To Our Shareholders

It is widely recognized that 2009 was one of the most difficult years in the history of commercial real estate. The slowdown in global economies pushed occupancies down and pressured rents. Values fell 30 to 40 percent, depending upon the quality and location of assets, as a result of a lack of financing and softening demand. As values fell, leverage rose and companies that had once been viewed as stable were no longer considered so.

These dramatic changes were unprecedented and required immediate action. Our associates around the globe mobilized quickly and, through an incredible effort, kept our non-development industrial portfolio over 92 percent leased. They also significantly increased leasing in our development portfolio. We successfully issued or extended a total of $3.7 billion of debt, direct or within our funds, and extended our global line of credit. And, everyone in ProLogis learned how to do more with less while controlling costs. It was a challenging year — one that proved the character of our people and their commitment to our success. We weathered the storm and are now a stronger company for it.

Looking to 2010, we believe market conditions will improve, but it will be a transitional year. We expect there will be more distress in commercial real estate but believe high-quality industrial will be impacted less than other sectors in the industry. The signs of stabilization that began in the third quarter of 2009 have continued; occupancies seem to have bottomed out in most markets, while rental rate declines have slowed. We are feeling more optimistic; however, our outlook is moderated by a healthy dose of caution.

In real estate, there are two key factors that affect market conditions — supply and demand. When supply significantly outweighs demand, it typically results in value declines. Currently, we think both of these factors are coming back into balance. Let me explain further.

Expected yields have risen by about 30 percent in the last year, while industrial rental rates are down 20 percent on average since peaking in 2007. Given this, new development would have to cost 50 percent less than in the past in order to be economically feasible. This disconnect in pricing has driven a dramatic decline in new development around the world. For example, in the United States, new starts were only 12 million square feet in 2009, considerably below the previous 25-year low of approximately 50 million square feet, and are not expected to rise materially in 2010.

Construction costs are down somewhat but are expected to rise. Last year, we could develop a building in most areas of the world for approximately 20 percent below 2006/2007 levels because material and labor costs were down. However, this drop does not appear to be sustainable, as emerging markets have resumed infrastructure development causing increases in certain commodity prices. Given that activity, we expect a five percent or more increase in costs in 2010. With expected yields up and market rents down, we do not expect to see new speculative supply anytime soon, especially if construction costs rise. In the interim, our development will consist primarily of build-to-suits for customers whose needs cannot be met with existing space.

As for new demand, we are becoming more optimistic. Growth in U.S. industrial demand has long been closely correlated with growth in real GDP. For every 1 percent increase in real GDP, we see an additional 50 million square feet of demand. Estimates for 2010 real GDP growth range from 2 to 3 percent; if this correlation holds, it will go a long way toward bringing occupancies in line with historical averages. In addition, the obsolescence of older facilities and ongoing supply chain reconfiguration activity throughout our global markets could lead to dramatically improved occupancies in 12 to 18 months, aided significantly by a complete lack of new supply. A scenario with virtually no supply but with some demand growth sets the stage for rents to rise potentially faster than anticipated as occupancies increase.

Investors are becoming more bullish. With worldwide spending deficits, they are once again looking at real estate as an inflation hedge. There are now multiple bids for industrial portfolio sales, and prices have risen by about 10 percent since last summer.

Charles Darwin’s concept of “survival of the fittest” is not lost on us. Over the last 15 months, we have invested considerable energy in assessing risk and evaluating opportunities. We believe we have learned important lessons from the market disruption of the last year. We have revisited our approach to development and positioned the company to capitalize on the opportunities that we believe await us down the road. But, what Darwin actually said was, “It is not the strongest of the species that survives, nor the most intelligent, but the one that is the most adaptable to change.” This year has provided us the opportunity to change in ways we never thought of before, and those changes will help us to thrive in the years ahead.

We thank you for your continued support.

Walter C. Rakowich
Chief Executive Officer