretty good about our build-to-suit volume going forward. So it's really the spec, which is discretionary. And we can, as Dan said, start that at any time.

And the next question comes from the line of Blaine Heck with Wells Fargo.

So you've called out Southern California as being soft again. Can you just talk about any specific segments of the market that are particularly weak whether that's by submarket or size? And what makes you confident in the recovery even as it seems it might be delayed kind of relative to your original expectations? And secondly, just curious if you can expand on which other high rent markets might be weighing on the outlook.

Blaine, it's Chris Caton. Thanks for the question. So Southern California is a market that continues to soften, vacancy rates are continuing to rise, yes, after different submarkets. The softest area of Southern California is midsized and smaller units in the Inland Empire. The strongest area is probably Orange County. And Los Angeles, while subdued, has a 4% market vacancy rate, so as demand comes into that marketplace, bear in mind, demand has been negative over the last year, a very rare occurrence, as demand comes back in that marketplace, you're likely to see the vacancy rate make a difference in Los Angeles as well. In terms of other markets where we're watchful, the soft markets in the U.S. include New Jersey, Seattle and Savannah.

Yes. The other thing I would say about Southern California is that don't discount the effect of the port labor issue that was resolved. That took longer, a lot longer than most people thought. And that affects a lot of the people -- a lot of the users in the South Bay immediately adjacent to the ports and the like. So that market can get tight real quick if that port volume comes back.

I think that the small to medium spaces in the Inland Empire are kind of a mismatch. They're, by and large, the older buildings that were built there when the market was not really designed for the big 500,000 million square foot buildings. And those are -- somebody who wants a lot of space has to go to the Inland Empire. Somebody who wants 100,000 to 200,000 feet has more choices. So that's where the softness is in the Inland Empire.

And the next question comes from the line of Vince Tibone with Green Street.

Could you discuss the markets of relative strength in your portfolio in terms of demand and market rents? And also, are you seeing any different levels of demand by building size, more broadly? We noticed that occupancy fell the most on a sequential basis, for buildings less than 100,000 square feet, but actually grew for buildings 250,000 to 500,000. So just curious if those trends on occupancy are kind of a fair representation of the demand profile today.

Vince, Chris Caton here. So first, in terms of strength, there is a wide range. And speaking of the benefits of diversity, the strongest markets in the world include Mexico, Texas, parts of the Southeast U.S., Pennsylvania, but also looking out to the Netherlands, Germany and Brazil, Toronto as well, as a strong market. You also have stable markets, Chicago, Southern Florida, Baltimore, D.C.

And then really at Southern California alone is really the main weak market. So that would be the range. In terms of size categories, what you see -- what you hear in the marketplace in terms of tours and, in fact, some leases that are getting made, is there's a bit more activity, particularly among self-performing e-com and retailers at the larger end of the spectrum. That would be the main, I'd say, new news in the last 90 days.

And the next question comes from the line of Ki Bin Kim with Truist Securities.

So going back to your comments about a softer environment. I'm curious if you've seen any changes in CapEx or concessions that might be -- that might not be so apparent in the headline phase rents.

And second question, going back to your comments on strategic capital. Where do you think cap rates are selling out at for good assets in good markets? And does that change your view on the level of contributions that you might make going forward?

Ki Bin, it's Tim. I'll take the front half of your question just on free rent. We have seen an increase in free rent. I think what's important to remember there is we've had exceedingly low amounts of free rent granted in the last few years. And I would say the current rates that we've seen in this last quarter, and what we're bracing for this year, would still not really be on par with long-term averages. I would say that concession is not fully back to normal. But it is turning up logically in this environment.

Yes. In terms of where deals are being priced out, I would say 9 months ago, a year ago, there was very little activity, and we were pricing deals in good markets in the U.S. in the low 9 IRRs, albeit not much was happening at those kinds of return expectations. Today, I would say those are 100 basis points lower and there's a lot more volume in that a lot of transactions happening in the marketplace in the low 8s.

Europe, that number -- those numbers would be in the mid-7 IRRs. The reason I'm answering in IRR and not cap rate is that the mark-to-market in different locations is -- significantly vary. For example, for the same IRR, you would be a lot lower cap rate in Southern California than you would be in a market that is leased at market rents.

And the next question comes from the line of Tom Catherwood with BTIG.

Hamid, I appreciate your comments on rates and the Fed's actions or inaction serving as the key governor of customer activity and leasing right now. But how are you seeing supply chain disruption, like in Baltimore, and geopolitical risks impacting customer behavior, if at all?

I don't think Baltimore has been a big deal in terms of its impact on our business. It's obviously been a big deal to the people who died in the accident and the like, but -- and to traffic patterns. But not to the customer. The customers have enough optionality that they can deal with those kinds of disruptions.

I do think the geopolitical stuff has people a little wigged out, more -- definitely more than last quarter. And look at the interest rates, I mean, we're up at good 70, 80 basis points since the last time we all met. And I think that didn't happen evenly throughout the quarter. I think in the last month that sentiment has changed pretty dramatically.

So I think both of those things are weighing on decisions, particularly if the decisions are discretionary. And people, when there are no choices like they were no choices in Southern California, they always lease more space than they need because they don't want to be held short. And when the opposite is and they have some choices, they take their time because they expect better deals if they wait.

And that difference, even if it's minor, even if it's 5% to the upside and 5% to the downside can be a 10% swing, which are sort of the kind of numbers we're talking about here. So that's very much what happens in the short term. In the long term, demand has to match supply and they can't keep doing that forever. So now if you're going to ask me exactly what that point is, I can't really tell you. But we think it's a matter of quarters, not years.

And the next question comes from the line of Jon Petersen with Jefferies.

Maybe one more question on the port of Baltimore. I know it's not a big container traffic port, but have you seen any knock-on demand show up in other East Coast markets given the dislocation that's created?

And then also, maybe a part two, but I know SoCal has been weak over the past year, you've talked about that a lot, and the resets already happened. I guess I'm curious if you could help us contextualize, from where we stand today, if you compare the strength of like SoCal versus the East Coast markets like New Jersey and Pennsylvania, like from where we stand today, which one looks the best over the next year?

Jon, it's Chris Caton. First on Baltimore, you're right. The container traffic there is typically 50,000 TEUs a month. The time horizon of necessary diversions is not thought to be more than a couple of months. By comparison, New York, New Jersey is a 300,000, 350,000 TEU port. And a lot of these diversions have gone to Norfolk. So you've seen some leasing in Norfolk. It's not a market where we operate. So no, there are not knock-on effects.

As it relates to Southern California versus the East Coast, the SoCal market remains fluid, and I believe -- we believe it will underperform. This is a 6-month, 12-month view. Naturally, New Jersey has a completely different set of factors as it relates to rent growth that it's experienced over the last several years in terms of the level of demand that we see in that marketplace, as well as sublease trends. Now it's not the moment to get bullish on New Jersey. Let's see the port agreement, the IOI port agreement get made. But over time, both will be very strong performers after this period of fluidity and uncertainty.

Yes. The way I would answer that question is that if you limit it to the next 12 months, I would build PA, New Jersey, SoCal. And if you ask me for the longer term, I would go SoCal, New Jersey, PA. And I would put all 3 of them in the upper 1/3 of markets across cycles. Maybe the upper 20% of markets across cycles.

And the next question comes from the line of Ronald Kamdem with Morgan Stanley.

Just hoping we could put some numbers on the soft demand that you seem to be messaging. So previously, you were forecasting 1.5% of stock of net absorption this year. I'm just wondering what that number has shifted to given what's happened over the past 30 to 45 days. And if you can tie in where you see sort of availability rates and next 12-month market rent growth.

Yes. Let me take -- we have taken demand down for this year internally from 250 million feet in the U.S. to 175 million, and fundamentally have kept demand at the same level going forward. What we debated that we were going to do is whether we add the 75 million that we missed this year into the subsequent 2 years, and that's where the bid and ask is in our shop. And we're not clairvoyant, so that's -- I'm just giving you the range of how we think about it.

Now you answer the second part of your question, Chris.

Yes. As it relates to market vacancies, we look at vacancies, not availabilities. Availability is a range between 150 and 250 basis points above these figures, depending on the cycle. We have vacancies peaking in the mid-6s later this year. So that's up about 20, 30 basis points versus what we discussed last year.

I think what's important to understand in the cycle is the recovery potential in 2025 related to each of the constituent pieces. Hamid walked you through the demand picture. But what's important to recognize is the supply picture. That was a big factor over the last year, 18 months. And the meaningful falloff in supply is marked. It's off 80% from peak. It's off about 1/3 from pre-COVID levels. So we're talking about 35 million square feet of starts in the first quarter.

That annualizes to about 160 million, 170 million square feet. So you're going to actually see this snap later this year and into next year, and those vacancy rates moving noticeably down, likely to move noticeably down from mid-6s towards 5% over the course of next year.

One other thing I would -- your response has triggered this. Vacancy rates do not literally affect pricing power. I think when you're operating under 5%, you've got a lot of pricing power. Now whether that's 2% or 3%, doesn't matter. You have a lot of pricing power. And even though you might have 2 customers that really need the space, 4 are looking for the space because they just don't want to be caught short down the road. So it just sort of feeds on itself.

When the market gets to sort of around 6%, you're at equilibrium. When it gets too much above that, you get into a soft market. And that's a macro analysis, obviously, you've got to apply that market to market in each situation. But that's the way we look at it.

We don't think we're getting into those levels of vacancy that we've seen in other cycles, even during the good times. The worst that we're projecting in this period is almost as good as the best we've seen in other cycles. So that's a key distinction. And we've just been spoiled by market in 3 years where vacancies have been lower than they've ever been. And I think you've heard me say at times that, if the normal range of a market is 1% to 10%, we've been operating in a 12%, 13%, and more recently, I've said we're in an 8% or 9%. And today, I would say we're in probably 6.5%, 7%.

And the next question comes from the line of John Kim with BMO Capital Markets.

I just wanted to get some additional color on the weaker net absorption due to tenants becoming more cost conscious. I'm wondering if this test-the-thesis that industrial rent is somewhat inelastic given it's a small portion of the overall transport and logistic costs? And also, where are tenants going in your view? Are they simply not expanding, or are they downsizing or going to less expensive markets or submarkets?

So we've actually tried to test that theory by looking at whether Southern California's loss has translated into an equal gain in adjacent markets like Vegas and Phoenix. And the answer is, while absorption has increased in those markets, it doesn't fully account for the drop-off in Southern California. So some of that demand has just been deferred. And the question is when will deferred demand convert to real demand. And that's the $64 million question. Is it 1 quarter? Is it 2 quarters? Is it 3 quarters? Don't know. We think it's a couple of quarters.

But it will happen. And particularly the port coming back, that part accounts for over 30% of imports in the U.S., and it's been basically down. So we think it's going to -- that's going to have a dramatic effect. Now we may have missed it already for this Christmas season, I don't know. But certainly, next year, that market is going to come back absent a recession or some kind of geopolitical blow-up.

And John, I might just add, I guess, the way you're putting the equation together, it is what we see that, yes, the rate environment causes this consternation. But as Chris has been highlighting in a number of his answers, as we look at where utilization sits and some of the capacity that's available, it's just the first place that customers can look in terms of finding a way to continue to operate in the short term. That would ostensibly end, and we'll watch for that as utilization rises, and that's what would add to new demand.

And the next question comes from the line of Vikram Malhotra with Mizuho.

Just 2 quick ones. First of all, just on the 3-year outlook. So it sounds like you're saying '24 is a bit lower than you predicted, '25 and '26 is similar. Does that essentially mean the 3-year outlook is kind of adjusted down somewhat?

And then secondly, just to be -- just to give us some numbers. I think what you were saying is the rest of the market rent growth is now, I guess, flattish, but SoCal is down. Do you mind just putting some more numbers on that? Like just how much is SoCal down Q-over-Q or year-over-year versus what other markets in the U.S. are doing?

Vikram, it's Tim. We're not calling anything on '25 and '26. In my prepared remarks -- or maybe I should say, I think our view would be that our views are upheld. And what I tried to highlight in the opening remarks is that if we get to a little bit lower average occupancy this year, recognizing that our 3-year forecast called for a more normalized level of occupancy in the end anyway, that's where this concept of, well, maybe the adjustment to same-store from an occupancy change is coming a bit more this year than it would otherwise next year. But right now, we would hold out our view for '25 and '26 in terms of aggregate NOI and same store.

Now rent change in this very immediate term -- I'm sorry, market rent growth is a little bit below expectations. That will have some effect, but that will be relatively muted through same-store over the period.

Yes. We -- let's just put some numbers since you asked on it. I think in the Analyst Day, we talked about a 3-year forecast for '24, '25 and '26 rental growth of 3% to -- sorry, 4% to 6%. I would say we're at the lower end of that range and maybe a little bit lower than that when you look at it over a 3-year period. My number, and this is not the official number, my number would be north of 3% and around 4% probably, just shy of 4%.

And then just on the detailed question on what's happening in market rent growth in the first quarter. Southern California, down 6%, U.S. down about 1%, 1.2%. So when you multiply it through, you can see all other markets are flat.

And the next question comes from the line of Nicholas Yulico with Scotiabank.

I was just hoping to get a feel for, again, going back to the occupancy guidance, if there's a way that you can give us a feel for how much decline in new leasing commencements you have been embedded in the number this year. Because it sounds like the retention ratios have been better, so leasing velocity on the new side seems subdued. You talked about that leasing demand forecast being down, I think it was 30% on the numbers you gave, the 250 million to 175 million in the U.S. How much is like new leasing in the portfolio going to be down this year for the guidance?

Well, I will -- this is Tim. I'll give it to you in this way. And this might help some of the folks who have struggled looking at the supplemental and some of the stats there, and our messaging. Because what you don't see in the supplemental would be things like, well, how much lease signing occurred in the first quarter. And that was down. Even though you see strong occupancy, that's on commencements, signings were off about 12% in the first quarter. So that's down. You can see that when you look through our pages in our leasing versus occupied statistic where there's only about a 10 basis point difference in those versus a more historical norm of 40 to 50 basis points. So those are the pieces a little bit underneath the surface that are guiding our view that the pre-leasing that we're normally looking for at this point, which is ranging 4 to 6 months ahead of commencements, is shy and why we think the average occupancy is ultimately going to be lower.

And the next question comes from the line of Todd Thomas with KeyBanc Capital Markets.

Two questions. I guess, first, can you discuss your rent change expectations for the full year and whether anything has changed there as it pertains to the revisions to your outlook? And it looked like rent change on signings was trending in the low 70% range through February, which was higher than the rent change in the quarter. I guess, any thoughts about rent change -- trends relative to this quarter and for the year?

And then my second question, in terms of the occupancy breakout by unit size and your comments about larger and smaller spaces earlier in the call, do you expect a recovery later in the year to be broad-based from a space or unit size? Or do you expect to see more strength or maybe more persistent weakness in either the larger or smaller unit size as conditions tighten up in a few quarters?

Todd, it's Tim, yes. On rent change, so as mentioned, we had 67% start in the quarter. The signings were 70%. So you do get a sense that it can move up and down each quarter. You may also recall, we had very strong rent change on signings in Q4, which may leave you wondering why didn't that show up here in Q1 on the commencements. And that's speaking to just how long this pre-leasing period can be. It can be more than just 3 months. And for that reason, I expect we'll probably see rent change right now, my view would be it's going to be above Q1, in Q2, and then also higher on the full year, in the low to mid-70s, over 2024 is our current view.

As it relates to the contours, I think I'd first point you to the market color that was given earlier as illustrating the shape of the recovery going forward. As it pertains to different size categories, there is more vacancy and more availability in the over 500,000 category, but that's also where, in the last 90 days, we've seen a little bit of a pickup. So I think we'll see size categories advancing at a similar pace over the course of the year, and there'll be real differentiation across the different markets.

And our final question comes from the line of Vince Tibone with Green Street.

I was just curious, are you seeing any other landlords gain to offer more free rent or tenant allowances to try to attract to their vacancies?

A really interesting question. So this is what has really surprised me from this cycle. We are getting calls from merchant developers that have had financing, have completed projects and are getting panicked. And for us to look at those opportunities. Boy, we're looking at those opportunities. Because that's where a good balance sheet and that's where being on your front foot is all about.

I think there were a lot of people in this business that thought, we'll just get some financing at 0 cost and throw up some buildings and it will lease. And I think that's what accounted for some of that over-exuberance on the development side. And I think we're going to end up being beneficiaries of that, and I'm seeing that real time. So yes, I think people who are merchant developers and do not have the financial wherewithal are acting in a somewhat distressed way sooner than I would have guessed. And we're happy about that.

So that was the last question, Vince. So with that, I want to thank you for your interest. And this is part of a long story, and we'll be there next quarter to tell you about the following chapters of it. Take care. Bye-bye.

And ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.