Hamid R. Moghadam
Dear Fellow Shareholders,
In 2014, our financial results reflected strong performance across our three business lines. Earnings surpassed the top end of our guidance range, with core funds from operations growing from $1.65 per diluted share to $1.88 per diluted share, a 14% increase. This performance reflects the strength of our repositioned portfolio, which is focused on the highest-quality assets in the best markets around the world.
ROADMAP FOR SUCCESS
Capitalizing on the Rental Recovery
We identified and captured opportunities for increases in rents and took advantage of a strong, though somewhat uneven, improvement in market fundamentals. The Americas, Asia and certain parts of Europe exceeded our expectations while Southern, Central and Eastern Europe lagged. Overall, our global occupancy increased to 96.1% at year-end. For the year, rent change on rollover was 7.4%, which translated to our share of GAAP same store NOI growth of 3.7%.
Our results in the U.S. underscore the quality of our assets and reflect the outstanding work of our operations team. Our U.S. portfolio ended the year at 96.7% occupancy, outperforming the market by 320 basis points. Demand was broad-based; at year-end occupancy in our Americas portfolio exceeded 98% in roughly half of our markets. This occupancy, combined with double-digit rent increases on rollovers, drove our share of GAAP same store NOI growth of approximately 5.3% in the U.S., a level not seen since before the downturn. Although the rate of new building deliveries is increasing, it continues to lag absorption. Net absorption in 2014 was right on forecast at double the rate of deliveries. For 2015, we expect completions of 170 million square feet against absorption of 225 million square feet.
In Europe, our 95% occupancy outperformed the market by 210 basis points—a testament to the skills of our people and the quality of our locations and facilities. As we forecasted last year, cap rate compression was a mixed blessing as it drove strong appreciation for our assets while continuing to be a headwind to rent growth. Looking forward, we expect market occupancies in Europe to rise as supply remains constrained. Space utilization will continue to run at a high level and customers will need more space to support these incremental growth needs, just as they did in the U.S. two years ago. As a result, we expect to see an extended recovery and several years of favorable market conditions in this region.
In Asia, market conditions remained strong and operating results were on plan. We continue to see new space requirements from domestic retailers and e-commerce customers.
Realizing Value from our Land Bank
Last year, we put our land to work in speculative and build-to-suit projects and monetized $430 million of land in development starts with an estimated overall profit margin of 20%. Demand for our facilities is driven by population growth, urbanization, macroeconomic changes and reconfiguration of the supply chain. Our approach was two-fold: meet the needs of our biggest global customers in our developed markets and serve customers in emerging markets that lack Class-A facilities.
Development stabilizations totaled more than $1.1 billion; our share of value creation was $236 million, or $0.47 per share. Though we are still early in a cycle of above-average development profits, our well-located land bank has an estimated build-out potential of approximately 180 million square feet or $10.7 billion at high returns on invested capital.
Using Our Scale to Grow Earnings
Our global reach makes it possible for us to deploy capital where we see the highest risk-adjusted returns. In the U.S., where market conditions were strong and values were high, we were a seller of non-strategic holdings. Conversely, in Europe our focus has been on third-party acquisitions—to illustrate, we deployed $1.2 billion to acquire quality assets in target markets at significant discounts to replacement cost. Timing here was critical as cap rates compressed throughout the year.
We deployed $3.1 billion of capital at cap rates that were 60 basis points higher than what we achieved on dispositions and contributions. This shift into higher-quality and higher-yielding assets improved earnings and upgraded our portfolio.
Our scale in existing markets allows us to grow with minimal incremental overhead. We have the capacity to take on $10 billion in overall assets in our existing markets with very small additions to G&A. Our global reach benefits our customers, who appreciate the streamlined approach of working with a single provider. We give our customers the flexibility to reconfigure their supply chains across diverse geographies, regardless of local market conditions.
EXPANDING STRATEGIC CAPITAL
Two landmark ventures in 2014 advanced our strategic capital franchise. First, we formed the Prologis U.S. Logistics Venture with Norway’s sovereign wealth fund, Norges Bank Investment Management (NBIM). This is our second venture with NBIM following the formation in 2013 of Prologis European Logistics Partners. Second, we completed a successful Initial Public Offering in Mexico. The FIBRA simplifies our structure and positions us for long-term growth in this important region. Perpetual-life vehicles now account for more than 90% of our strategic capital revenue.
The significance of strategic capital goes well beyond financing our global expansion. Our co-investment ventures are a source of capital for investments and they provide incremental revenues through asset management and incentive fees. This in turn improves our shareholders’ return on invested capital and protects our earnings against fluctuations in foreign currency.
SOLIDIFYING OUR FINANCIAL POSITION
We’ve worked to further fortify our balance sheet by enhancing liquidity and reducing currency exposure. Capping this significant effort, we completed more than $7 billion of capital markets activity in 2014. As a result, leverage declined to 36.5%, debt to adjusted EBITDA fell to 6.8 times and liquidity increased to $3.4 billion.
Thanks to our improved operational metrics, including same store NOI and occupancy, as well as significant liquidity, we received two credit rating upgrades in 2014. Moody’s upgraded Prologis to Baa1 from Baa2 and Standard & Poor’s raised our corporate credit rating to BBB+ from BBB, both with a stable outlook. We’re proud of this achievement. We’re well on our way to building one of the best balance sheets in the real estate industry.
We entered 2015 with a platform primed for growth. Our plan is straightforward and focuses on capitalizing on the rental recovery, putting our land bank, talent and capital to work to serve the needs of our customers, and leveraging our scale to drive growth and create value.
With this approach, we can take full advantage of opportunities across the globe. We own the right properties in the right markets and our portfolio has never been better aligned to support our strategy. We have market-leading presence in key cities across four continents; this reach allows us to deploy capital profitably on multiple fronts. We have the financial capacity to carry out our plan, and we have protected our downside with a prudent capital structure and significant liquidity. We remain patient and disciplined.
Our long-range plan is supported by the insights and counsel of our board of directors. At Prologis’ 2015 annual meeting of shareholders, D. Michael Steuert will retire from our board after 12 years of dedicated service. He has been a constant resource on our audit committee and we are grateful for his many contributions. In January, we welcomed David P. O’Connor as a new independent board member. David brings 25 years of expertise in real estate investments and capital markets to Prologis and we are pleased to have someone of his exceptional talent join our board.
I would like to recognize the incredible dedication of the talented people throughout our organization. Their passion, professionalism and commitment are a source of great pride, and they are the foundation of our success. I am honored also by the confidence and trust of our customers, investors and partners. We strive constantly to be worthy of that trust as we pursue our goals to deliver growth, performance and value.
Hamid R. Moghadam
Chairman and Chief Executive Officer