The world’s leading logistics real estate developer is making a big bet that interest rates will decline next year faster than the consensus estimate, moves it said will unlock significant institutional capital that’s been waiting on the sidelines.
In its annual projection for the year ahead, Prologis Inc. (NYSE: PLD) said it expects inflation to slow more quickly than expected, giving the Federal Reserve more latitude to cut the federal funds rate — the rate banks charge each other for overnight loans — deeper than it or even the markets are anticipating.
The current federal funds rate sits at a range of 5.25% to 5.5%. The Fed’s projections made last week indicate a pivot to three to four rate cuts in 2024, bringing the rate down to the 4.5% to 4.62% range. Market participants believe there will be deeper cuts than that next year as inflation continues to slow appreciably. Prologis’ forecast tends to lean toward the market view.
In its forecast, Prologis said that the 10-year Treasury yield, the mechanism often used to benchmark the cost of real estate loans, will fall below 4% in 2024. As of Monday morning, the yield on the 10-year note stood at 3.91%.
Prologis predicted that the rate cuts will be back-loaded into the second half of the year. This in turn will encourage “institutional dry powder” to reenter the market as the capital markets cycle begins to turn. Institutional funds, which generally drive logistics real estate development, have mostly been parked on the sidelines amid what had been an 18-month spike in borrowing costs.
The rapid rise in interest rates, which Prologis Chairman and CEO Hamid R. Moghadam has criticized on several occasions as being overdone, has led to a dramatic decline in construction project starts. Prologis expects that the decline in global construction starts to intensify in 2024 to hit the lowest level since the 2008 financial crisis.
The U.S. vacancy rate could climb to the high 5% range as projects currently under development are delivered, according to Prologis, which said vacancy rates will eventually drop into the 4% range as additional capacity is absorbed.
In an email to FreightWaves, Prologis said it arrived at its interest rate forecast after analyzing cost and pricing trends throughout the supply chain, as well as supply and demand factors. The company said discretionary spending on travel, entertainment and housing could slow appreciably in 2024, if not enter into deflationary cycles.
Among Prologis’ 2024 projections is a reversal in the global freight recession, paced by double-digit growth in port and truck traffic. Latin American rents will grow at more than double the global average, led in part by an increase in production nearshoring. Vacancy rates in Mexico, currently under 2%, will remain tight in 2024. Supply will be capped by limited access to sufficient power sources, especially for new manufacturing-related requirements.
Technology advancements will drive up energy requirements in logistics facilities, incentivizing owners to double solar capacity, Prologis predicted. Logistics warehousing demand in China will rise to its second-highest level on record, the company forecast.
Cap rate compression will occur in U.S. and European markets but go the other way in Asia, Prologis said. Cap rates are inversely related to market pricing; thus when cap rate compression occurs, prices increase without a relative increase in rental income.
Like every broad-based forecast, not all of Prologis’ 2023 projections panned out. U.S. rent growth rose 7% during the year, not the 10% that Prologis had forecast. E-commerce leasing this year proceeded at a moderate pace and was not the second-most active year on record (after 2021) that the company had predicted. Demand for solar warehouse capacity was held back by supply chain issues and did not grow as rapidly as Prologis had forecast.